Buffalo Wild Wings (NASDAQ: BWLD) is in a battle with hedge fund and major shareholder Marcato Capital. The back-and-forth between the two parties has been going on since last summer, but Marcato recently escalated its dispute as it tries to effect change at the restaurant chain.
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In the red corner . . . Marcato Capital
One of Marcato's biggest points of contention is that the share price has underperformed over one, three, and five-year periods relative to U.S. restaurant indices. Benchmarking can be a tough way to make an assessment over short periods of time, and which benchmark is used can be debatable. Performance can also vary greatly depending on time periods selected.
For the sake of comparison, though, here is Buffalo Wild Wings' stock price compared to the Dow Jones U.S. Restaurant and Bar Index.
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Data by YCharts.
Gross underperformance isn't exactly depicted here, but I will concede that for a company that has been aggressively expanding, Buffalo Wild Wings' stock return has been less than hoped for in the last couple years. One reason Marcato gives for this weakness is shrinking same-store sales, and as a result, falling profit margins.
Chart by author. Data source: Buffalo Wild Wings quarterly earnings reports.
To help fight back, the hedge fund has suggested the company sell about 80% of its company-operated locations to franchisees. That would move the company to a total mix of 90% franchised locations.
The reason? Less risk as franchisees would take over operations, raising profit margins for Buffalo Wild Wings as the company collects royalties and fees rather than running restaurants. Marcato is also pushing for the nomination of four of its own proposed members for the board of directors to bring fresh insight to the company.
In the blue corner . . . B-Dubs
Buffalo Wild Wings management has for the most part rebuffed Marcato's push for change. It believes its expansion plan and new initiatives like takeout and the boneless wing Thursday promotion will eventually work to help return individual locations to growth.
The company has also argued that same-store sales and margins are shrinking industrywide, a problem that has reared its head for over a year now. Overall growth in new restaurant openings in the U.S. has outstripped demand, leaving industry players to fight over market share. Same-store sales returning to growth may simply be a matter of waiting out the storm.
Weakening results for the broad restaurant industry. Chart by author. Data source: TDn2K.
As a result, Buffalo Wild Wings says it is rethinking its growth strategy with plans to open smaller format stores in higher-density urban areas. The aggressive refranchising proposal has also been rejected as the company says it won't be able to sell its restaurants for nearly as much money as Marcato projects.
It is also worth noting that Marcato's franchising plan would be uncharted territory for a company like B-Dubs, as can be seen from Marcato's own presentation materials. Notice that the high percentage of franchised location businesses operate in the quick service and fast food segments of the industry, not the casual and upscale-casual segments.
Buffalo Wild Wings sits at a roughly 50/50 franchised to company-owned mix. Other casual chains are mostly company-owned and operated. Image source: Marcato Capital.
Those chains aren't exactly concerned with quality. In switching to a primarily franchised model, the company could risk losing control over quality in exchange for a short-term boost in profitability.
However, the chain did recently announce the sale of 70 locations to franchisees. Management says it continues to assess the sale of others and will do so when it makes financial sense. As an additional concession, the company brought on one of Marcato's board nominees to help reinvigorate the business.
What is an investor to think?
This is a classic case of an activist investor vs. management face-off. The thing to remember is, as investors, running the business is not the name of the game. That's what management is for, and we're along for the ride. If you don't like the ride, find a different company to invest in.
That being said, Marcato has some valid points that could help improve the restaurant chain's performance. It seems that management is parsing through them and accepting suggestions they think make sense, and some fresh perspective on the board could help further those efforts. The company's annual meeting will be held on June 2.
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