Managing a publicly traded restaurant company is a completely different animal than running your own restaurant. Just ask Edward P. "Ned" Grace III, president and CEO of Bugaboo Creek Steak House, Inc., based in East Providence, Rhode Island. On April 6, 1994, Grace took his small company public at $12 per share, and his life has never been quite the same.

This year, at the company's annual shareholders' meeting, Grace had just finished outlining an exciting future for the 16-unit company, when a man stood up to ask a question.

"Mr. Grace," the investor started, "I listened to your wonderful presentation, and it sounds like things are going great. But I'm 72 years old and I want to know how much longer it will be before I start to see a return on my investment?"

Bugaboo's stock — which had gone public at $12 a share, climbed as high as $16 and dipped as low as $6 — had stabilized in the $9-to-$10 range. And original investors excited by the concept were wondering, "Where's the beef?"

Standing in front of his investors, Grace acknowledged the man's fears and concerns, and he asked for patience. He tried to reassure the investors that their money was safe, the restaurants were strong and the company was on track to becoming a successful, performance-based organization.

"I felt horrible," says Grace. "This poor man believed in us. He liked our restaurants, trusted us with his money and believed in what we were doing at $12 a share. But for the past two years, he'd seen his investment go down. That's almost a breach of trust, and I'm not comfortable with that. I'm a person who likes to keep his word, and it's a big disappointment that I haven't done that yet."

Grace's experience at that meeting was only one small reminder of the new world Bugaboo had entered. Like many other restaurant operators, Grace needed capital to grow his company, and he saw only a limited number of financial avenues. Forced to choose between venture capitalists and a public offering, he turned to the stock market. And, like those other operators, in return for expansion capital, Grace agreed to submit his business to constant inspection, criticism and evaluation. Sometimes he wonders whether he made the right choice.

Why go to market?

In 1995, initial public offerings (IPOs) raised nearly $30 billion for companies going public. And since the beginning of the decade, approximately 2,800 private companies have netted more than $130 billion through IPOs. But the '90s have been a roller-coaster ride for restaurant-industry stocks. And companies that have braved a public offering know the decision isn't simple and the task isn't easy.

"There are really only two strong reasons for restaurant companies to go public," says Barry M. Stouffer, a restaurant analyst for J.C. Bradford of Nashville, Tennessee. "You go public to raise capital or you go public for liquidity reasons, [meaning] you go from private to public ownership so that investors can get better valuation and can readily sell some of their interest."

The beginning of this decade saw a surge of public restaurant offerings. One of the most dynamic restaurant IPOs of the decade was Boston Chicken. The stock soared 143 percent the day it opened in November 1993 — jumping from $10 to $241/4. But one year later, the stock had settled at 131/2. Last month, the stock closed at $35.

Other IPOs generating excitement early in the decade included Lone Star and Outback Steakhouse. "But restaurant offerings really tailed off after 1993," says Stouffer. "And the [weak] performance of restaurant stocks in 1994 and 1995 curtailed recent IPO activity in the industry."

Even though Stouffer says "restaurant stock valuations are lower than they were earlier in the decade, and that should continue to slow IPO activity," companies like Bugaboo are still entering the market and taking their chances.

"I didn't really have the luxury of waiting for the market to turn. We needed the capital. We could have gone to venture capitalists, but frankly, that route would have diluted our interests," says Grace. "Private venture capital would have given us more time to refine our concept before going public, but at what cost? How much would the venture capitalists be telling me what to do? They become fairly controlling. That's why some people call them 'vulture capitalists.' When we got right down to it, we decided we really didn't have a choice."

The ups

Although the decision to go public is usually premised on the need to raise capital or to provide an exit strategy for private investors, public offerings do provide other competitive advantages for companies. Customers often feel more comfortable doing business with a public company, banks are more likely to make loans to interested franchisees and management can add stock-option plans to their arsenal of employee incentives. Grace says "using stock options as a tool was one of the bigger motivations . . . in going public."

Still the primary motivation is capital. In the two years since going public, Bugaboo has increased its system from four units with roughly $10 million in sales to 16 units generating close to $50 million in sales. The benefits of capital infusion are even more apparent for Austin, Texas-based Schlotzsky's, Inc.

Schlotzsky's route to a public offering wasn't as direct as Bugaboo's. "Going public became a clear target in 1991," says John Wooley, chairman and CEO of the deli. "The restaurant industry is a very competitive environment, and we felt like we needed to take our concept to the next level and to be a national concept. You can get there more easily by being public."

But the company needed to secure private venture capital to get there. "It took us two years, from 1991 to 1993, to find a venture-capital group that would participate," says Wooley. "We must have pursued a hundred different venture-capital presentations before we hit one where somebody understood what we were trying to do and wanted to invest in us."

That first round of capital helped Schlotzsky's pay off some debt and gave the company a comfortable capital base to help it grow. Starting with 234 units at the end of 1992, Schlotzsky's took the capital, repositioned the concept and began aggressively opening units. By the end of 1995 — two weeks after going public — the company had doubled in size, to 463 units.

