Noodles Doubles In IPO Debut: Time To Sell?

By Will Ashworth | July 03, 2013 AAA

Fast Casual restaurant chain Noodles and Company (Nasdaq:NDLS) priced its IPO June 27 at $18. In its first day of trading it closed up 104.2%, one of the top first day returns for U.S. IPOs since 2001. It's clearly time for those who got shares in its IPO to sell--Isn't it? I'll have a look to see if there's any reasons why you shouldn't take profits.

Highlights of the IPO
Noodles & Company originally priced its shares between $13 and $15.

  • By the time of its IPO less than two weeks later its shares sold for $18 each netting the company $100.4 million (includes over-allotment) after the underwriter's fees and other offering expenses.
  • It intends to repay $85.9 million of its $100.3 million in outstanding long-term debt saving the company approximately $3 million in annual interest expense.
  • Argentia Private Investments, one of Noodles & Company's private equity owners, the other being Catterton Partners, received a $400,000 special dividend in conjunction with this offering. There will be no dividends paid by the company.
  • The two private equity partners acquired Noodles & Co. on December 29, 2010.
  • Catterton has significant restaurant experience with Outback Steakhouse, P.F. Chang's and others. Argentia is a private equity investment vehicle for PSP Investments, the pension investment manager for the Canadian Public Service, The Mounties, and the Canadian Armed Forces.
  • While the terms of the original purchase by Catterton aren't available, it's clear that debt wasn't a big part of its purchase as it increased by only $43 million in fiscal 2010. According to the prospectus, Catterton, Argentia and some of the management invested $201.5 million in equity to buy the company. So, a possible deal price adding together the two figures is $245 million.
  • Noodles & Co. has 291 company-owned restaurants and 52 franchised locations in 26 states and the District of Colombia.
  • Over the last eight years it has gone from 100 restaurants to 343 as of the end of May.
  • The average restaurant comes with a total cash investment of $725,000, net of tenant allowances.
  • The average restaurant generates $1.18 million in revenue and $263,000 in store profit annually resulting in a payback of 3-4 years.
  • System-wide comparable store sales growth in 2012 was 5.4%, higher than in both 2011 and 2010.

What You Get
Clearly, you're buying into a restaurant chain that's growing. In 2013, it plans to open between 38 and 42 company-owned locations along with six to eight franchise locations. But don't expect its franchise development to get much busier. The company uses franchising to raise brand awareness in areas where it doesn't intend to locate in the short to medium term. In that regard it's very much like Starbucks (Nasdaq:SBUX), who uses a licensing format in places where it doesn't plan to invest directly.

SEE: How To Analyze Restaurant Stocks

Noodles & Company's revenue growth is best described as workmanlike. Since 2008, it has grown from $169 million to $297 million at the end of January. That's a compound annual growth rate of 15.2%. In terms of operating income, it's managed to grow 67.5% annually on a compounded basis over the same period. Its management team, which consists of several former McDonald's (NYSE:MCD) and Chipotle Mexican Grill (Nasdaq:CMG) executives, has done a good job building a stronger bottom line. In the interim as it ramps up store openings you can expect profits to be somewhat volatile while it builds out its footprint across the U.S. It expects to be able to grow to 2,500 stores over the next 15-20 years. From this perspective the potential of its concept is tremendous.

Valuation
At its IPO price of $18, Noodles & Company had an enterprise value 14.6 times its adjusted EBITDA of $36.3 million. When compared to Chipotle, which has an enterprise value 19 times EBITDA, it's more than fair. Fast forward to July 2 as I write this and its enterprise value has ballooned to 38 times EBITDA or twice the valuation of Chipotle. Given its growth prospects it's certainly not outrageous--but it isn't cheap either.

Daniel Gross, global business editor at Newsweek's Daily Beast, believes Noodles & Company's underwriters blew its IPO pricing costing the company $100 million in gross proceeds. Mr. Gross is just plain wrong. The fact that the stock doubled has little to do with whether its shares were priced accurately or not. Sure, in hindsight, it might have been able to go out at $24 per share (19 times EBITDA); however, the exercise isn't to see how greedy a company can be but rather to establish a market for its shares. Whatever Mr. Market decides after that is out of its hands. Pricing it at $18 ensures you sell all 5.3 million shares available in the IPO and don't end up with egg on your face as it tanks on its first day of trading. If anything, this tells us investors still have a big interest in owning stocks. And that's a good thing.

Bottom Line
If I was one of the lucky ones who got shares at $18, I'd be a definite seller at this point. If you weren't able to get in on the IPO (that's most of us) I'd wait for it to drop back into the mid-30s. While its potential appears huge, the unknowns at this point are also significant. Better safe than sorry.

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