Famous Dave’s is a BBQ restaurant chain with deteriorating fundamentals that is ridiculously overvalued.  The company has benefitted from an activist investor and a new CEO, but much of its recent progress masks declining guest traffic and weakening unit economics.  The bull case focuses on cost cutting, but the real problem with Famous Dave’s is not a bloated cost structure but a sharp and accelerating decline in guest traffic.  Famous Dave’s restaurant base is aging, its franchise base has not had positive same-store sales in 10 years, and competitors like Texas Roadhouse produce BBQ entrees at lower prices, with better service, in nicer restaurants. 

The stock has been on a massive tear this year, up over 100%.  During this time several large shareholders with significant restaurant operating experience have sold out completely.  We expect the company’s underlying problems to manifest themselves more clearly to the market in the coming quarters.  The company is probably worth about $9 to $11 per share versus $19.60 at the time of this writing.  Given the frenzied buying in recent months and the illiquidity of the stock, the market will probably overshoot on the downside.  If you can stomach the volatility, it is a very compelling short, albeit one that might be best for your personal account given the thin liquidity. 

We also think the long-term fundamentals for Famous Dave’s are very troubling.  Both the company and franchisees have been underinvesting in the existing store base.  It is no longer economic to open full-service Famous Dave’s restaurants, and we expect new franchise openings to slow, franchise closings to increase, and for the overall footprint of Famous Dave’s to stagnate or shrink.  The company might try to fight this trend by opening restaurants itself.  If they do, it will be a low-return investment that will squander future cash flows. 

Some key points:

1) Valuation is very high

Famous Dave’s is very expensive for a casual dining restaurant company.  At $19.60 per share, the market cap is around $145 million. With debt at $16 million, TEV is just over $160 million.  Trailing EBITDA minus a conservative estimate of maintenance capex is just over $10 million, so we are talking about a 16x pre-tax multiple for a brand with declining traffic.  The company operates 53 of its 191 restaurants, so while it has a nice franchise base of 138, it does have a meaningful fixed-cost base with the company-operated restaurants.  There is more downside to this company than to a more franchising-focused brand.  16x is a very rich multiple.

2) Underspending on stores since 2008

Company capex backing out new store openings has been meaningfully lower than my conservative estimate of maintenance capex for the last five years.  You will see this when you visit the stores too.  Famous Dave’s is an interesting concept because they don’t have a prototype building.  You can build a Famous Dave’s restaurant in an old box vacated by a different brand.  In some ways, this is a positive thing for Famous Dave’s -- it means store-opening costs for the company and franchisees can be pretty low (and meaningfully lower than for other concepts that require a full build-out).  But this cuts both ways.  When the stores have not been invested in, there is more of a “worn down” feeling to the space, as many of these buildings are quite old.     

3) Very weak performance at franchisees

Part of Famous Dave’s stock price increase has been driven by improving performance at company-operated stores.  But the sales trends in the larger franchise base have been awful.  Ultimately, you can’t rebuild this company when your franchise base suffers continued same store sales declines.  As I wrote earlier, franchise same-store sales have been negative 9 of the last 10 years with one flat year. 

4) I like the new CEO, but . . .

New CEO John Gilbert seems good.  He has made process improvements that greatly increased to-go and catering performance.  But this masks the problems Famous Dave’s is having with dine-in customers.  Ultimately, this business can’t just lean on to-go business.  If dine-in traffic continues to fall, then you will reach a tipping point where nobody wants to sit in an empty, decrepit restaurant. 

The market is very excited about the new CEO and cost cutting opportunities, but it neglects the very real negative trends in the business.  We see this over and over and over again in rising markets like this one.  This is like Ruby Tuesday revisited.  Annual unit volumes are only $2.6 million for company stores and $2.7 million for franchises.   

5) BBQ is hard to succeed in

BBQ is hard for full-service casual dining chains.  Customers are very low-frequency, just a few visits a year on average, and the business is very seasonal.  Dinosaur (which Soros owns I think) has had some success in very concentrated population areas, but there’s a reason you don’t see a lot of BBQ chains succeeding.  Dickey’s is the only one that has really worked, but it is basically a quick-service concept.       

6) The competitive landscape is fierce

Casual dining is really suffering right now as companies are being very promotional in an effort to get customers in the door.  It’s nice to have a company specific short-idea where the macro trend is also very much helping.  Many companies in the space are overvalued, and Famous Dave’s is the most egregious example. 

Lots of casual dining chains promote BBQ options, as you might have seen.  One particular competitor that we believe is really cutting into Famous Dave’s dinner business is Texas Roadhouse.  Texas Roadhouse has vastly superior quality, excellent service, way nicer new-build restaurants, and their average dinner check is 9% lower than Famous Dave’s.  Customers are responding by flocking to their restaurants.  Annual sales are $4.0 million versus Famous Dave’s at between $2.6 and $2.7 million. 

7) The smart money is gone

James Pappas, a hedge fund manager who is in the Pappas restaurant family and has had good success with restaurant investments, was a major shareholder (and 13-D filer) that sold into recent strength in the stock.  The stock is also way up for Patrick Walsh, an activist investor that joined the board earlier this year.  I have a high opinion of Walsh and think he has done a good job cutting costs, but I wonder how comfortable he is with this stock up near $20.    

Bottom line:

Famous Dave’s unit economics at its full-service casual dining restaurants are deteriorating, and at $2.7 million unit volumes, there is not a lot of margin of safety here.  There is a whole new group of “value investor” shareholders that like Famous Dave’s cost cutting opportunities, but I think they misunderstand the economics of the business.  This really does remind me of the Ruby Tuesday situation, where a company with very weak unit economics attracted a bunch of value investors that did not totally understand the business.  Famous Dave’s deterioration has been masked by improving food margins, some low-hanging-fruit process improvements from the CEO to drive to-go business, and cost cutting from a newly focused board of directors.  All these are great developments, but the underlying troubles are much more serious.  Famous Dave’s is not attracting guests, its value proposition (and quality proposition) versus its competitors is terrible, and to pull off profitable growth it needs franchisees, who have suffered 10 years of falling traffic, to invest in new stores.  This is not going to happen quickly or easily.  Famous Dave’s only chance is its quick casual concept, The Shack, which might have some promise.  I think it will be a long road to see if The Shack has legs. . .I also think existing franchisees, who are experienced at full-service restaurants, are not likely to race into a new quick-casual concept.  The likely result is that Famous Dave’s will have to use its excess cash flow to fund growth itself.  This is going to be a value-destroying proposition.      

How often do you see a stock rally 100% despite deterioration in the most critical aspects of its business?  Thank you Mr. Market.