Developing a healthy financial appetite for burgers

A few weeks ago I gave the keynote speech at the Capital Roundtable, organised by Burt Alimansky, a big conference on activist investing.

It was a high-powered audience, with representatives of virtually all the most notorious activist hedge funds. To name a few: Tom Hudson of Pirate Capital, Eric Rosenfeld from Crescendo, who was speaking right after me, Bill Ackman from Pershing and Phil Goldstein from Opportunity. Carl Icahn was also represented.

Then, the keynote speech to open the conference – me. I have spoken at many conferences but here was an audience – composed of lawyers and accountants as well as the hedge fund managers – where everyone would be saying “James who?” when I started speaking. I decided the only way to do this was to work really hard on making them laugh.

I started with a screen shot of the November 2004 cover of New York magazine, which featured a hedge fund manager (from Pirate Capital) in a bathtub filled with money. I said: “I showed this to my wife to try to explain what it is I do for a living. She looked at it and said: ‘Does this mean you are going to start bathing regularly?’” OK, see, you chuckled a little. A tiny bit, maybe. You can use that joke, too, if you need to speak anywhere.

I then focused on a topic I know very well – junk food. In particular, junky fast food. And what is it with these activists and value investors and their junk food?

Let’s review the list for a second: Bill Ackman and then Nelson Pelz have both been activists in Wendy’s. Ackman has also tried to shake up McDonald’s.

Pirate Capital is in CKE Restaurants (owner of Carl’s Jr, Hardees and others), while David Nierenberg is in Casa, a chain of Mexican restaurants out west. Recently even Heartland Value advisers, instead of filing their usual passive 13G filing, actually went semi-active with a 13D on Smith & Wollensky, one of my least favourite steak restaurants in New York (I like non-public company Les Halles). Jason Ader, a former restaurant analyst, has used his hedge fund Hayground to file a 13D on Denny’s (not quite active but I’m waiting, hopefully).

And, lest we forget, Warren Buffett has been accumulating his stake (no pun intended) in Outback Steakhouse (I tried eating there with the kids. Never again).

And just last week, Pirate Capital filed another 13D, on Chuck E. Cheese, perhaps the greatest restaurant known to mankind.

First, let me state that I own all the stocks mentioned above except for Casa (which I used to own but sold after their earnings jumped), Smith & Wollensky and Outback Steakhouse, and I am in the process of peeling out of some Denny’s (although I think it’s a great chain).

One of my favourite plays in the space now is CKE Restaurants. CKE has been a phenomenal turnround story in recent years. Ever since new management focused on the super high calorie burger – the “100% Angus™ beef Six Dollar Burger” – in their Carl’s Jr establishments (see the recent Paris Hilton commercial if you don’t know what I’m talking about), the company has been on fire from a cash flow and margins perspective.

As of March 30, Pirate owned 9.5 per cent of the company, having bought as low as $13 and as high as $17. The stock is currently in the $16s. It is quite clear why Pirate is involved in this stock: it is cheap on all the ratios and management is turning the company round. It trades for just 7.6 times its enterprise value and 8.9 times operating cash flows.

Now it has dealt with Carl Jr’s, the company is focusing on Hardees. According to its recent 10K filing, it seeks to “improve restaurant operations by streamlining the menu . . . remodel Hardee’s restaurants to the ‘Star Hardee’s format’ and ‘grow the lunch and dinner portion of Hardee’s business while maintaining Hardee’s already strong breakfast business’”.

I think activists and value investors like fast food chains for a few simple reasons. First, it is an easy business to understand. (Don’t lie, you love a Big Mac and supersized fries. Don’t even try to deny it.)

Second, the chains are sitting on valuable real estate that is probably on the balance sheet at cost even if they bought the plots 20 years ago. McDonald’s, for instance, is often thought of as more of a real estate company than a food chain.

And third, the brands of the main restaurants, while not on the balance sheet, would probably cost tens of billions to replace.