I wanted to follow-up my post about the Shake Shack (SHAK) IPO because I think the stock is presenting an interesting opportunity on the short side (finding shares to borrow is another story completely). Sometimes investors use paired trades – shorting one stock and going long another in order to bet on the valuation differential – to reduce their risk and still bet against a highly valued stock.
First, let me give a quick recap of Shake Shack today, post-IPO. At $45 per share the company’s equity is valued at $1.6 billion. This is for a company that had 63 restaurants open at the end of their most recently reported quarter, with more than half (32) franchised. The 31 units they own average $5 million in sales annually, but that figure will decline over time because the company’s focus on Manhattan (where each unit does more than $7 million per year in sales) will dissipate over time as Shake Shack goes national.
The key for investors is a tidbit included in the company’s IPO prospectus; over the long term Shake Shack sees room for 450 owned units in the U.S. with average unit volumes of $3 million per year and 20% four-wall margins. With less than three dozen U.S. locations today, you can see that it will probably take two decades to reach their 450-unit goal.
So why is that data crucial for investors? Well, consider that in 2014 fellow burger chain Red Robin (RRGB) operated 408 restaurants in the U.S. and each one averaged $3 million in sales. Furthermore, the average company-owned Red Robin had a four-wall margin of 21.4%. In addition, Red Robin plans to open 20 new units in the U.S. in 2015, so by the end of this year the company will have 428 units averaging $3 million in annual sales at a 21% profit margin. Essentially, Red Robin is today what Shake Shack will be in 20 years.
You probably see where I am headed with this. Red Robin’s current equity market value at around $80 per share is only $1.14 billion, compared with Shake Shack at $1.6 billion. How on earth can Shake Shack be worth more today than Red Robin? It can’t be, at least in any rational world (yes, I know, the stock market is not always rational).
By The Numbers:
Red Robin: 408 owned units, 99 franchised units, $1.14 billion equity value
Shake Shack: 31 owned units, 32 franchised units, $1.60 billion equity value
Bold investors can short Shake Shack by itself and hope the market comes around to realize the current share price is irrational sometime soon. Less bold investors can short Shake Shack and pair it with a long investment in Red Robin. As long as the valuation differential between the two converges over time, the trade will make money. Count me as one who does not think Shake Shake can maintain a 50% equity valuation premium to Red Robin over the long term. In the short term, though, anything is possible (as we see today).
Note: Shorting Shake Shack is difficult right now since it is a newly public company, but as time passes it will be easier to find shares to borrow (my broker, for instance, does not have any shares available as of now).
Full Disclosure: No positions at the time of writing but positions may change at any time