Shack Attack - Thoughts on Shake Shack’s IPO
I’m a huge fan of Danny Meyer and his Union Square Hospitality Group, a restaurant empire that he started almost 30 years ago with the opening of Union Square Cafe in the then-gentrifying neighborhood of Union Square. His book ’Setting The Table’ is a masterclass in building and running a hospitality business, and required reading for onefinestay’s NYC team. I recommend it to entrepreneurs all the time. The founding story of Shake Shack, which filed to go public today, features in this book. It’s come a long way from starting out life as a hot dog stand in Madison Square Park 10 years ago.
The IPO prospectus makes interesting reading for any hospitality, retail or ‘multi-local’ entrepreneurs (or an ex-banker like myself who enjoys reading S-1 filings!). Here are some of the highlights from my quick scan:
- The ‘TAM’ (total addressable market) for burgers globally is $135bn. This means that $135 billion dollars is spent on burgers around the world every year. Who knew? However, as a food business delivered locally this addressable market needs to be put in perspective: in reality for Shack its chipped away $5m at a time, with $2m of upfront investment and a 2 year payback period (on average) & all of the challenges with scaling HR systems e.g. general manager pipelining, etc.
- There’s a real discrepancy between Manhattan Shake Shacks and rest of country / world. Wonder how true this is for other retail / restaurant concepts. Manhattan Shake Shacks generate about $7.5m of total sales with 30% operating margins at scale - non Manhattan Shacks are considerably less successful at around $4m with 22% average operating margins (so less than $1m generated annually). For reference: McDonalds averages $2.5m per store - this is great performance
- Same store = not an opportunity for much growth. Shacks seem to cap out at around $7.5m sales (in NYC), and with 30% margins (very high in the industry) there’s probably not a lot of further efficiency gains possible. Having seen the lines out the door for the Battery Park City Shack, I can attest that its hard to imagine squeezing much more topline in a Shack.
- Ever seen a Shake Shack in Dubai? Or London? This is because Shack licenses its brand to Alshaya, a highly successfully franchisor in EMEA of international retail & restaurant brands. This will deliver over $5m in license revenue this year - given strength of brand I would have thought licensing is a big opportunity in non core territories.
- Annual growth is just under 40%, EBITDA margins about 25% (which is pre new store opening costs, central HQ costs, etc.). On this basis Shack stores will do just over $100m revenues, $25m EBITDA pre central costs & new store openings this year. That’s a lot of profit. However, there’s a lot of costs below this line too - around $16m in ‘non store’ HQ costs (G&A); new openings ($5m or so run-rate), depreciation as this is a capital intensive business (another $5m). These are only slightly offset by license fees (approx $5m this year). So it looks like a pretty low margin business (<5%) while investing in growth, as one would expect. One hopes that HQ costs don’t need to scale with new openings but this is often an issue for multi-local businesses.
All this is to say that Shake Shack looks, unsurprisingly, like a restaurant business, not a technology startup. Its easy to see why growth has been around 40% instead of higher: stores cap at fairly low levels (compared to say hotels) of revenue & profit contribution, & its expensive and time consuming (relative to Internet or e-commerce businesses) to generate real profit because its predicated on store expansion. Since most of the world exists outside Manhattan, its going to be many sub $1m EBITDA stores to build a cash generation machine - the key bet that needs to pay off is that its urban, higher order value ’Shackonomics’ will port to markets that will over time look less and less like Manhattan. And its a long term bet - which dovetails in any case to Danny Meyer’s approach.
Besides the continued roll-out of same store Shacks, which is ‘business as usual’ for Shake Shack, I would imagine there’s a real opportunity to extend the ‘fine casual’ format to adjacent meal types & own this category domestically. Consumers are ready for an urban brand & sustainable approach - both in terms of ingredients as well as management practices - in pizza/pasta, sandwich shops, etc., and the existing stores could be a great vehicle to incubate and test these. Chipotle is a great example of this but USHG takes the concept even further, and it has the engine to roll these out industrially. After all, there’s only so many times you’ll eat a hamburger per week if you are within Shack’s core demographic today. Another big opportunity that leverages the power of the Shack brand and its per-store metrics should be ability to cut great franchise deals in non-core markets. I’m sure these guys have invested in a crack corp dev team to facilitate this.
As a homegrown NYC brand, with a long-term, employee-first corporate culture, it’ll be interesting to see how the Shack story continues to play out over the next few years. I wish them lots of continued success.