Analysis of SLVR financials.
Disclaimer. Do your own DD. My analysis may be completely wrong.
The 1998 Annual Report was interesting from several standpoints. In my view, the figures imply that SLVR cannot be profitable in the near future. On p. 21, dividing 1991 operating income by net sales yields 5.4%. This means that after the smoke clears, restaurants bring in that percentage of net sales as profit for the company. That is not enough to balance company overhead, though.
(In a previous posting a long time ago I think I had incorrectly concluded that the restaurants had a 20% return, so don't believe what you read unless you check it out yourself. If a restaurant takes about $1.5 million to build, I now calculate the return on investment as less than 10% for a 20 year investment life: initial investment per restaurant -$1.5 million; cash flows of $140,000 per year, and sale at year 20 for the purchase price.)
Shareholders have long known that SLVR was a good concept. The same-restaurant sales growth appears to be keeping pace with inflation. The population is increasing. Nostalgia will continue at least until the demise of the baby boomer generation. As long as the neighborhoods around the restaurants retain their affluence and safety, SLVR should expect to compete effectively.
Therefore, the only question is when the company will become profitable. We see from p. 21 that the administrative expenses plus depreciation (excluding abandoned site costs and hoping we won't have these again) is just over $3 million, and is remaining relatively constant. Operating income is about $1.5 million. This implies that operating income must double in order for the company to break even. That is probably an underestimate, since administrative expenses would likely increase at some point. Attempting to reduce administrative expenses further is problematic, because quality control would suffer, and quality is key to the success of SLVR.
Since the current net sales are generated from 11 restaurants with none opened in 1998 (i.e., relatively stable cash flow for 1998), it appears that the company will not be profitable until at least a dozen more restaurants are opened of similar sizes. Because opening restaurants must be done with great care (finding a good location, performing market and census analysis, negotiating leases, arranging construction, etc.), it is unlikely in my view that more than four restaurants can be opened per year without significant risk. Moreover, the estimate of a dozen new restaurants bringing profitability presumes that the restaurants could be opened without debt expense, which is not the case.
P. 16 carries the statement that up to two restaurants could be constructed in 1999. I think that is a little optimistic, and it will likely be one restaurant, if any. Cash and equivalents are $1.6 million, and working capital (p. 9) is $600,000.
Additional restaurants will require external financing. The company is trying to get a $3 million loan to open at least two restaurants in 2000. I am not convinced that they will obtain this loan, because as far as I can tell, the operating income from a restaurant is insufficient to pay the interest on the loan. On the other hand, the company has $21 million in assets. Banks do have reasonable assurance of repayment of debt, either on time or through liquidation.
To be profitable (please check my calculations), SLVR must either a) somehow achieve operation of about 25 restaurants; b) greatly increase current sales; c) increase operating efficiency of existing restaurants dramatically; d) or else must cut administrative expenses by half. None of these goals seems feasible in the near term. New restaurants appear to cost more to finance than they bring in as profit. Sales are already brisk, and seating is limited, so per-restaurant volume may be hard to increase. Labor and operating expenses are difficult to reduce without losing customers. The salaries of the Board of Directors members are not unreasonable, particularly if they are also doing work for the company; even if they worked for free, it would not be enough to offset the loss.
This sounds pretty grim, but it is not the whole story. As SLVR buys restaurants, they increase their asset base. Also, even if the financing on new restaurants eats up (so to speak) the profits, it is not by much. Each restaurant brings in about $140,000 yearly net profit to the company (divide restaurant operating income by 11 restaurants). Amortizing $3 million for 30 years at 10% (estimated parameters) yields about $316,000 per year if paid monthly. Therefore, two restaurants would bring in about $280,000 per year, but the mortgage payment is $316,000. If same-restaurant operating income could be increased by 2% each year, after about seven years the restaurant net profit would exceed the required payment. Meanwhile, the restaurant becomes an asset through payment of the principal.
The plan all along has been to create a chain with sufficient name recognition that it could be franchised. That is when the explosive growth will occur, not before.
On p. 4 it says that the directors and others bought about $1 million of SLVR stock. That may be because they had confidence in the company, but I must wonder if part of the rationale was to keep the stock price above $1 in order to avoid de-listing. However, the fact that Mr. And Mrs. Giaimo appear to own close to four million shares of SLVR does indicate that they have an incentive to make the company succeed. Their leverage through stock is vastly greater than through salary.
By the way, speaking of shareholders and stock, I wonder who owns the stock that is not in the hands of the directors. It looks as though are about 8 million shares not owned by principals or those with more than 5% interest. There are fewer than 500 shareholders. This means that the average holding of the silent majority is 16,000 shares per shareholder. That is a substantial amount, especially given that most of the shares were probably purchased at higher prices and are being held despite the falling price. Some shareholders are probably the friends, relatives and business associates of the principals. Some may be SLVR managers or upper echelon employees. It would be interesting to know. With so few shareholders, maybe it would pay to have a big party. If half of the people attended, they could fit in a diner. Or if everybody wanted to come, maybe have a midnight till dawn special shift with two seatings.
