Calling Del Frisco Restaurant Group’s performance as a public company “abysmal,” activist investor Engaged Capital LLC presented a straightforward solution: Sell the company.
“The environment for M&A in the restaurant industry has rarely been more active than it is today,” Engaged principal and chief investment officer Glenn W. Welling wrote in a December 6 letter to the company. “… It is imperative that the board takes advantage of this window by forming a strategic review committee of the independent directors, hiring advisors, and beginning a process to explore strategic alternatives immediately.” Engaged owns 9.9 percent of Del Frisco’s shares.
A day earlier, Del Frisco’s board of directors unanimously adopted a shareholders rights plan “to protect the best interests of all Del Frisco’s shareholders.”
The parent company of Del Frisco’s Grille, Del Frisco’s Double Eagle Steakhouse, Barcelona Wine Bar, and bartaco, said it recently observed unusual and substantial activity in the company’s shares. The plan is designed to allow, in the company’s words, “Del Frisco’s shareholders to realize the long-term value of their investment by reducing the likelihood that any person or group would gain control of Del Frisco’s through open market accumulation without appropriately compensating the company's shareholders for such control or providing the board sufficient time to make informed judgments.”
Also known as a “poison pill,” it would be come into play if a shareholder accumulated 10 percent of more of Del Frisco’s common stock. It’s set to expire on December 4, 2019.
The letter Engaged sent to DFRG was a scathing one. It suggested there are “numerous parties” interested in acquiring Del Frisco’s concepts at valuations that would deliver a significant premium to the current share price. Engaged also pushed for shareholder representation on the board, the hiring of financial advisers, and the formation of a strategic review committee consisting of independent members of the board to oversee and manage a process to evaluate strategic alternatives.
“Since its IPO in 2012, DFRG has declined by 47 percent, while [Ruth’s Chris], its closest peer, has nearly quadrupled in value. Over any reasonable short- or long-term time frame, DFRG has underperformed its peers, the restaurant industry, and the broader market,” Engaged wrote.
However, Engaged still sees value in the company’s concepts. Double Eagle it called “one of the premiere high-end dining concepts in the U.S. with [average-unit volumes] in excess of $14 million per restaurant, restaurant-level EBITDA margins of 25 percent, and the potential to triple its unit count.
Of its newest restaurants, Barcelona and bartaco, which were closed June 27 for $325 million, Engaged said the first’s beverage mix of 46 percent and consistently positive same-store sales “provide the foundation for an extended runway of profitable growth.”
The company labeled bartaco as a brand with the potential to be a “blockbuster concept.”
“With outstanding restaurant-level EBITDA margins of 28 percent, modest unit capital investment costs, and the potential to increase the unit count 10-fold over time, we believe the sky is the limit for bartaco if the growth strategy can be properly executed,” Engaged wrote.
However, once again, this was spun against the possibility of there being “multiple parties interested in acquiring DFRG today, either in pieces or in its entirety.”
Engaged took issue with the June acquisition on several fronts. It called the deal “risky” and said it was “compounded by the board’s lackadaisical oversight of the financing and the questionable strategic rationale for the deal.”
The company also claimed the purchase “was likely defensive in nature, intended to dissuade an already interested bidder [or bidders] from making an offer to acquire DFRG.” It suggested this explained why DFRG signed the agreement prior to securing necessary financing. Upon the June closing, the company entered into a $390 million term-loan agreement.
Engaged criticized DFRG’s track record running a multi-concept company. “Of the three brands DFRG operated prior to the Barteca acquisition, only the performance of Double Eagle could be deemed as acceptable. DFRG’s other brands, the Grille and Sullivan’s, have experienced years of margin compression and negative same-store traffic,” the company wrote. DFRG completed a $32 million sale of Sullivan’s Steakhouse to Romano’s Macaroni Grill September 24.
In the third quarter, Del Frisco’s came out with a quarterly loss of $0.07 per share compared to last year’s loss of $0.03. Del Frisco’s posted revenues of $105.30 million compared to the year-ago figure of $73.34 million.
On a concept-by-concept basis, three of the four chains in Del Frisco’s lineup reported red same-store sales. The same was true of customer counts.
It broke down as follows:
- Double Eagle: –2.4 percent comps/–4.7 percent traffic/average check 2.3 percent
- Barcelona Wine Bar: 2.5 percent comps/1 percent traffic/average check 2.3 percent (the lone brand to report positive)
- Bartaco: –7 percent comps/–5.9 percent traffic/average check 1.5 percent/average check –1.1 percent
- Del Frisco’s Grille: –0.4 percent comps/–9 percent traffic/average check 8.6 percent
CEO Norman Abdallah said DFRG “made significant headway” integrating Barcelona and bartaco, and that integration of Del Frisco’s major back-end support systems is tracking to go live during the first half of 2019 and full integration is planned by mid-2019. This is at the early end of the company’s 12- to 18-month timeframe laid out when the transaction was first struck.
“Once completed, we will see cost-saving opportunities in G&A and purchasing across the portfolio because of greater scale, combined know-how and capabilities for a best-in-class supply chain,” he said. “These savings are now likely to be at the high end of our $3 million to $5 million range, with significant run rate savings beginning in the second half of 2019.”
Through the first three quarters, Del Frisco’s opened two Double Eagle units, a Grille, and one bartaco. Two bartacos and one Barcelona store opened in the first half of the year under previous ownership. In Q4, a Double Eagle—Del Frisco’s first on the West Coast—opened in downtown San Diego. Two Grille locations, one in Philadelphia and one in Fort Lauderdale, are still planned. As is a Barcelona in Charlotte, North Carolina, and two bartacos—one in Massachusetts and another in Dallas. This would bring the total of 2018 openings to 10 for a total of 13 (including the previous openings). That would signal a record number of annual openings for Del Frisco’s, and is a sign of things to come.
“Between now and the end of 2021, our intention is to grow our footprint by 10 to 12 percent annually, focused on our three highest-returning brands,” Abdallah said. “Typically consisting of two to three Double Eagles, two to three Barcelona Wine Bars, and four to six bartacos each year.”