Sweetgreen (SG): Make Time Your Ally On IPOs

Date: 11/16/2021
Author: Mr. X

It was the best of times, it was the worst of times…

Consider A Tale of two Initial Public Offers (IPOs).

First, it was the best of times for Sweetgreen [SG]. The fast(ish) food company that provides healthy meals is to gentrification today what overpriced cupcake boutiques were a few years ago. (Remember those?)

Sweetgreen is likely to outlast those more decadent symbols of an Ancien Régime. Sweetgreen is upscale, uses apps and its website to allow for easy pickup and delivery orders, and has a solid brand that focuses on real food in an increasingly processed and artificial world. It’s not an accident that it initially gained popularity among workers in tech, finance, and government. Fast, healthy, customizable, and authentic is what people want, especially those who work in sterile environments manipulating code, figures, and narratives.

The S-1 claims the company has experienced “positive momentum across all of our channels” ever since the introduction of COVID-19 vaccines and the return to offices by employees. Even a public relations fiasco when co-founder Jonathan Neman said “no vaccine nor mandate will save us” from COVID-19 hasn’t stemmed the restaurant’s growth.

Of course, Neman was right, as even some government officials occasionally mutter about learning to live “with” the virus, though there will be a few more lockdowns and mandates before we get there. A healthy diet for busy workers is also going to be an important part of the permanent pandemic world. Still, especially in DC, you aren’t supposed to say certain things, particularly the stuff everybody secretly knows.

(Look on the bright side Jonathan – at least it doesn’t compare to Papa John’s in terms of PR disasters).

If you’re looking at the bottom line of SG, you might see some problems. Each restaurant reportedly requires about $1.2 million worth of investment. A business model based on a “return to offices” seems questionable. It’s not just that lockdowns or other health policies could disrupt sales – it’s that many workers want (and, in a tight labor market, can demand) remote working. Expansion into the suburbs partially solves this problem, but then you are dealing with a fundamentally different kind of market. The company is not profitable and probably won’t be anytime soon. And while a healthy lifestyle is an attractive brand, the reason so many Americans eat unhealthy diets is because, paradoxically, it costs more to eat well than to eat junk.

Inflation is hitting food prices just like it is everything else – though vegetarians can take some solace in that beef and veal prices are rising far more quickly (at 6.5% year-over-year in September 2021) compared to fresh vegetables (just 0.6% year-over-year). Still, SG will at least be hit by poultry prices. More importantly, just like every other quick-service restaurant, they need to deal with labor forces that can walk off the job if they don’t get what they want.

The company may have a plan for that. It recently acquired Spyce Food Co. – where robots make the food. However, a transaction like that requires major capital in an industry where profit margins are low and getting lower.

A restaurant isn’t like a tech company, where you don’t expect to see gains for years. One might think investors to be cautious. Yet Sweetgreen provided sweet green for early investors on day one, with shares increasing by as much as 91%. The initial marketed price range was $23 to $25 a share. The company priced shares at $28. It opened at $52 a share, and closed at $49.50. The company thus raised $364 million to cover its plans for expansion.

Now let’s look at an IPO that didn’t go so well.

Warren Buffett

Warren Buffett is known as a prudent man who doesn’t take huge risks. Thus, his backing of the Indian fintech company Paytm (PAYTM.India) might have seemed like a strong IPO. Mobile payments are rapidly expanding around the world. In some Asian countries, they are the default way of making transactions. The company could potentially challenge Chinese firms that may be suffering from their government’s aggressive moves for political control over corporations. With backing from Buffett’s Berkshire Hathaway, it seemed like Paytm would be well placed to ride India’s surging tech market.

That didn’t happen. Paytm was the biggest ever IPO for the Indian market, but shares plunged 27% on day one. It was especially puzzling to some investors because other recent Indian IPOs have done well – so well, that Indian regulators are trying to curb speculative frenzy. This might have been a problem for Paytm, as new rules limiting how much people can borrow to buy shares of a new stock and restrictions on the ways companies can spend newly acquired capital may have hit at precisely the wrong time.

Yet even with that, one might have easily expected Paytm to still be the perfect company at the perfect time – with the Indian government also working to cut down on the use of physical cash. This extends to the point of demonetizing older banknotes. “Health” is a good excuse for governments to cut down on the use of cash, but a more digital economy also allows those in power to control transactions more easily. Given that I believe in using power politics to your advantage when it comes to investments, why did Paytm fail?

