Investors Hungry For Potbelly IPO

NEW YORK ( TheStreet) -- Potbelly's initial public offering expected Friday morning is rumored to be oversubscribed from investors eager to take a bite into the strong performing category of fast-casual restaurants this year, but don't expect other popular sandwich shops to follow suit in the near future.

"We're past the point of really having any significant capital needs," said Don Fox, CEO of Firehouse Subs of Jacksonville, Fla.

"The owners love what they are doing. They're still very engaged in the business. There's no reason from a personal or business standpoint to make that kind of effort and there are negatives to becoming a public company that can affect performance," said Fox of the 670-location sandwich chain. "And frankly that public environment would not be in aligned with the way we conduct business," Fox added, referring specifically to short-term decisions for shareholder gain as opposed to long-term decision-making.

Only 28 of Firehouse Subs' locations are corporately owned. That's a significant and important difference between Potbelly and others like Firehouse Subs.

Unlike many of its sandwich-shop competitors, Potbelly is choosing to expand in the hot, fast-casual restaurant industry through corporate-owned locations as opposed to franchising. Potbelly said it does plan to do some franchising.

Potbelly plans to raise roughly $94 million from the IPO, the Chicago-based sandwich shop said in an updated S-1 registration filing with the Securities and Exchange Commission on Wednesday. It will sell 7.5 million common shares -- split between 146,442 shares sold by existing stockholders and the rest from the company. (It also has an overallotment of up to 1.2 million shares to sell to the underwriters). Potbelly is listing under the ticker symbol PBPB on the Nasdaq.

Banking on the strong IPO market this year, Potbelly on Wednesday upped the offering price to between $12 and $13 a share from the original pricing of $9 to $11 a share, according to the filing.

But it plans to use roughly 60% of the proceeds it receives and immediately return those to shareholders in the form of a cash dividend. Using the midpoint range of $12.50 a share, the company expects to receive net proceeds of $83.9 million, $49.9 million of which be used to pay a cash dividend on common and preferred stock, Potbelly said in the filing.

The remaining $34 million will be used to repay borrowings under the company's credit facility and for working capital and other general purposes, it said.

As of Sept. 23, Potbelly had a total of 295 shops in the U.S., six of which are franchised. Potbelly also has 12 franchised shops in the Middle East.

Potbelly plans to continue opening stores, with 32 to 35 new stores by the end of 2013. It plans to grow stores by roughly 10% on an annual basis, maintain margins above 20% as the company grows and maintain "general and administrative expenses under 10% of revenue," the filing said.

Seeing that it plans to expand mainly through corporate locations, bankers -- and investors -- are eyeing the dollar signs. Corporate-owned locations means that sales revenue (as opposed to just royalties) goes directly to the parent company.

"A corporate-owned brand could probably go to an IPO quicker than a franchised brand," said Paul Segreto, president and CEO of Franchise Foundry, a franchise consulting firm. Companies are "more attractive to investment bankers ... with more corporate-owned locations."

Franchised companies would need to see significant royalties in addition to a bigger bottom line on the balance sheet to appeal to bankers and private-equity firms, Segreto said, which means at least 500 locations or more.

Chipotle ( CMG) and Starbucks ( SBUX), for instance, have mainly corporate-owned stores; Panera Bread ( PNRA) is split between corporate-owned and franchises.

Chipotle's stock is up 43% this year; Panera is up just 1.2%.

Investors Are Hungry for Potbelly

Potbelly is "multiple times oversubscribed to a very strong retail and institutional book," said Scott Sweet, senior managing partner of IPO Boutique. "This is -- without question -- the deal of the week," he said, although it doesn't quite have the demand of fast-casual chain Noodles ( NDLS), the last restaurant deal to come to market in June. Noodles' stock is up 12% since its first day of trading on July 1.

Potbelly will also have to surpass the strong first-day performance of Burlington Coat Factory ( BURL), whose shares soared 47% on Wednesday, its first day of trading, above its IPO price of $17 to close at $25.01.

The Fast-Casual Appeal

Potbelly and other sandwich shops, Jersey Mike's, Jimmy John's, Firehouse Subs, to name a few, are benefiting from what customers perceive as healthier options to fast-food chains.

"This entire sector has been in a really solid growth position for many years now," Firehouse Subs' Fox said. "The offerings are a lot healthier. Customers have the choice to be as indulgent as they like and easily modify a sandwich with a wide variety of proteins."

It's also operating in the strong performing fast-casual segment of restaurant dining.

"Fast casual" is a subsector of limited-service restaurant dining. It's usually characterized by serving cook-to-order menu items, better quality ingredients and slightly higher check averages than a typical fast-food chain. Consumers, still reeling from the recession, want a better dining experience than at a fast-food chain, yet stop short of wanting full-dining experiences.

At Potbelly, for instance, restaurants allow for diners to sit down in a casual atmosphere decorated similarly to the first restaurant which originally was an antique store. They also have live local musicians playing to allow for a relaxed experience.

Customers like "the unique experience," Sweet said. "It's not like going into a Subway. It's a whole different experience."

Still executives like Fox give a nod to Subway for paving the way for the sub sandwich category's success. With more than 40,000 franchises across the globe, Subway is still privately held.

Lots of Sandwich Competition

Firehouse Subs has specific goals of roughly 2,500 restaurants. It is in its fourth year and is on pace with the 10-year plan it set out for itself to reach 2,000 restaurants by 2020.

"As long as I am performing at a superior level, I don't fret too much over what level of penetration those other sandwich shops have," Fox said. "Subway is ubiquitous. They're almost become a non-factor in my thinking."

"We've got to be the best at what we do. Period. We've got to be a superior choice so that it doesn't come down to just numbers," Fox said. "We are clearly different from them and our customers understand that. Firehouse isn't necessarily designed to be in all areas."

Jersey Mike's has a similar outlook as Firehouse Subs.

"Combine the healthy nature of our product against the taste outstanding and add to that a true authentic East Coast sub with high quality ingredients ... that separates us from other food establishments," said Hoyt Jones, Jersey Mike's president. "And I think that's why it resonates literally from coast to coast. There isn't a market that we haven't been successful in."

The Manasquan, N.J.-based franchisor expects to end 2013 with just about 700 locations, with about 125 new locations opened over the course of the year. It plans to open another 150 to 175 stores in 2014 moving further into the Pacific Northwest, New England and deeper into more major metro areas.

"The big news this year obviously was New York City and we will open our second store in midtown sometime in next four or five weeks," said Jones. "We're excited about our foray into New York, but were also growing. We're active in 35 states."

The company feels comfortable with a goal of 4,000 domestic stores -- 10% of which would be corporate-owned, the rest franchised, Jones said. Currently about 4% are owned by corporate, he says.

Jones said strong vendor relationships and supply pricing are key to franchisee success.

"We're able to run good margins," he added. "A lot of our growth is internal," due to existing franchisees building out additional stores.

Jones also said cultivating stronger franchisees, many of whom already have restaurant experience and are likely to own franchises under other brands, is also key. "So they know food costs, labor costs, facility costs and what they're looking for as a return on their capital," he said.

Even with its success so far, Jersey Mike's doesn't have an interest in going public. With founder and CEO Peter Cancro as the company's sole owner and a line of credit available at Wells Fargo to continue to grow existing company-owned stores, there is little need to appeal to the public markets, Jones said.

"I think all the benefits of being a privately-held company are just too great and with our growth model primarily being franchised, it's probably not warranted," Jones said.

-- Written by Laurie Kulikowski in New York.

To contact Laurie Kulikowski, send an email to: Laurie.Kulikowski@thestreet.com.

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