Good Food, Poor Judgment

Chart House looked tasty to me, but I misread the restaurant chain's ability to expand profitably--and missed a clear financial warning

"Irresistible." That was the unfortunate word I chose to explain to friends why I featured Chart House Enterprises (CHT ) in this column a year ago. The little restaurant company had all the right ingredients: Fine food. Good service. Shares below book value. A smart, motivated insider in Chicago real estate mogul Sam Zell, whose own stake was under water. Profits, impressive growth plans, and, best of all to me, no one on Wall Street paying attention. Chart House, I wrote, was "a stock on the ground floor, ready to rise."

Except, that is, for a stop first in the basement. The stock, at $5 a year ago, now trades near $2.75 (chart). If I want to humor myself, I can recall its high ($6.38) or focus on how it has outperformed the Nasdaq. But that's just foolery. Truth is, I misjudged its ability to expand profitably, and I missed a clear financial warning sign.

From its depths, you might not believe that Chart House is turning 40 this year and trades on the New York Stock Exchange. Known for serving beef and fish at choice spots near marinas and ski slopes, the chain fell into Zell's fold in 1996. As chairman, he recapitalized and hired new managers. By last year, Zell said Chart House was "firmly in the black."

Wrong. It recently reported a $10.4 million loss for 2000, on revenue of nearly $142 million. Even before asset writedowns and restructuring charges, the bottom line for last year shows $6.6 million in red ink, vs. a $1.4 million profit in 1999. Cash flow dwindled to $552,000, from $3.2 million, as the operating margin shrank to 6.3%, from 7.4%.

What happened? Thomas Walters, the CEO who joined in 1998 from Morton's Restaurant Group (MRG ), blames cost overruns and construction delays. Even as he was remodeling some older locations, Walters was opening several new ones in Atlanta, Phoenix, and elsewhere for a second chain he has set out to develop, Angelo and Maxie's Steakhouse. It all proved too much, too fast. "Where we didn't do a good job," Walters told me, "was in financial controls."

By fall, Chart House was paying the price. Lenders clamped down on credit, and Walters soon was scouting for cash to finish half-built restaurants. Here's where I got X-ray hindsight, recalling in vain this warning from company financials: "The Company may require alternative sources of long-term financing. However, no assurance can be given that such financing will be available or available on terms satisfactory to the Company."

FINE PRINT. Such boilerplate weighs down every financial statement. It's easily ignored. Yet sometimes it's prophetic, and--given Chart House's heavy capital-spending plan--I should have zeroed in. It now has had to tap Zell for $13 million in credit on the sort of terms you see in tiny print on the back of your Visa statement: 21.6% in current interest on borrowings, plus a 12% fee on unused credit. Zell isn't talking, but William Diefenderfer, a Washington attorney who chaired the panel of outside directors that approved the deal, told me those were the best possible terms. He also said the board is fully behind Walters: "The guy is aces."

I wonder. As for Zell, who holds 35% of the company, he's now set to act as buyer of last resort in a new deal. Chart House is offering shareholders the right to buy up to an estimated $9 million in new convertible preferred stock. However many of the shares others don't buy, Zell will. Chart House aims to use the cash to limit the level of higher-cost credit it draws from Zell. Yet the likely result for most investors is heavy dilution, while Zell is guaranteed a $400,000 fee.

With lots of capital improvements behind it, strong sales growth, and the stock still idling near book value, Chart House looks tempting again. Yet as I sit here in my dunce's cap, please excuse me if this time I resist.

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By Robert Barker

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