Pirate Capital discloses 5.3% stake in OSI Restaurant Partners, Inc. (OSI) -13D
Pirate Capital discloses 5.3% stake in OSI Restaurant Partners, Inc. (NYSE: OSI) in 13D filing. On June 2, 2006, Pirate Capital sent a letter to OSI, urging the board of directors to undertake measures to enhance long-term shareholder value. The firm said, "Ascribing no value to Cheeseburger in Paradise, Lee Roy Selmon's or Blue Coral, we conservatively value OSI's equity at $50/share, with each incremental 100 bps of margin recovery at the core domestic Outback concept adding an additional $3 per share of value."
A copy of the letter disclosed in the filing:"
Mr. Chris T. Sullivan Chairman OSI Restaurant Partners, Inc.2202 North West Shore BoulevardSuite 500Tampa, Florida 33607
Dear Mr. Sullivan:
Pirate Capital LLC, as the investment advisor to Jolly Roger Fund LP, Jolly Roger Offshore Fund LTD and Jolly Roger Activist Portfolio Company LTD, is the beneficial owner of 5.3% of the common stock of OSI Restaurant Partners, Inc. ("OSI" or the "Company"). We are long-term investors, having invested inOSI because we believe the market price of OSI shares fails to reflect the value embedded in the Carrabba's, Bonefish Grill and Fleming's concepts (the "Growth Concepts"), the potential for margin recovery at the core Outback concept and the significant value in the Company's real estate portfolio. We are writing this letter to encourage your board to take immediate steps to unlock long-term shareholder value by (1) conducting a spin-off of the Growth Concepts and (2) ceasing new unit growth at domestic Outback and other fledgling concepts unless and until relevant unit-level economics and a broader return to prosperity at domestic Outback justify further development.
Given our concern that a renewed focus on generating shareholder returns might be stifled by your de facto control of the board of the Company you co-founded, we have made numerous attempts to set up a meeting with you to discuss our concerns. You have denied our requests, leaving us no choice but topresent our views in a public forum.
We feel compelled to voice our concerns now because we have become increasingly frustrated with your misallocation of capital and inability to manage the Company's assets in a return-focused manner. Our initial meeting and subsequent conversations with Messrs. Allen and Montgomery provided us a glimmer of hope that the "new" OSI would regain its luster as a first-class casual dining operator, and eschew its legacy as an aimless brand aggregator, attained under your direction in recent years.We view favorably OSI's previously announced decision to consider strategic alternatives ("Shareholder Value Initiatives"), including the separation of individual or multiple concepts, taking on additional financial leverage, share repurchases and the monetization of real estate assets. We take issue, however, with the pace at which your analysis is moving. Of even greater concern to us is our fear that senior management is burdened with conducting this review, serving as a significant distraction to what we believe should be their primary goal - namely, turning around the operations of the core Outbackbrand.
A GREATER SENSE OF URGENCY TO DRIVE SHAREHOLDER RETURNS
Your first quarter conference call included a promise to "thoughtfully review" the Shareholder Value Initiatives over the balance of 2006. Mr. Allen has stated publicly to the investment community that "[i]f you came here to watch us sprint you're in the wrong room. We're running a marathon....We're interested in great long-term investors, people that want to run this marathon with us."(1) In this context and for the foregoing reasons, we highlight our view that the trailing four fiscal years at OSI may best be characterized as a disaster from a shareholder returns perspective:
1. The Company has incurred approximately $1 billion in capital expenditures, of which we estimate $800 million to be "growth" CapEx;(1) Source: Transcript of Outback Steakhouse Analyst Meeting of February 17,2006.
2. Revenue has grown at a CAGR of 14% from $2.1 billion to $3.6 billion, while net income has grown at a CAGR of less than 5%;
3. The Company has lost approximately 300 basis points of operating margin, which we estimate to be primarily attributable to continuing weakness at domestic Outback units(2); and
4. OSI stock has declined 5%, compared with a 40% increase in the Dow Jones U.S. Restaurant and Bars Index ("DJUSRU"), in the four -year period ending June 2, 2006;
It is this history of significant underperformance that we feel should instill a sense of urgency among your board toward delivering improved shareholder returns. If we assume the "marathon" referred to above began back in June 2002 with OSI shares trading at $39/share (v. today's price of $37), we are confident that the vast majority of your shareholder base would favor an acceleration of the marathoner's pace closer toward something approximating a sprint.
ESTABLISHMENT OF A SPECIAL COMMITTEE AND RETENTION OF AN INVESTMENT BANK TO ASSESS STRATEGIC ALTERNATIVES
To the extent you have not already done so, we urge you to immediately establish a special committee of the board of directors to assess, with the help of a reputable investment banking firm, the "Shareholder Value Initiatives." Inthe Company's May 23, 2006 letter to Pirate Capital(3) responding to our request for a more detailed update on the status of the Shareholder Value Initiatives,Mr. Montgomery stated that "[u]ntil we complete our analysis, we cannot determine the recommendation that we will make to our Board of Directors." Pirate Capital is appalled at the suggestion that you deem it appropriate for senior management to be charged with this review process over the balance of calendar 2006.
