Is Shake Shack's IPO Announcement That Sell Signal the Market's Been Waiting For?

Let's be honest: everyone who owns stocks has been happy that the market has been so frothy of late. I mean, who doesn't appreciate a little irrational exuberance even when all of our synapses are surging with warning signals.

And this has certainly been a good year for tech. Heck, people are even feeling gracious about Alibaba and Xiaomi despite what their success may signal about western predominance and who you may be working for someday soon.

But there comes a point in every market cycle when something happens that is later regarded as the tipping point. That moment, like when you heard about 9/11 or when private equity master of the universe Steve Schwarzman had his billionaire birthday party just before the financial crisis, when you knew something significant had happened and things were going to change.

So remember where you were when you read that slightly upscale burger restaurant The Shake Shack had announced its IPO. Because as the following articles explain, it's not that we don't all appreciate a good hamburger, fries and a milk shake - occasionally - but that this may be a sign that we collectively have more money than sense and it might be a good idea to call a timeout. Again. JL

Jeffrey Goldfarb comments in DealBook and Tyler Cowen comments in Marginal Revolution:

A simple theory of IPOs suggests that they arrive when a product or company is experiencing “peak buzz." This will maximize the expected returns on the IPO when it comes to market.
When it comes to food, peak buzz usually arrives a wee bit after peak quality.

Shake Shack is turning the basic burger into complex financial cuisine.

The global fast-food chain, which was started by the celebrity restaurateur Danny Meyer, filed to go public on Monday with some of the tortured trappings served up with new technology stocks. Two classes of shares and creative financial metrics are especially unappetizing. There’s at least a sweetish bottom line to wash it all down.

Backed by private equity firm Leonard Green & Partners, Shake Shack is a self-described “modern day ‘roadside’ burger stand” whose vision is to “stand for something good.” It may achieve that with its twist on traditional American fare, but it falls short in the investment taste test.

For one thing, even after its initial public offering, the company’s existing owners will have control. Maintaining that through super-voting arrangements has become popular in Silicon Valley, where entrepreneurs are enamored of raising capital without surrendering much, if any, of their management sway. Perhaps to align itself with that crowd instead of the century-old patty on a bun, Shake Shack calls itself an “emerging growth company” in its I.P.O. documents.

In another nod to tech wizardry, Mr. Meyer points to unconventional ways to size up his conventional grub. Included in what the company calls its “Shack-onomics” is “same Shack sales,” a cute metric for revenue from locations opened for at least two years. Less savory are “Shack-level operating profit margin,” an elaborate method of comparison with competitors, and “cash-on-cash return,” a measure that isolates third-year operating profit for sites in the United States and divides it by the cost of opening them. Want anchovy-flavored turnip fries with that?

All that said, Shake Shack is profitable, unlike many new issuers of late. It also generates relatively healthy earnings before interest, taxes, depreciation and amortization,or Ebitda,  a more useful if still unofficial income yardstick. The bigger Red Robin Gourmet Burgers trades at 11 times expected Ebitda for the next 12 months, according to Thomson Reuters data. That would put Shake Shack’s valuation at about $260 million if it keeps growing at a similar pace. However, Habit Restaurants, a newly listed rival, fetches nearly 50 times Ebitda.

That kind of multiple, to borrow a Silicon Valley moniker for companies worth more than $1 billion, would make Shake Shack the home of the unicorn burger.

Does the Shake Shack IPO mean you should stop eating there?

A simple theory of IPOs suggests that they arrive when a product or company is experiencing “peak buzz,” or at least when the insiders in the privately held company think they are at or near peak buzz.  This will maximize the expected returns on the IPO when it comes to market.
When it comes to food, peak buzz usually arrives a wee bit after peak quality, given reputational lags.  So if you are seeing peak buzz, it is probably time to bail on the restaurant, at least on a restaurant which is going to be sold.  Bailing on the restaurant may in fact be slightly overdue.
After an IPO, the equity share of the original creators — in this case Danny Meyer — is diluted.  Meyer’s incentive to maintain quality standards and his personal brand name is weakened.  The subsequent public shareholders are more likely to insist on a less risky and more mass market approach, which is not in tune with what you, highly intelligent reader of this blog, are likely to prefer.
In other words, both the signaling and the moral hazard arguments suggest that soon you should stop eating at Shake Shack.  Alternatively, perhaps you should now go lots of times, in quick succession, given that quality will decline even more and you must stock up on your fix as a kind of intertemporal substitution.