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Coffee, sushi break restaurant IPO fast

The public trading debuts of Luckin Coffee Inc. and Kura Sushi USA Inc. this year gave investors a rare offering as the first restaurant IPOs on a major U.S. exchange since 2015, according to an analysis by S&P Global Market Intelligence.

Share prices for the two chains are up by double digits since their debuts, following a similar trend of markets initially welcoming new restaurant stocks in years past. But those debuts also come as restaurant chains continue to consolidate and private money keeps taking bites from the sector, experts said.

"The relative lack of IPOs in the restaurant space over the last five years, I think if you look at that, it kind of correlates with a real rise in M&A activity in the restaurant space. So, whereas the IPO activity has fallen off, the M&A activity has rapidly accelerated," said Sharon Zackfia, partner and group head of the consumer sector at William Blair & Company LLC, in an interview.

Whether the IPOs in 2019 signal a further thaw of the years-long freeze on restaurants going public remains to be seen.

"I don't know if I'd say the ice is broken yet, but I think it's certainly an encouraging first step for companies that might be considering the public market," Zackfia said.

Feast or famine

Between 2016 and 2018, no restaurant companies rang the bell at either the NYSE or Nasdaq, according to Market Intelligence data.

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The three-year fast on restaurant IPOs came after a six-year period when 21 restaurant firms went public.

Luckin Coffee's May trading debut was the first of its kind since that quiet period and its shares have since risen 11.1% through the close of trading on Aug. 19. The increase covers the quick-service coffee chain's first earnings report, which came in below analysts' expectations for revenue and EPS and pushed the chain's shares down almost 15% following the Aug. 14 report.

Kura Sushi's stock, meanwhile, rose 86.8% through Aug. 19 since its July 31 IPO. The S&P Composite 1500 Restaurants subindex is up 38.68% in the year ended Aug. 19, according to Market Intelligence.

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Earlier IPOs also fared well in initial trading. Noodles & Co. shares rose 93.3% in the 252 trading days after going public in 2013, while Shake Shack Inc. shares rose 64.7% in the year after its IPO in January 2015.

Shares in the New York City-based Shake Shack continued to beef up in 2019, rising 67.8% in the year ending Aug. 19. Shake Shack has met or beaten Street expectations for the first half of the year, according to Market Intelligence.

Shake Shack, like Wingstop Inc., is a brand in the early days of expansion with the potential to substantially grow its unit base over time, according to a July 29 report by Katherine Fogertey of Goldman Sachs.

Nevertheless, investors may find smaller public restaurant companies unappealing given their recent history, Kevin Burke, founder and managing partner of Trinity Capital, said in an interview.

While the likes of Wingstop, Shake Shack and Dave & Buster's Entertainment Inc. performed well, "there are more than twice as many unfortunate stories with respect to microcap and small-cap companies going public," Burke said.

Smaller restaurant companies typically lack dollar volume liquidity — a measure of share price multiplied by average volume that generally indicates investor interest — and do not have enough research analyst coverage or interest from index funds, Burke said.

"Public equity markets are just not made for these kinds of IPOs," Burke said.

Portion control

When Noodles & Co. went public in 2013, it unlocked the gate for other restaurant operators as initial investor reception to the first few restaurant IPOs was encouraging and valuations were favorable, Zackfia said.

The subsequent chilling of restaurant IPOs occurred during a general decline in consumer spending, a contraction in valuations and an acceleration in M&A interest, Zackfia said.

"Most restaurants of scale are profitable, so it's not as if they need money constantly, which helps them stay in the private market landscape longer," Zackfia said.

Consolidation is also an emerging trend in the restaurant space, Zackfia said. Many companies — including Fogo de Chão Inc., Bojangles' Inc., Papa Murphy's Holdings, Inc. and Zoë's Kitchen Inc. — that went public during the last decade have since returned to private ownership at a time when private equity interest in restaurant companies remains strong.

"There's still a lot of activity in the restaurant space. It just hasn't been as much on the IPO front," Zackfia said.

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Some public restaurants also struggle with replicating regional success at a national level, Zackfia said.

'The market has gotten wiser'

Being a public restaurant company is also hard if it is not growing revenue and total store count, Burke of Trinity Capital said. Chipotle Mexican Grill Inc. has fared well at this kind of growth while sandwich chain Potbelly Corp. has struggled, Burke said.

"I think the market has gotten wiser on what works and what doesn't work with scale and with growth," Burke said.

Chipotle, which went public in 2006, grew to 2,491 stores in 2018 from 1,084 in 2010, according to Market Intelligence.

Chipotle earnings have beat earnings expectations so far this year, according to Market Intelligence. The company has been "firing on all cylinders, with digital, delivery, menu innovation and stronger marketing," Peter Saleh, a BTIG analyst, said in a July 24 report.

Potbelly, meanwhile, had 218 locations in 2010 before growing to 486 in 2018, according to Market Intelligence. The company went public in 2013 and has so far missed earnings expectations in 2019, according to Market Intelligence.

Still, sales are expected to improve in the second half of the year due in part because of Potbelly's launch with delivery service DoorDash in July, Zackfia said in an Aug. 6 report.

More broadly, sales growth across limited-service chains is set to slow, though the restaurant sector overall has benefited from consumer spending, re-franchising and digital initiatives like apps, Fogertey of Goldman Sachs in a report.

"This is a critical point for restaurant stocks," Fogertey wrote.