"Each year, we're adding as many units as we built in the first 20 years of the business," Wooley says. In 1995, the company opened 120 new units. And with the second round of capital from the December 15 public offering, Schlotzsky's plans to have 610 units open by the end of 1996.

Wooley says he has "been really pleased by the offering," but he only sees it as a beginning. "For us, going public is really just a platform to begin from." The company's short-term goal is to have 1,000 stores. "But the long-term goal is to have 4,000 stores in the United States, averaging $750,000 per store, with system sales of $3 billion," says Wooley. "And having capital certainly makes it a lot easier to go after that goal."

And the downs

Growing the business is the upside of going public. But behind the rosy possibilities offered by huge infusions of capital, operators are learning the intricacies, idiosyncrasies and dangers of being a publicly held company.

"One day, I woke up and watched our stock price go from $13 to $9 after we announced that due to high beef and produce prices, our earnings would fall short of expectations," says Grace. "It was beyond our control, but all of a sudden, this company wasn't worth as much money."

Grace's story about the dangers of failing to meet analysts' expectations is by no means an anomaly. In November 1994, Ron McDougall, president and CEO of Dallas-based Brinker International, told Wall Street analysts that same-store sales had weakened for the country's second-largest casual-dining operator, even though new unit expansion was on target, revenue for the quarter was way up and operating income had soared. But Brinker had not met Wall Street's same-store-sales expectations. By the end of the day, Brinker stock had lost 17 percent of its value, and the company was worth $275 million less than it was eight hours earlier.

"Return on investment at the store level is one of the most important things we look for," says Steve Rockwell, a restaurant analyst with Baltimore's Alex. Brown & Sons. "That's one of the most important measures of profitability for a concept. If those numbers are disappointing, it's going to hurt the stock."

Take a look at Rock Bottom Restaurants. The Boulder, Colorado-based operator of microbreweries and pubs went public at $8 per share in July 1994, four months after the restaurant sector peaked. The company opened seven new restaurants with the capital, the stock soared and the company decided to go back to the market in February 1995 for a secondary offering at $18. This time the offering raised an additional $34 million.

After hitting a yearly high of $29, Rock Bottom came in with earnings of 8 cents a share when Wall Street had been looking for an increase in earnings to 17 cents a share — and the Street doesn't like disappointments. The weaker-than-expected earnings sent the stock to initial levels. Last month, Rock Bottom was trading at $133/8.

The golden rule

Most analysts agree that the '90s have been less than stellar for restaurant-industry stocks, but they also agree that it is very difficult to generalize about the sector.

"You can't track restaurant stocks like other stocks. With some cyclical stock groups, you can look at the overall macro environment and make a group call about the direction of the stocks. But you can't do that with the restaurant industry," says Rockwell. "It really is very much a stock-picker's industry. The stocks perform very differently, based on their individual fundamentals. In the next few years, there will be winners and losers in the sector, and the key factor will be management."

Barry Stouffer agrees. "Investing in restaurant stocks is like investing in a lot of special situations. It is not that often that there are macro factors that affect the entire group of stocks," he says. "But there is one generalization I am comfortable making: If you can't execute in this industry, you're going to fail."

Would you like a prospectus with that gumbo?

"Trying to raise capital is the most difficult thing for a small, single-unit restaurant," says Sam Talucci, owner of Magnolia Cafe, a Creole restaurant in Philadelphia. "Cooking the food is easy, but finding the money to open the second restaurant and move the business to the next step is the hard part."

Frustrated by the world of investment bankers, fully collateralized loans and venture capitalists, yet still intent on opening a second unit, Talucci decided to put together his own stock offering. He spent three years researching a little-known program called the Securities Corporate Offering Registration (SCOR), which is designed to help small companies raise capital through a small, public securities sale. On February 28, 1995, between the hot sauce and the sugar packets, Talucci put out table tents offering $1 million worth of class A common stock to finance a second restaurant.

To make the stock more attractive, Talucci offered dividends in kind to any investor. "If you bought $500 worth of shares, you got a 4 percent discount on your check, and if you bought $1,000, you got an 8 percent discount. Shareholders also got preferential seating, their name on the front door, all those little ego things that go along with owning part of a restaurant," he explains.

Initial response to the offering was extremely encouraging.

"We had almost 1,000 people ask for prospectuses," says Talucci. But after meetings with the interested investors, Talucci only succeeded in raising about $50,000-far short of his $1 million goal.

"It just didn't take off the way we thought it would," he says. "People were worried about the lack of liquidity. With a SCOR, there really is no secondary market for the stock. We were looking to put together a number of these offerings, build a small regional chain, then bundle the whole thing into a public offering five to seven years down the road. And that's where your investment becomes liquid and you make your return. But people weren't comfortable with waiting that long."

Today, Talucci is still trying to find financing for a second unit, and even though he won't try another SCOR offering, he remains convinced it is a good alternative.

"The SCOR makes a lot of sense," he says. "It's a good vehicle for small companies to use if you can convince your investors to take a chance. Everyone wants to own piece of a restaurant, and with the SCOR, you can own a piece without . . . the partnership downside risk. We thought it was a great idea, but we couldn't convince enough people to sink money into it. But you've got to try. In this business, you look at stuff, you try it and some things work. Others don't."

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