The answer is that we don’t know that it has – or that SG has succeeded. The major gains with IPOs, as Dr. Kent Moors pointed out when discussing EV company Rivian [RIVN], are made by the underwriters. In SG’s case, those included Goldman Sachs and JP Morgan. If you believe Berkshire Hathaway has lost its touch, you could simply follow the underwriters, but even then, you aren’t coming close to the gains that they made.

A $40 Trillion Mega-Wave is shifting the global economy… 

Changing everything from the clothes we wear to the cars we drive. It’s recently produced a 500% windfall in only 30 days.    

The Right Trading Approach At The Right Time

The bigger lesson is that day one trades don’t tell us very much. It often requires perfect timing or privileged access to buy a stock immediately with the actual opening price. While IPOs are media events, any gains made on day one aren’t likely to endure. Perhaps not coincidentally, RIVN dropped as much as 18% yesterday. It still remains well above its IPO price, but that’s small comfort to those chasing “yesterday’s gains.”

A better strategy may simply be to wait, not for a day or a week, but for a few months. Consider FIGS, a medical apparel brand we covered around the time it went public. It had a successful IPO, but didn’t really take off until about mid-June. It eventually hit a high of $50.40. However, it has since declined to just about $31 – about where it began. This provides an opportunity for those who were excited about the brand to give it a fresh look, now that the PR and wild predictions have faded.

To take another example, consider The Honest Company [HNST], founded by celebrity Jessica Alba. On paper, it looked like an exciting brand – celebrity appeal (obviously), a focus on authenticity (similar to SG), and a great deal of public excitement surrounding its IPO. Its IPO in May was heralded as a great success, with the company raising $412.8 million with shares at $16 each. However, it has since lost its shine, dropping to below $9.00. Those who were caught up in the initial excitement and have held may have lost about half of their initial investment – and that’s assuming they didn’t buy at the high point.

The best way to approach IPOs may simply be to ignore them altogether. Give it time. Wait to see the way things shake out. Unless you can practically guarantee you will be able to buy at the opening price, there’s no reason to succumb to what is essentially a glorified public relations event.

There is one exception – and that’s when you see a company that isn’t just a new “brand” but a new business model. This is precisely what I saw in Roblox [RBLX]. All the way back in November 2020, in the last weeks of the Trump Administration and before the IPO, I wrote:

NASDAQ argued recently that Roblox could become the “YouTube of Gaming.” This may understate the case. Roblox could be bigger. YouTube originally was just a platform. It allowed new artists and online personalities to develop free of corporate control or top-down programming. It was perhaps inevitable that the quest for monetization required more content management and central command. However, much of the creativity, originality, and charm of the platform’s early days have been lost. YouTube is rarely where you find original content today. Instead, it’s where you watch clips from last night’s late-night comedy shows.

Roblox has already solved the monetization problem in many ways with its in-house currency system. To some extent, it has done what Facebook tried and failed to do with Libra.  Now, it just needs to attract a more profitable market, maintain existing user engagement, and protect younger users from inappropriate content.

There will still be dangers, especially if parents, watchdogs, or legislators demand the company more aggressively monitor what is or is not allowed on the site. For now though, Roblox is counting on users’ own dedication, innovation, and intelligence. People want control over their own content and a way to develop new revenue streams. Roblox can provide it.

Now proudly listed on the Rogue Investing Daily Model Portfolio, RBLX is one of the star performers. As of this writing, it’s over $126 a share. It’s also the leader in the metaverse, the key new space that tech companies are warring over right now. In fact, the former Facebook, now Meta [FB], is playing catch-up.

At The Intersection of Power and Profits

Roblox was an exception because I saw it has something fundamentally unique, not simply an improvement on what others had. It was a different kind of business, not an existing business done differently. Unless you see an opportunity like that, I wouldn’t get caught up chasing an IPO. To allude back to our Tale of Two Cities example, it needs to be something revolutionary, or it’s not worth doing.

If it’s just evolutionary, then let evolution work. Give it some time. Wait to see if it falls from highs. Catch it on the rebound, as one might think about doing with FIGS or HNST today. It’s simply too early to say what Sweetgreen [SG] or Paytm’s true value may be. However, I do know that there are other restaurants and payment processors.

In an arguably overheated market, time is on your side. Psychologically, the imaginary gains you don’t make on day one may hurt. But when it comes to what really matters, the real losses that come from errors of excitement will hurt far, far worse.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com three times a week to bring you news on what those with power are debating, planning, and doing.

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