Chipotle's Jalapeño Of An IPO

Tonaysha Askew and Summer Trazzera were torn: Wait, or go elsewhere? At 11:48 a.m. the other day, they stood in a line that already had extended 10-deep outside a Chipotle Mexican Grill in Orlando. "She's obsessed with this place," Trazzera told me. "Yeah, I'm obsessed," Askew said. So they waited, 18 precious lunch-hour minutes, to get takeout. What makes Chipotle worth a wait? "It's fresh. It's filling," Askew said. "And," Trazzera put in, "they don't sacrifice the quality."

Choosing Chipotle, the young women passed over such former haunts as Taco Bell (YUM ) and Subway, never mind a nearby McDonald's (MCD ). This is no cause for alarm at Mickey D's, however, since it owns 92% of Chipotle and aims soon to sell stock in an initial public offering. The deal's key terms -- number of shares, price -- have yet to be set by Chipotle and its lead underwriters, Morgan Stanley (MWD ) and SG Cowen. Yet when they do fix a price, don't look for a bargain. This IPO figures to be hotter than a jalapeño.

BASED IN DENVER, CHIPOTLE opened its first restaurant there in 1993. Founder and Chief Executive Steve Ells, who now is 40, got his degree in art history at the University of Colorado and then went on to the Culinary Institute of America before apprenticing at a fancy San Francisco restaurant. Two years later, he set out to bring what he knew about fine food to a mass market. Chipotle makes to order a small variety of Mexican dishes -- tacos, salads, and its signature burrito, served with or without the tortilla wrapping. It's tasty: I had a burrito plus an especially delicious side order of guacamole and fresh tortilla chips. With an iced tea, the tab came to $9.96. McDonald's was sold on the idea and in 1998 bought control.

To investors, Chipotle's record of growth has to look mouth-watering. The chain expects by yearend to have more than 480 stores, 312 of them added since 2002. From revenues that year of $205 million and a pretax loss of $17 million, the past four quarters brought revenue of $542 million and a pretax profit of $14 million. The balance sheet is lean -- at June 30, net debt came only to $11 million, most of that on a line of credit from McDonald's -- and shareholders' equity stood at $292 million.

Risks? The biggest is the hunger for capital that Chipotle's growth strategy implies. In the past four quarters, the company ate the $56 million that operations generated plus $30 million more as it opened locations. Proceeds from the IPO will feed some growth, but investors have to wonder when Chipotle will need to raise fresh capital either by borrowing or selling more equity. Another worry is the shares that McDonald's figures to sell or hand out to its own stockholders in the future. Chipotle's registration statement notes that the company expects McDonald's ownership stake eventually will "decline significantly." Then, Chipotle may feel pressure on its margins. Via McDonald's, it pays less for everything from workers' compensation insurance to beverages from Coca-Cola (KO ) to credit-card processing. These costs and more are set to rise as McDonald's stake falls. Finally, there's the annoying fact that McDonald's is ensuring its hold on Chipotle via a class of supervoting stock.

Just the same, shares in Chipotle are a cinch to attract high interest. How might investors value them? One guidepost is the last hot stock in the "fast-casual" end of the restaurant biz, Panera Bread (PNRA ). At the height of investors' love affair with this bakery cafe, in the spring of 2002, the stock went for 4.6 times trailing revenues. At that, Chipotle would command a market value of nearly $2.5 billion, or 88 times earnings. Don't be surprised if investors wind up as obsessed with the stock as Tonaysha Askew is with the burritos.

By Robert Barker

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