The annual report paints a rosy picture. Indeed the trends are good. However, despite the progress on several fronts, I cannot see how profitability is possible anytime soon. I would love to be mistaken. I do believe that the focus of management on attraction and retention of good employees, and on the value of the human resources, is completely sound and, above all, highly ethical. They say the guys with the white hats win, so let's hope we deserve to wear them.
Here are the scenarios, as I see them.
1. The company continues to erode with losses, and is finally bought out by a similar chain, which would consolidate administrative operations. That would probably happen at a share price approaching book value, but likely not much more.
2. The company expands the number of restaurants through bank financing, achieves brand recognition, and starts franchising nationwide. Stockholders and directors celebrate. Stock moves to $5. I think this would take until 2002.
3. The company dilutes the stock through a new issue, raising about $15 million. This would permit construction of about 10 new restaurants. Stock price falls by half or more. A 1-for-10 reverse split keeps the stock from being de-listed. This is actually the best alternative in the long run, because then the new construction is financed interest-free by the stockholders, who would eventually obtain that money in the form of increased share prices due to realized profits. It would be best if the stock could be issued as a private placement, since volume of SLVR does not indicate to me a huge demand for more stock. The victims are the previous stockholders, but hey, that's why they call it speculation.
4. The directors decide that success is not possible, and drain the company dry through exercised and sold stock options coupled with increases in salary.
I am long, and holding at a loss, but I am hoping for option 2. In my opinion, unless options 3 or 4 come up, it is likely that a stock price of .75 or below is a buying opportunity, because it will then need to rise to 1 or more within a few months to avoid de-listing. Please take all this with a grain of salt, because I am not knowledgeable about stock exchange regulations.
The fundamental question is: how can SLVR make significantly more money from existing diners. If they could double operating income, they would be profitable today. Let's figure out how it could be done.
Get every patron to spend twice as much. This won't happen, of course. But suppose 20% of the patrons spent three times as much. That might help. Assume that 20% of the customers are gentrified, either yuppies, dinks (dual income, no kids), rich, professional, government workers from the faceless bureaucracy, or otherwise well heeled. That might be an overestimate, but bear with me. These people will not object to spending a lot of money on a meal. Indeed, their time is more important than the money. For someone making upwards of $70,000 per year salary, or with a family income exceeding $100,000 per year, it makes little difference whether dinner costs $20 or $40 per person, as long as they enjoy themselves. One way to encourage this is with something we could call the “executive menu,” available upon request. It would be a special menu, separate from the ordinary one so as not to embarrass the normal eaters. On it would be very high quality items, such as superior wines (Margaux, St. Emilion, Champagne, the Mosels, Chianti Classico) and special variations of the usual menu (stir fried vegetables teriyaki style with a well composed salad and saffron rice; prime filet mignon with baked potato and ratatouille; red snapper in lemon-butter-garlic white sauce with string beans almondine and broiled tomato; mezzaluna pasta in cream sauce with tiramisu for dessert; mango-kiwi milkshake smoothie with fresh raspberry puree).
A normal add-on is delivery service, but traffic is so heavy in the metropolitan areas that this is best contracted out through firms such as Take-Out Taxi or other, similar companies. The “executive menu” might go over big if delivered, though. Make sure it arrives in stylized, microwavable containers, like the most elegant tv dinners. Also, at the end of the day, the executive menu can be offered to the late-night eaters for discount prices, so no time-sensitive ingredients go to waste.
SLVR needs to build an image, not of the diner, but of the ‘50s as related to the new century. Very elegant, creative, dynamic and forward-looking T shirts and sport shirts should be sold at the counter. SLVR should develop several designs. One example might be a diner shape, but impressionistically streamlined. In front of it are shapes of people looking up and beyond it to a star-filled sky. Something along those lines. The words “Silver – Starlight Edition” or similar upscale lingo could be present. Start a fad.
Start a catering service, or furnish food to existing caterers. Keep the kitchen going all night.
Provide car service from the parking lot, like the old days, if local permits allow it. That could easily double or triple the number of “seats” per restaurant. Where weather permits, put out picnic tables in sections of the parking lots and serve the meals there; during daylight only unless well lighted and safe.
I am just brainstorming this stuff, without knowing how much has already been thought of and rejected for good reasons. However, maybe some SLVR shareholders have ideas that would work well for the company. It might pay to make SLVR management aware of them.
I intend to hold most of my shares for the long term. I like the food at SLVR and would like to see them succeed. The world is a better place with diners in it.
Don't invest anything you can't afford to lose. |
