Cheeseburger in Paradise Lost – Corporate Governance Lapses at Red Robin

Red Robin Turned Down Meeting with Large Shareholder and Launched Expensive Defense Campaign

By John Jannarone

Anyone who looks at a long-term stock chart can conclude that positive change is needed at Red Robin Gourmet Burgers. But rather than make meaningful improvements, the casual dining chain’s latest move was to serve shareholders a costly surprise.

Shares of Red Robin, which competes with the likes of Brinker International’s Chili’s, Darden Restaurants Inc.’s Olive Garden, and Dine Equity’s Applebee’s, have fallen from a peak of over $90 four years ago to recent lows around $25. Over that time, the company’s same-restaurant sales have been negative the vast majority of quarters as it likely lost business to competitors undergoing successful operational improvements.

There is plenty the company could have done for shareholders in recent years. Roughly 85% of its stores are owned and efforts to refranchise them to generate cash have been slow. As Stephen Anderson of Maxim Group points out, the company has allowed a bloated cost structure to linger and chosen to focus on an off-premise strategy while neglecting the core in-restaurant business, which has a higher margin.

Shareholder frustration culminated earlier this year when Vintage Capital Management built a position in the company, which has risen to about 11.6%, and requested a meeting with the board of directors. Vintage has spoken to the company but was denied multiple requests to have an in-person meeting with the board of directors, according to people familiar with the matter.

Instead of meeting with Vintage, the board has begun throwing shareholder dollars into a defense campaign, which can quickly become an expensive endeavor. On June 5, the company adopted a so-called poison pill, a strategy designed to prevent a hostile takeover. Poison pills are generally criticized as a sign of weak governance by proxy advisors ISS and Glass Lewis because they can reduce management accountability. But to put a poison pill in place without taking a meeting with a top shareholder should be of even greater concern.

The poison pill announcement also indicated the company had hired two advisors that specialize in activism defense: investment bank Evercore and public-relations firm Joele Frank. (It’s possible Red Robin had spoken to the firms in the past, but neither had been mentioned a single time in a press release or SEC filing for Red Robin in the last several years, according to a search in Sentieo). Joele Frank declined to comment while Vintage could not be reached for comment.

While a poison pill prevents a hostile bid, the strategy looks unlikely to scare Vintage off. The investment fund has subsequently announced it would be willing to make an all-cash offer at $40 a share pending due diligence and urged the company to undergo a sale process while it continues its search for a new CEO.

If the company refuses, Vintage will have a chance to install board directors – long before next year’s annual meeting. According to the company’s bylaws, special meetings “may be called at any time” by shareholders with at least 10% of the outstanding shares. Directors can be nominated at those meetings.

It appears Vintage has the firepower to buy Red Robin if it were to make a formal bid. Indeed, the investment fund has pulled together debt financing for larger bids in the past. In 2014, Vintage had a $2.3 billion offer on the table for lease-to-own retailer Aarons. And last year, shareholders in Rent-A-Center, another retailer, approved a $1.4 billion offer from Vintage, though that deal never closed.

There’s a chance another bidder – such as a private equity firm – would pay more than Vintage is willing to offer. According to Maxim Group’s Mr. Anderson, the bid represents a valuation of 4.5 times trailing-12-month Ebitda. That’s lower than many takeover valuations, such as Bob Evans, which was sold to Golden Gate Capital for a 5.5-times multiple or Buffalo Wild Wings, which fetched a 10.3-times multiple when it was sold to Roark Capital, he said.