I spent part of the morning reading through the S-1 registration statement for the upcoming IPO of McDonald’s spin-off Chipotle Mexican Grill, which is going to trade under the symbol CMG. It’s an old habit – my first job in journalism was as the writer of a newsletter called The IPO Reporter. The big debate back then was whether Cisco Systems had much of a future (short answer – YES).
Even before I picked up Chipotle’s S-1, I was favorably inclined towards the Mexican chain for two reasons. First, I like IPOs of basic businesses that are relatively straightforward to analyze. No need to guess about whether the new combination heart valve stent/cure for erectile dysfunction will be approved by the FDA. Restaurant stocks are up a healthy 14% over the past year but that’s just the middle of the pack of the 120 or so industries tracked by Morningstar. And second, when I lived in Washington, D.C., I absolutely loved the burritos at the Tenleytown Chipotle. Chipotle's emphasis on fresh ingredients and “food with integrity” brings to mind Whole Foods, a company (and stock) that’s been a big winner playing the same trend.
So I was pretty interested to read that the company has been doing well, opening 104 new stores in 2004 and 80 in 2005 to end the year with 489. Overall sales were up 32% in the first nine months of 2005 from the year earlier. Typical only of very fast growing companies, revenue has been up consecutively every quarter going back to the beginning of 2003. Revenue has grown faster than expenses in every year going back to 2000. And cash flow has also been rising at rapid rates. Expansion has been fed not just by new stores but by smart strategies. Comparable store sales rose 10.2% in 2005 after the company added a salad to its menus that was basically made of the same ingredients already on hand for burritos.
So how does the company measure up relative to its peers? Assume Chipotle sells for $20 a share, the high end of its range, and net income for 2005 was $30 million, or the $33 million earned in the first nine months minus the typical $3 million fourth quarter loss. With some 32.5 million shares outstanding after the deal, that’s 92 cents a share or a P/E ratio of 22. I looked at four similar medium-cap, fast growing chains (Panera Bread, Cheesecake Factory, PF Chang’s and California Pizza Kitchen) and found they had an average P/E ratio of 34.
One thing you don’t like to see in an IPO is a large amount of shares being sold by an existing shareholder that wants to cash out. That’s because the company doesn’t gain those proceeds to invest in the business. In the Chipotle deal, McDonalds is selling about 1.8 million of the 7.9 million shares being offered. That sounds fine, since Chipotle still raises over $100 million and given that McDonalds will still own 69% of the company (and 88% of the voting rights). Finally, unlike some of the more egregious private equity IPOs, new shareholders would be paying only a bit more than the average price of $11.59 a share that early investors paid.
There are certainly some risks worth noting, including benefits Chipotle gains from its close ties to McDonalds. If the Golden Arches cut their voting stake below 80%, Chipotle’s would lose the benefit of being part of its parent's much larger health and 401(k) plans. If McDonalds trims below 50%, a host of other jointly-run services like credit card processing would also be dropped.
Morgan Stanley, manager of the IPO, just raised the projected share price range to $18 to $20 from $15.50 to $17.50 in a filing yesterday. That's a sign of strong demand and an indication the deal could price soon. Not to abuse the food metaphor too much, but smells like a tasty one to me.