Lessons learned from Ruby Tuesday’s saleLessons learned from Ruby Tuesday’s sale

Steve Rockwell has more than 35 years of experience in the restaurant industry, and served as Ruby Tuesday’s vice president of finance from 2008 to 2010. This article does not necessarily reflect the opinions of the editors or management of Nation’s Restaurant News.

Ruby Tuesday agreed this week to be acquired by the private-equity firm NRD Capital for $2.40 per share, plus the assumption of debt. 

The enterprise value of the acquisition is approximately $340 million, comprised of $146 million to acquire the stock and $194 million of net debt. That’s a far cry from Ruby Tuesday’s peak enterprise value of approximately $2.4 billion, including equity of $2.2 billion, attained in spring 2004. 

Some historical context is important to fully understand how Ruby Tuesday’s financial condition deteriorated. During the first part of the 2000s, Ruby Tuesday was on a roll. The company was expanding and same-store sales were rising through fiscal 2004. Ruby Tuesday had a share repurchase program and was actively buying back stock at the same time it was investing heavily in growth. Cash flow was strong and, cumulatively, from 2001 through 2004, the company outspent its cash flow by only about $13 million. As a result, debt was relatively modest. 

But in the mid-2000s, conditions began to change, with 2005 the first year of many that same-store sales declined, falling 7.1 percent at company-operated restaurants. Partly reflecting the soft sales, cash from operations declined 16 percent, or $36 million. Unit expansion was in place, so capital expenditures increased $10 million from 2004 to a record $161 million, with another $64 million of cash used to repurchase shares.

Around this time, activists were circling several restaurant companies and viewing their real estate holdings as a potential source of cash through sale-leasebacks to pay dividends or to take the company private. Partly to fend off these potential activists, Ruby Tuesday, which owned 258 of 579 company-operated restaurants at the end of fiscal 2005, accelerated its share purchase program in 2006 and 2007, and bought back nearly $400 million of stock. Unit expansion continued apace, with capital expenditures totaling just under $300 million for 2006 and 2007. Internally generated cash flow declined, requiring the company to add nearly $350 million of debt. Another $76 million of debt was added in 2008, resulting in debt increasing to $588 million in 2008, from $168 million in 2004.

Same-store sales recovered in 2006, but declined again in 2007, and dropped nearly 10 percent in 2008, as the company unsuccessfully attempted to reposition itself to appeal to more upscale guests. Same-store sales never recovered, earnings have been under pressure ever since, and the company’s stock has spent most of the last 10 years under $10 per share, and the last two years under $5 per share.

There are several lessons to learn from this story:

• Real estate has tremendous value. Management evaluated a large sale-leaseback at least twice in the 2000s to raise cash to pay off debt. If it had done so, it’s likely that Ruby Tuesday would be significantly worse off than it is now. Rents would have been based on higher average restaurant sales, and landlords are likely to have been less forgiving than lenders. Financial engineering can return cash to shareholders, but it can also increase the risk profile significantly, especially in a difficult sales environment.
• Repositioning an established brand is difficult. When I was Ruby Tuesday’s vice president of finance and in charge of investor relations, from 2008 to 2010, investors asked for examples of brands that had repositioned themselves similarly to Ruby Tuesday. I cited Red Lobster and Olive Garden as two chains that had evolved from their origins. Evolved is the key word: Those brands changed over a period of years, while Ruby Tuesday attempted to change over a period of months. The company also undoubtedly confused customers by couponing aggressively to drive traffic, a move that contradicted the push to move upscale.
• Pay attention to early warning signs. This can be very difficult, especially for public companies that have external pressures, because an issue can be short-term and reacting to it could result in disrupting operations. In Ruby Tuesday’s case, the 2005 decline in same-store sales was prophetic. In the context of the time, when competition was intensifying, the 7.1-percent decline followed by an anemic increase of only 1.4 percent in fiscal 2006 was a signal that the company had issues. Management should have slowed expansion sooner and cut back or eliminated the share repurchase program immediately, the latter being easier to do. Either or both of those actions would have conserved cash and lowered debt levels.

Today’s restaurant market bears some similarities to the one Ruby Tuesday faced in the mid-2000s: Activists are circling a number of underperforming brands; expansion in recent years is contributing to a softer sales environment; and credit is more available than it has been since the recession.

Patience is required by investors before buying a stock, after an issue is first priced into the stock. Companies need to exercise the same restraint before buying back stock. For instance, Chipotle Mexican Grill repurchased stock at nearly $580 per share in 2015, and $450 per share in 2016, after a series of foodborne illness outbreaks, compared with the current stock price of about $330 per share.

I am a firm believer that operators should hold onto real estate as a hedge against a downturn, rather than opting for sale-leasebacks. Impact investors should approach monetizing real estate with caution and stress-test sales to determine how much of a decline would result in a cash squeeze, while understanding that changing the direction of sales from negative to positive is very difficult.