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I am recommending a long position in Morton’s Restaurant Group Series A Convertible Preferred Stock.  The Convertible Preferred shares are convertible into one share of MRT common or the company can redeem them for $5.00 in cash.  I’ll get into the details on these mechanics at the end of the write-up.  I wanted to post this idea before MRT reports tonight, so it is not as in-depth as I’d like it to be.  I welcome any dialog or feedback and look forward to your thoughts. 

Morton’s generates about $320mm in revenue and 47c in EPS a year.  Revenue is expected to grow about 8% in 2011 and EPS is up over 50%.  The EPS leverage is from positive comps that has driven store level profit margins which is typical at any restaurant that is driving positive comps.

Morton's has 79 stores including about 6 internationally.  They have reported six consecutive quarters of positive comps partially driven by a shift in concept that is part more bar business driven and part different store layout driven.  Additionally, they are net taking price which has more than offset commodity pressure.  So, while comps are positive, traffic isn't necessarily as positive as comps (obviously you want comps to be traffic driven).

Read into current trends – RUTH reported 3Q11 results this week and showed a positive comp of 6%.  I interpret this figure that illustrates the space is at least ok.  Additionally, MRT comps are very highly correlated with RevPAR which was strong all through the quarter in each month of July, August, and September.  This bodes very well for the quarter ended September which is MRT’s worst quarter of the year as no one eats steaks in August and business expense account spending is also way down during the summer. 

MRT 3Q guidance calls for rev of $71-73mm on a 6-8% comp and EPS of negative 10-12c loss.  I expect all that to be very achievable.  FY guidance calls for rev of $320-323mm on a 6-8% comp and EPS of 45-49c.  That seems to be achievable and implies the shares are trading at about 11x 2011 EPS.  Additionally, they are expected to do about $29mm in EBITDA in 2011 which implies an EV/EBITDA multiple of ~5.3x. 

Mgmt engaged bankers to sell the company in early 2011, but nothing has happened yet.  Take out multiples in the space have been for about 7.5-8.5x EBITDA which implies a share price of about $8.00 - 9.50.

Details on the convertible preferred mechanics are found in an 8k dated February 26^th, 2010.  The quick details are:

• After February 26^th, 2012 holders can convert their holdings into one share of common stock of MRT which is currently trading at $5.01.
• At any time prior to a conversion, the company can convert the Preferred into $5.00 per share in cash (there is a stipulation that the Preferred has to have traded above $5.00 for ten consecutive days for any period and was met in March 2011).

I think this will play out as follows: the common will be trading well above $5.00 in February 2012, and mgmt will then issue common and redeem the shares at $5.00 in cash prior to the conversion date.  If the shares are trading below $5.25, the company will allow holders to convert their preferreds into common stock. 

The reason I find this so compelling is the ability to hedge the preferred with the common.  If the shares fall out of bed over the next four months, we can sell MRT common one for one with our preferred holdings.  The shares aren’t liquid, but they do trade ~10k shrs a day.  At worst, I think I’d be able to hedge this for a loss of about 10%.  The upside is likely capped at $5.00, 20% above $4.15 spot price.  As this is 100% hedgeable for only a marginal loss, I like it a lot.  I own a full position at $4.27 and would add to it below $4.10. 

I think this is a high conviction low risk trade to make 20% over four months with minimal downside as it is hedgeable. 

Catalyst