Shake Shack: An Appetizing Prospectus
The highly successful Manhattan-based fast-casual chain, Shake Shack, has released a prospectus in regards to their much-anticipated IPO. Shake Shack, like many other now-prosperous restaurant chains, came from humble beginnings. The chain started in 2001 with a successful hot dog cart in Madison Square Park. That cart upgraded to a permanent kiosk in the park in 2004. Now, eleven years later, Shake Shack has expanded to nine countries and thirty-four cities. In addition to the humble beginnings, Shake Shack shares an additional commonality with well-known food chains: a creative founder. Danny Meyer, the company’s founder and author of the New York Times bestseller Setting the Table, is well regarded within the restaurant community; notably, for his vast portfolio of successful restaurants.
The 171-page prospectus adequately illustrated the company’s financial metrics and potential risk as you would expect in any prospectus; however, more importantly, Meyer transcribed his overall vision for the company in a way that corporate executives rarely do. Perhaps I am biased because I thoroughly enjoy stuffing my face with excess calories and saturated fat; either the case, we believe the hype around this IPO is well warranted. As much as the value-investor side of me would love to take you through the valuation, something else entirely pervades the fundamental analysis. As an investment, Shake Shack is in a paradoxical situation: investors are attracted to the growth potential around this company, yet the growth potential is what scares them. According to the consolidated statement of operations data, the Non-Manhattan Shacks brings in about half the revenue of the Manhattan Shacks, and has an operating margin of around 20% versus the 30% operating margin at the Manhattan locations.1 In light of this, the core catalyst presented by this company is the potential inability to replicate the Manhattan store success.
However, like many company characteristics, the numbers often fail to illustrate the actual issues within the company. In this case, the vast majority of the Non-
1 The preliminary prospectus for Shake Shack Inc, Form S-1 from the Securities and Exchange Commission.
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Manhattan locations have been open a relatively short time compared to the Manhattan based locations. “New Shacks sometimes experience normal inefficiencies in the form of higher labor and other operating expenses and, as a result, Shack-level operating profit margins are generally lower during the start-up period of operation.”
Even if the lower revenues from Non-Manhattan stores cannot be fully attributed to the normal inefficiencies that are “sometimes” experienced, the locations are still highly lucrative. In the prospectus, Shake Shack says it expects the majority of future restaurants will come in closer to $2.8 million to $3.2 million a year (Manhattan Shacks come in around $7.5 million). To exemplify this success, Chipotle average sales are around $2.4 million. The reason we highlight this potential catalyst is because of the astronomical growth potential at Shake Shack. As of now, the company has 63 locations and only 36 of those are currently in the U.S. Ultimately, the company believes it can open 450 locations, just in the U.S. alone. As Jim Cramer said, “That is an unbelievable growth trajectory”.
Despite the impressive financials and growth trajectory, at the end of the day this is a company that sells hamburgers in a highly competitive market; given that, we have to ask ourselves what separates Shake Shack from its list of competitors. Fortunately, it didn’t take long to find the secret sauce at this company: marketing. In June 2014, Shake Shack was ranked #10 on Restaurant Social Media Index’s top 250 restaurant brands. In addition to this, Shake Shack can be seen in several blockbuster movies and countless television shows. For people who have been apart of The Shakesperience, the well received branding of Shake Shack is unsurprising, from the menu to modern décor, Shake Shack has found a niche in pop culture.
According to Technomic, despite the ubiquitous health conscious consumer trend across the nation, the burger market actually grew 9% in 2014. In addition to this, the eponymous shakes at Shake Shack are also doing well; the frozen custard offering is also apart of the overall strategy by management to distinguish their menu relative to other burger chains. In regards to the overall industry, the fast casual sector is growing at a rapid rate and stealing market share from Quick/Full service sectors in the process. One of the core reasons behind the recent success of fast casual chains is their ability to charge customers prices similar to that of Full service restaurants and have twice the turnover.
This week Shake Shack released their opening share price between $17-$19 on five million shares, giving them about $90 million. At a $675 million valuation, each
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Shake Shack is worth about $10.7 million, or nearly 4.3x as much as a single McDonalds. Naturally, it will be difficult to replicate the success found in the older more established locations. Nevertheless, Shake Shack will find and enter markets that could potentially mimic the success found at the original restaurants. For example, the company has already leased property in Austin, Texas, a city that reflects core values held by the company.2 As companies like Chipotle continue to revolutionize the dining experience, it will be interesting to see if the larger companies can adapt to the modern consumer; and if the newcomers like Shake Shack can scale their business outside of the cult following found in Manhattan. Everyone can agree that this company is in fact “cool”; however, “cool” does not always translate to profits. Economically, this perception of “cool” is normally attributed to the rarity, the price, or the uptake rate of the item. The reason “cool” companies sometimes fail to realize profits is because either: (A) they get too big and cannibalize themselves by the bandwagon effect, or (B) they fail to grow because of their fear for scenario (A). Therefore, is it pivotal for Shake Shack to find the happy medium, where they grow both revenues and respect.3 In conclusion, the key to success for Shake Shack is to grow slow and efficiently. As Shake Shack enters new markets outside of Manhattan, they will realize that their success is not because of the cult followers, but what they did to gather such loyal fans. Chipotle dominated the food service industry because of marketing; and McDonald’s got dominated for the lack of. If Shake Shack has anything, it’s branding power, and because of that, I feel completely confident that they will be doing some dominating of their own in the not-so-distant future.
2 Austin, TX is home to the University of Texas, the head football coach Charlie Strong is well known for his Core Value discipline system used by the UT football team. 3 The bandwagon effect is a phenomenon whereby the rate of uptake of beliefs, ideas, fads and trends increases the more that they have already been adopted by others (Much like the University of Texas).
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