Vintage Capital’s Brian Kahn just put his money where his mouth is – 1980s style.
The activist investor, which built an 11.6% stake in Red Robin Gourmet Burgers (ticker: RRGB) and had previously said it was willing to make a $40 a share offer, has made a “non-binding proposal” to acquire the struggling burger chain. Until now, there had been some doubt about whether Mr. Kahn would actually make a bid or if he was simply trying to attract another buyer.
Now, the only real hitch is that rather than put financing in place, Mr. Kahn secured a “highly confident” letter similar to those used by Michael Milken’s Drexel Burnham Lambert in the heyday of junk bonds. Back then, the market was so confident in Mr. Milken’s ability to secure financing his clients could actually bid for companies based on Drexel Burnham’s good word.
“Highly confident” letters eventually fell out of favor when competing investment bankers began to say “we don’t write letters — we write checks” and a boom began in bridge loans. Those costly finance packages are a placeholder for bonds or debt that later replaces them and generate another layer of fees for banks – something Mr. Kahn presumably wants to avoid.
While the “highly confident” letter is unusual, it would probably be a mistake for Red Robin to dismiss Mr. Kahn’s proposal. After all, the bid requires only $450 million in debt. That appears less than Mr. Kahn needed to pull together for a $2.3 billion bid for lease-to-own retailer Aarons in 2014 and a $1.4 billion bid for Rent-A-Center last year.
Indeed, the more pressing issue is that Red Robin investors are simply out of patience. Shareholders interviewed by CorpGov Thursday said that while they believe the company could eventually be worth far more than $40 a share, the company has shown minimal progress toward turning around the business. One investor said the company’s only focus has been to find a new CEO – a process that looks difficult to complete with Mr. Kahn in the picture. And the company’s decision to hire an aggressive activism defense team hasn’t inspired much confidence, the shareholders said.
In a statement, Red Robin said its Board “will carefully review and consider the proposal to determine the course of action it believes is in the best interests of the Company’s shareholders.” Mr. Kahn and his legal counsel, Willkie Farr & Gallagher LLP, didn’t respond to requests for comment.
What can the board do now? If it tries to ignore the bid, it is very likely to anger investors even more. The entire board would likely be kicked out next year – or sooner if Mr. Kahn calls a special meeting – and their reputations would suffer greatly.
The other choice, which one shareholder interviewed by CorpGov suggested was best (and Mr. Kahn probably wouldn’t mind), is to hire an investment bank to commence a sale process rather than run a defense campaign. There’s reason to believe that someone could value the business at a higher price than $40 and the directors would enjoy a somewhat graceful exit.
Indeed, while the company’s same-store sales have generally been negative for the last few years, the brand itself appears very much intact. That could make the company attractive to a private-equity firm that wanted to turn Red Robin around without public scrutiny. Just look at Red Lobster, which Golden Gate Capital bought for a depressed price and restored sales growth in just a few years.
Another restaurant company could also find cost savings and synergies in marketing, purchase orders, rent, and at the corporate level. Those benefits could probably justify an even higher price than Mr. Kahn or another financial investor would be willing to pay.
Another big source of value that any buyer could unlock is in its owned stores. Roughly 85% of Red Robin’s stores are owned and efforts to refranchise them to generate cash have been slow. Red Robin trades at a free cash flow yield of 22%, according to Sentieo. Restaurant companies that franchise most of their stores easily trade at twice that valuation.
All this leaves perhaps only one way for any of the board directors to keep their jobs: Finding a sympathetic investor to take their side. Earlier this year, Papa John’s found a friend in Starboard Value, which made an investment in the pizza chain and stuck a deal to add three board directors. If Red Robin’s board doesn’t find a friend of its own soon, its days are likely numbered.
John Jannarone, Editor-in-Chief