This post is part of the On the Margin blog.
Restaurant investors in recent years have poured money into small concepts with the promise of getting big. Chains with annual cash flow of as little as $10 million have gone public and had successful debuts.
The latest to apparently consider this idea is Freshii, the Chicago-based, healthful, fast-casual concept.
Bloomberg reported yesterday that Freshii is interviewing bankers for an offering, confirming some apparent rumors. Yet the most notable aspect of that story is the valuation Freshii would apparently receive in an IPO: As much as $1 billion.
Even in this era of overinflated valuations for growth chains, that would take the cake. Based on conversations with some investment bankers and consultants, investors would not likely give Freshii a valuation anywhere near that figure. The company simply could not generate the cash flow. If it did get that valuation, the multiple would blow away any restaurant currently trading on the public markets.
Most, if not all, of Freshii’s locations, close to 200, according to Bloomberg, are franchisee owned. Investors love franchising because of its high profitability and because companies are shielded somewhat from food costs and recessionary swings. But they get their revenue from royalties paid by franchisees, and so a system needs to have a lot of units to generate the cash flow that could warrant a massive IPO pay day.
Neither Zoe’s Kitchen Inc., which operates most of its 157 locations, nor Wingstop Restaurants Inc., which has 800 mostly franchised units, has a market cap near $1 billion. Papa Murphy’s, which has 1,400 mostly franchised units, isn’t in the neighborhood, either.
The exception is Shake Shack, which has a market cap of $1.6 billion and is quite small, with 63 total locations, 31 of them domestic, company-operated locations. But those domestic locations have ridiculous average unit volumes of $5 million. The company’s enterprise value multiple is lower than both Zoe’s and Wingstop.
Nick Mazing, founder and portfolio manager with Ampera Capital, said that some investment banks put would together aggressive comparable valuations in an effort to win business. That might have led to the talk of a potentially $1 billion valuation.
There are other things that might keep Freshii from that valuation, including some growing skepticism among investors about small restaurant chains. Most of the concepts that have gone public over the past couple of years have come down following their post-IPO highs. And initial stock pops have eased since Habit Burger and Shake Shack both more than doubled during their wintertime IPOs.
We emailed Freshii about the Bloomberg report and did not get a response, and also emailed founder Matthew Corrin. We will update this if and when we hear back.
This is not any criticism of Freshii. Nor is this to say the chain would be unworthy of the public markets. While some investors decry the influx of small consumer companies on Wall Street, they do provide investors with the opportunity to invest in growth chains at an early stage in development.
Freshii has some advantages, including its franchise model and rapid growth, as well as deals with companies like Target to place units there. It also has a menu of healthful items in a fast-casual setting. Those concepts are hot right now. Some of them, like Sweetgreen and Cava Mezze Grill, are getting unheard-of valuations from private-equity investors and venture capitalists.
But $1 billion? We doubt it.