January 18, 2017 | 8:25 AM by Jay Kunstman | jkunstman@jaguaranalytics.com

Fiesta Restaurant Group (FRGI) – Weak Comps but Case for M&A Rising

Fiesta Restaurant Group owns, operates, and franchises two fast-casual restaurants brands: Pollo Tropical and Taco Cabana. The brands specialize in the operation of fast-casual ethnic restaurants that offer distinct and unique Caribbean and Mexican-inspired flavors.

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Over the past year, the company has seen its share price fall over 27%, and even more dramatically from early 2015 when shares were trading at a high of $69. Restaurant consultants say that Fiesta’s recent struggles are “really indicative of poor management – opening and closing stores that fast. They’re biting off more than they can chew.” As an example, the company spent $80M expanding into Texas with very little success. Analysts such as Raymond James, Piper Jaffray, and Standpoint Research have all downgraded shares during this time, while Jefferies and Canaccord Genuity have reiterated their Hold ratings. Since the company reported its Q415 earnings, total revenues and comparable store sales for both Pollo Tropical and Taco Cabana have been deteriorating.

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In addition, over the past year, the company underwent certain C-suite changes, store closures, as well as updating shareholders on strategic initiatives:

• On February 24th, the company first announced that it was going to be separating its Pollo Tropical and Taco Cabana concepts into two companies in 2017 or 2018.
• On August 25th, Fiesta Restaurant Group announced that President and CEO, Tim Taft, informed the Board of Directors that he had decided to retire. In light of this transition, the Board said at the time that “it intends to review the company’s strategic plan, including the previously announced separation of Taco Cabana. A tax-free spin-off may remain a viable route to maximizing shareholder value.”
• On September 27th, the Board re-evaluated the previously announced separation of Taco Cabana and concluded that continued brand ownership is in shareholders’ best interest and that no spin-off would be happening. Also, COO of Taco Cabana, Todd Coerver, resigned. Lastly, the company announced that it decided to suspend additional development of Pollo Tropical restaurants in Texas and to review its strategy for development in the state while it continues to build brand awareness.
• On October 24th, the company announced it would be closing 10 Pollo Tropical locations and will re-brand up to 3 of them in Texas as Taco Cabana restaurants.

Potential M&A

The biggest catalyst for Fiesta right now is the potential for an acquisition. In September of last year, things started to pick up when activist investor JCP Investment Partnership revealed a 6.2% stake in the company. JCP said it believed “significant operational and strategic opportunities are available to the issuer to enhance shareholder value.” In recent years, JCP succeeded in forcing two targeted companies to engineer sales. In 2014, it successfully orchestrated The Pantry convenience store sale, and in 2016, engineered a CST Brands sales.

Then, on October 14th, the NY Post ran an article that said the company is quietly alerting potential suitors that it intends to put itself up for sale. According to the Post, there has been some early indication of interest from private equity firms in the $717M market cap business, a source said. The article mentions Golden Gate Capital, which owns California Pizza Kitchen and Red Lobster, who is said to be intrigued by the expected opportunity. They also reiterate the recent filing by JCP Investment.

Finally, on December 2nd, Dealreporter, citing sources, said the company is exploring a potential sale and has hired JPMorgan to help in the process. Analysts and industry veterans have given their take on the topic as well:

Aaron Allen, an Orlando restaurant consultant believes Fiesta is a good candidate for a sale. “It has the right flavor profile that, with better management and cash, it wouldn’t surprise me at all that new owners could restore the brand back to its former potential.”

Wedbush analyst Nick Setyan said, “I think there’s a lot of national potential there. I think Fiesta is reasonably a candidate to be bought out.”

Piper Jaffray analyst Nicole Miller Regan even took a look back at 149 activist campaigns that occurred in the restaurant industry from 1997 to now and found that 70% of the campaigns are followed by positive returns in the year following a campaign announcement. Of note, two-thirds of those campaigns are followed by returns of more than 20%.

If a potential deal is in the works, there’s no timetable on when it could occur. That being said, in yesterday’s trading session, there was an unusual buyer of 1,000 March 30 Puts for 3.20, a $320,000 bearish bet. While the company’s Investor Relations page does not list any upcoming events, Fiesta historically announces Q4 earnings in mid-to-late February.

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