OSI Restaurant Partners (OSI:NYSE) BULLISH
Price: $35.77  |  52-Week Range: $34.45-$48.28
  • Pirate Capital is the latest activist at the casual dining table.
  • OSI's depth presents an appealing investment opportunity.
  • The stock could return to the $45 level by year-end.
Position: None
Investing
Activist Track: Pirates of the Outback
 By James Altucher
RealMoney.com Contributor

6/20/2006 11:50 AM EDT
URL: http://www.thestreet.com/p/rmoney/investing/10292684.html

It's almost funny how much activist hedge funds like casual dining and fast-food restaurants. Out of the 11,000 companies out there, is this category really so poorly managed and undervalued that the activists gravitate toward the space? Or perhaps it's a function of "buy what you understand," and everyone understands a Big Mac.

Personally, I haven't been a big fan of Outback Steakhouse, which is owned by OSI Restaurant Partners (OSI:NYSE) . I took my two kids there last year and I really didn't like it. I much prefer other activist favorites like Chuck E. Cheese or even Denny's. But clearly, Warren Buffett disagrees. He owns 1.8 million shares of Outback.

And this past week, Pirate Capital, whose activist efforts I've written about repeatedly, got involved in OSI.

OSI is the third-largest operator of casual dining spots, operating 1,298 restaurants in the U.S. and 21 other countries. Of these restaurants, 86%, or 1,137, are company-owned. Some of its most popular restaurant chains are the aforementioned Outback (775 domestic and 140 international locations), Carraba's Italian Grill restaurants (200 locations), Bonefish Grill (90 locations), Cheeseburger in Paradise (two locations), Fleming's Prime Steakhouses (39 locations), and Roy's (20 locations).

OSI's top competitors, which account for the top two operators of casual dining spots, are Darden Restaurants (DRI:NYSE) and Brinker International (EAT:NYSE) .

Most recently, OSI has experienced a 2.6% decline in same-store sales but it's unclear if this is a useful operating metric. As Eddie Lampert has pointed out when looking at Sears Holdings' (SHLD:Nasdaq) same-store sales, it's easy to boost them in any particular year by making sure you open up a bunch of stores in the prior year. Most stores, no matter how bad, will show a huge increase in same-store sales from the first to second years, artificially boosting the number.

In fact, the fastest growing parts of the OSI empire are its newer brands: Sales at chains such as Bonefish Grill and Fleming's Prime Steakhouse rose by 1.7% and 7.4%, respectively.

On June 5, Pirate Capital filed a 13D stating that it holds 5.30% of the total common stock of OSI Restaurant Partners. In the filing, Pirate said it believes that "the market price of OSI shares fails to reflect the value embedded in the Carrabba's, Bonefish Grill and Fleming's concepts, the potential for margin recovery at the core Outback concept and the significant value in the Company's real estate portfolio." Click here for the full filing.

This isn't the first time Pirate has played in this space. In the past few months, Pirate has bought up 10% of CKE Restaurants (CKR:NYSE) , which owns the Hardees and Carl's Jr.'s chains. Pirate has been pushing CKE to sell off real estate and use the proceeds to buy back stock. CKE hasn't started this year, but Pirate has won a seat on the board of CKE.

In OSI's case, Pirate is asking for three things.

First, Pirate is encouraging OSI to establish a special committee of the board of directors to devise a plan for shareholder value initiatives. In the response to this, the board said one of its primary goals for OSI is for its shareholders to see greater returns. So in this respect, OSI is open to any constructive ideas Pirate might have in mind.

Second, Pirate proposed spinning off some of OSI's most profitable restaurant chains, such as Carrabba's, Bonefish Grill and Fleming's, that have strong growth potential.

Finally, Pirate urges OSI to cease domestic new-unit growth of Outback and other fledgling concepts. The Outback Steakhouse chains' low earnings have caused OSI to "deteriorate to approximately 11%, or an estimated 300 basis points below the casual dining sector average."

At the end of this filing, Pirate Capital LLC requested a meeting with OSI Chairman Chris Sullivan to find ways to unlock the value in its shares. OSI CEO Bill Allen announced that the company may begin selling some of its real estate. It did not describe what it would do with this potential capital gain, but OSI could possibly use this to buy back some of the company stock.

I like the restaurant space, Pirate has a great track record, and Buffett is a believer in the company as well. The fact that I do not like their steak has no bearing on the fact that I believe the stock is heading back to $45 or higher by year-end.

Here's some additional information:

At the time of publication, Altucher and/or his fund had no positions in stocks mentioned, although positions may change at any time.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

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