Buffalo Wild Wings proxy battle with Marcato is a 'lose-lose' situation for shareholders

• Wedbush analysts called the proxy battle between B-Dubs and Marcato a "lose-lose" situation for shareholders.
• The equity research firm downgraded the company's stock to "underpreform" from "neutral."
• Wedbush also lowered its price target for the company to $115 from $150.

Source: Buffalo Wild Wings

Shares of Buffalo Wild Wings fell more than 4 percent on Tuesday after Wedbush slashed its rating on the stock, calling the company's proxy battle with activist Marcato a "lose-lose" situation for shareholders.

"We view the outcome of the upcoming proxy vote as irrelevant given our view that neither alternative offers a viable solution to the company's ongoing deterioration in fundamentals," Nick Setyan, an analyst at Wedbush, wrote in a research note Tuesday.

Setyan downgraded B-Dubs shares to underperform from neutral and cut the price target to $115 from $150. Shares of the company recently changed hands at $144.63, down more than 4 percent.

According to the analyst, if the company were to continue along its current strategy, same-store sales would likely grow at a slightly positive rate, but would be driven by discounting and promotions, which will ultimately drive the average check lower and place more pressure on Buffalo Wild Wings' margins.

In addition, he pointed to growing wing costs and labor inflation as headwinds for Buffalo Wild Wings in coming quarters.

All of this is a potential threat to the wing chain's ability to meet its earnings forecasts as the company is unlikely to be able to offset its higher costs by raising prices. As a result, Setyan reduced his 2017 earnings forecast to $5.16 a share from $5.48. His 2018 forecast dropped to $5.78 a share from $6.23 a share. Both estimates are far below the Wall Street consensus estimates.

According to Thomson Reuters survey of analysts, B-Dubs is expected to earn $5.54 a share this year, and $6.79 a share next year.

However, Setyan said the hedge fund's plan is not "a viable alternative" to the company's strategy.

Marcato wants to boost Buffalo Wild Wings' franchised stores from 50 percent of its fleet to 90 percent, a strategy Setyan said is "no longer compelling" and likely won't boost the stock up significantly over current prices.

"In recent presentations, Marcato has implied that the lower end of their expected 2-5 year range for the process of refranchising may be more realistic," he wrote. "Even the lower end of that range is a meaningful amount of time for unit and area managers to deal with uncertainty in a highly competitive restaurant labor market."

Meanwhile, both sides continued to make their cases, just days ahead of the June 2 vote.

Buffalo Wild Wings CEO Sally Smith addressed shareholders Tuesday, touting her nearly 21-year tenure with the company. She blamed slowing mall traffic, a decline in sports viewership, and millennial consumers who cook at home more frequently and order delivery for why sales have been sluggish.

"Despite these headwinds, Buffalo Wild Wings continues to perform well, achieving positive same-store sales growth in the first quarter of 2017 and generating substantial free cash flow," she said.

Smith also touted strategies the company is employing to improve its results such as testing smaller locations that can be opened in more heavily populated areas to focus on takeout and delivery. The chain also is trying marketing programs that are aimed at boosting check size and looking for ways to cut costs.

On the other side, Marcato founder Mick McGuire boasted in a letter to shareholders Tuesday about the support it received from independent proxy advisory firms Institutional Shareholder Services and Egan-Jones.

Egan-Jones supported all four of the board candidates proposed by Marcato, but ISS only supported three of the four. ISS backed McGuire, Scott Bergren, a former Pizza Hut CEO, and Sam Rovit, CEO of CTI Foods, who is also on Buffalo Wild Wings' slate.

ISS did not support Lee Sanders, former chief development officer of TGI Fridays, saying that Sanders did not need to be added to the board because the proxy advisor did not feel Marcato needs to fully implement its refranchising strategy.

Like Setyan, ISS said refranchising such a high percentage of restaurants could be risky as the transition period is very disruptive.

In his research note, Setyan cited the experience that Jack in the Box had when it refranchised a smaller number of restaurants than is proposed for B-Dubs. Jack in the Box's employees felt insecure and were less productive during the conversion, according to the chain's CEO Lenny Comma.

Marcato, which now owns 9.9 percent of the outstanding shares of Buffalo Wild Wings, continues to push for refranchising, which it believes will create significant value for shareholders.

Both Buffalo Wild Wings and Marcato encouraged investors to vote for their proxy card ahead of the vote Friday.