Wall Street Punked Again
Oops! They did it again! Wall Street has botched another initial public offering of a flyover-country food company. A few weeks ago, I looked into the public offering of Noodles & Co., a modest but large carbs dispenser based in Denver whose restaurants populate Big Ten country. That stock popped on its opening, the way Internet stocks routinely did in the 1990s, rising 104 percent on its first day of trading.
In theory, that shouldn’t happen. Underwriters gauge demand by talking to big investors and asking how much they’d be willing to pay, based on their assessment of the quality of the company and the sexiness of its story. If the shares double at the opening trade, the underwriters screwed up. They misdiagnosed the demand for the stock. Worse, their client, the company selling shares, left money on the table. My theory was that a personal and geographic food bias was at work, a kind of coastal snobbery. It’s likely none of the people working on that deal had eaten at Noodles & Co. And everybody knows that the midsection of the U.S. is a food desert. The dudes at UBS and Morgan Stanley ate crow over Noodles & Co. because none of the dudes at UBS and Morgan Stanley ate at Noodles & Co.
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After that debacle, you’d think that Wall Street firms would learn to do a little more due diligence on the interior food culture. But Wall Street is slow to learn. And almost the exact same thing happened last week, with the initial public offering of an Arizona-based natural-food-store chain called Sprouts.
On July 31 the 150-store chain sold 18.5 million shares of common stock to the public at $18 a share. As is often the case, the firms underwriting the deal, led by Goldman Sachs and Credit Suisse, had the option of purchasing another 2.75 million shares at the same price. That would bring the total sold to 21.275 million shares at $18 a share, for a total of $344 million after commissions. Coincidentally, $18 is the same price the Noodles & Co. IPO took place at. And guess what? The stock of Sprouts went banoodles.
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Here’s the chart.
The stock opened trading at about $36, double the IPO price, and closed the first day at $39.86—a one-day gain of 121 percent. Now the company is valued at an impressive $5 billion. Had the IPO gone off at the price the market was really willing to pay, Sprouts could have raised $760 million by selling the proportion of its shares to the public. That’s a big difference.
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So what the hell is Sprouts? And what makes it so hot? I’ll make a rare confession of ignorance. My food tastes run high and low, and I travel whenever I can. But just as I had never heard of Noodles & Co. before its IPO, I had never heard of Sprouts. The first Sprouts Farmers Market store, advertising healthy living for less, opened in Chandlers, Arizona, in 2002. It has grown organically (get it?) and through acquisition. In 2011, with the assistance of the private-equity firm Apollo, it merged with Henry’s Holdings, which owned 43 stores that operated under the Henry’s Farmers Markets and Sun Harvest Market brands. Last year, Sprouts bought Sunflower Farmers Market, a 37-store chain. All in all, the company last year effectively had 163 stores and total sales of $2 billion. When it purchases stores from rival chains, it typically rebrands them as Sprouts markets.
Sprouts is a big and healthy business. The prospectus notes that its stores have racked up impressive same-store sales growth in recent years, through the downturn and in this stunted recovery: 5.1 percent and 9.7 percent in 2011 and 2012, respectively. In an age of big boxes and mega-centers, its stores are on a human scale—the average store size is about 27,500 square feet—and are tricked out to look like bright, airy farmers’ markets.
The stores are nestled in the country’s Southwest. There are 26 in Arizona, including one in (surprise!) Surprise; 75 in California (including two in Yorba Linda); 29 in Texas; 24 in Colorado; and a handful in Nevada, New Mexico, Utah, and Oklahoma. (Here’s a store locator.)
The map of the stores may help explain why Sprouts is seen as a growth story—and why it slipped under the Wall Street radar. The stores’ geographic footprint is confined to huge, wide-open states where underwriting syndicates rarely tread. That’s good, the Sun Belt and energy-rich states are seeing solid population growth. Sprouts clearly has a strong foundation in a comparatively wealthy, economically vibrant market. More significantly, it has no position whatsoever in many of the nation’s most heavily populated areas. No Sprouts has yet sprouted on the eastern bank of the Mississippi River. That means some of the world’s most desirable consumer markets—Atlanta, Washington, D.C., New York, Boston, Chicago—are virgin territory for the company. We all know that people on the Eastern Seaboard can adopt foreign grocery concepts as their own, even if they come from Texas. (See under: Foods, Whole.)
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The company makes no secret of its Texas-size ambition. In the prospectus, it notes: “According to research conducted for us by Buxton Company, a customer analytics research firm, we have significant growth opportunities in existing and new markets across the United States with the potential for approximately 1,200 locations operating under our current format.” Were Sprouts to grow to 1,200 stores, that would represent an 7.5-fold increase. “We intend to achieve 12% or more annual new store growth over at least the next five years, balanced among existing, adjacent and new markets,” the company says.
Clearly public investors, who include lots of people and institutions based in Sprouts country, think much more highly of the chain’s growth potential than its bankers did. And again, I’d argue that the same snobbery and narrow vision that led to the underpricing of Noodles & Co. was at work in the Sprouts offering. It’s a safe bet many of the bankers on the deal—and especially the people who run those divisions—had never shopped at a Sprouts. It’s doubtful any of their help has ever set foot in one, either. When brands are not part of your daily life, it’s easy to discount them. Wall Streeters either need to get out more or set up outposts in dusty Western towns.
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So what’s next? A chain of pizza joints based in Wyoming? A yogurt chain based in Oklahoma? (Oh, wait.) Who knows? But listen, here’s a hot tip: forget the next cloud-based virtual application software provider. The next time you see an initial public offering from a food company based in flyover country, tell your broker you want in.
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