Our understanding was that Messrs. Allen and Montgomery were brought in last year to revitalize OSI as a portfolio brand management company focused on the efficient deployment of capital, while preserving the stature of core Outback as a leader in the casual dining space. Especially in light ofdisappointing recent sales figures and traffic trends, we feel strongly that senior management should be focusing their time primarily on operational improvements. Determining the strategic direction of the Company is a task for your board, with input of senior management as decisions take shape. Moreover,we are concerned that your senior management team may lack the independence necessary to appropriately assess whether adopting some or all of the Shareholder Value Initiatives is in the best interests of all shareholders. We view your apparent willingness to charge senior management with basic "blocking and tackling" duties on the strategic initiatives front to the potential detriment of a focus on core brand operational improvements as both reckless and disingenuous.
(2) Unlike certain other casual dining operators with multiple concepts, OSI does not break out profitability on a concept-by-concept basis.
(3) A copy of the Company's letter to Pirate Capital is attached as an Exhibit to Schedule 13D.
SPIN-OFF CARRABBA'S, BONEFISH GRILL AND FLEMING'S
The argument for creating value through the sale or spin-off of one or more "growth" concepts is well established. We view the spin-off of the above-referenced Growth Concepts into a separate, publicly-traded entity as the most effective way of creating long-term shareholder value. In conjunction withthe spin-off and depending upon the amount of capital raised, we would encourage the Company to take on an appropriate amount of leverage to fund the repurchase of at least 15% of OSI shares outstanding.
Our analysis assumes an expected contribution by the Growth Brands of $185 million, or 42%, of OSI's 2007E EBITDA of $440 million. We conservatively value the Growth Brands at $25 per OSI share, or 10.2x 2007E EBITDA. Valuing domestic Outback at 7.5x a severely depressed 2007E EBITDA level of $200 million yields another $20 per share, while our valuation of International Outback at 8x our 2007E EBITDA of $53 million results in another $6 per share. Ascribing no value to Cheeseburger in Paradise, Lee Roy Selmon's or Blue Coral, we conservatively value OSI's equity at $50/share, with each incremental 100 bps of margin recovery at the core domestic Outback concept adding an additional $3 per share of value.
Beyond creating long-term shareholder value, such a sale or spin-off would bring other long-term strategic benefits. We would expect a sale or spin-off of the Growth Brands to boost managerial accountability, resource allocation and overall concept-level focus at both companies. Further, the public-listing of the Growth Brands would more closely align management and restaurant partners' compensation to the performance of their respective restaurant concepts. Allowing investors the choice of investing in either a growth company through the newly-issued shares, or a value/turnaround story through ownership of the "stub" Outback, should increase the likelihood that the individual pieces willbe rewarded full market multiples by appealing to more traditional investor constituencies.
CEASE NEW UNIT GROWTH AT DOMESTIC OUTBACK AND OTHER FLEDGLING CONCEPTS
At great expense to OSI shareholders, the Company has become an undisciplined restaurant concept collector. We believe this lack of focus on returns has caused restaurant-level margins to deteriorate to an industry-low of approximately 11%, or an estimated 300 basis points below the casual diningsector average,(4) while return on incremental invested capital has been abysmal. We associate OSI's perception of itself as a "portfolio brand management company" with a heightened level of execution risk, necessitating a fiercely disciplined approach to capital allocation across portfolio concepts.
(4) Based on our estimated fiscal 2006 restaurant level margins at Brinker International, Darden Restaurants, Rare Hospitality, Applebee's, Cheesecake Factory and PF Chang's.
The Company has stated publicly its intention to allocate capital toward concepts with the potential to grow revenues to $1 billion and $500 million, respectively, for casual and upscale casual concepts. While we view the sale of the Paul Lee's concept in January as a step in the right direction, we aretroubled by the fact that OSI is quietly building Blue Coral (a new upscale seafood concept), continuing the build-out of the unprofitable Cheeseburger in Paradise concept, and continuing to grow domestic Outback units in the face of declining customer counts and key operating metrics.
Our view is that long-term shareholder value will be maximized by ceasing new unit development at domestic Outback and other "non-core" concepts until the turnaround at domestic Outback gains considerable traction.
We believe that you and your board have lost credibility among both investors and Wall Street research firms, with the market now heavily discounting your strategic vision and ability to generate an equity-like return on invested capital. We challenge you to prove both constituencies wrong.
Our comfort level in owning OSI shares therefore rests largely in our conviction that one of the following two eventualities will occur: either the existing board of directors will take immediate steps to unlock shareholder value by instituting the measures outlined above; or the 2007 proxy season will include several new director nominees providing your frustrated shareholder base the ability to inject into the boardroom fresh perspective and a return-focused approach toward maximizing long-term shareholder value through the efficient allocation of capital.
Pirate Capital, as one of your largest shareholders, reiterates its request for a meeting with your board to discuss our views in greater detail.
Sincerely,/s/ Matt Goldfarb
Senior Investment Analyst"