Business

07.02.13

How a Pasta Chain Called Noodles & Co. Punked Wall Street

The hottest IPO this year wasn’t in tech—it was a casual dining chain called Noodles & Co. So why did Wall Street undervalue it by half? Daniel Gross on finance’s food-snob dilemma.

The hottest initial public offering this year wasn’t a Silicon Valley tech firm, or a Chinese shale oil play, or a biotechnology start-up out of India. No. It was a low-end pasta joint based in Denver that went public on Friday.

Really?

Really.

Noodles & Co. staged its IPO on a sleepy, muggy, low-volume trading day. But the shares, initially priced at $18 per share, went banoodles when trading started. They opened at about $35 and closed at $36.75, up 104 percent. After digesting the news over the weekend, traders pushed shares up further on Monday; it closed at $38.47. This was the sort of IPO that Facebook expected (but didn’t produce) last year. And in 2013, you’d think that only a paradigm-changing, social-search, cloud-based gaming app would be able to take the market by storm.

If you were a Wall Street banker, you wouldn’t think that a place that bills itself as “Your World Kitchen,” where most dishes cost about $8, and that has an outpost in Manhattan, Kansas (but none in the real Manhattan), would be a smashing success. And indeed, the company’s origins, combined with Wall Street’s geographic and food snobbery, led the underwriters, led by Morgan Stanley and UBS, to misjudge Noodles & Co.’s value.

In theory, underwriters test the waters. Before an offering, they go around and talk to investors, and gauge how much they’d be willing to pay, based on their assessment of the quality of the company and the sexiness of its story. The idea is to price the shares at a level where first-day buyers see a nice 5 or 10 percent pop. That’s their reward for jumping in early and establishing a market for the shares. But if the shares double at the opening trade, the underwriters screwed up. They helped the company sell shares to the public at $18 a piece when it turns out the public was more than willing to pay $36. Noodles & Co. raised nearly $97 million by selling 5.357 million shares to the public at $18 each; they could have raised nearly $200 million by selling a stake of the same size.

Like the rest of us coastal dwellers, Wall Streeters are food snobs.

Plainly, Wall Street blew it. The shares soared not because there is some bubble raging in restaurant stocks, or because noodles are a hot new concept. Rather, they soared because traders outside the bubble of Wall Street and the institutional investors they deal with had a different view of Noodles & Co.  And when you take a step back, it seems as if Noodles & Co. was actually set up to punk Wall Street.

Neither Noodles nor Morgan Stanley wanted to comment on the offering. On Friday, Noodles CEO Keith Reddy told Bloomberg: “We’ve been delivering some of the best results in the restaurant industry in the last five years, and the market understands that and respects that.”

Yet, like the rest of us coastal dwellers, Wall Streeters are food snobs. We know that hot food trends come from New York, and Brooklyn, and from Southern and Northern California, and from Spain and Asia. Not from the heartland.

Noodles & Co. was founded in 1995. It is based in Denver (which most East Coasters know as the place you have to fly to before you switch planes for Aspen or Vail), and really has no presence on the coasts. Like the U.S. economy as a whole in the post-recession years, it has grown from the inside out. Go to the store locator on the company’s website, and you’ll quickly discover that Noodles & Co. is big in the Plains and in Big Ten country. There are 50 in Colorado, 9 in Iowa, 33 in Minnesota, 15 in Michigan, 36(!) in Wisconsin. There are only 7 in California.

Ordinarily I’d be happy to try a casual dining chain for a reporting assignment. But there are none within striking range. In Connecticut, there’s one lonely outlet—in West Hartford, not in Fairfield County. There’s one in East Brunswick, New Jersey, and none in New York. (One is coming soon to the Westbury Plaza in Garden City on Long Island.) In other words, there are as many Noodles & Co.'s in North Dakota as there are in the heavily populated tristate area. The coming-soon list is heavy on college towns: Ann Arbor, Michigan; Lincoln, Nebraska; in Richmond near Virginia Commonwealth University. An email sent to Daily Beast colleagues on both coasts in search of anyone who had ever eaten in one was met with deafening silence. I’m guessing an internal e-mail sent by the Wall Street underwriting team would have produced a similar result. Very few Wall Streeters have a personal experience with the chain.

Reading between the lines of the menu and the offering, it’s easy to conclude that Noodles & Co. dishes up mid-priced, middlebrow food for mid-America. And in an age of ever-increasing authenticity and greater detail—there’s now a Cambodian sandwich joint in New York’s Chelsea Market, and taco truck connoisseurs debate the merits of the different regions from which the vendors hail—Noodles & Co. offers a sort of everywhere-and-nowhere combination. The menu has Pad Thai, Spaghetti & Meatballs, Wisconsin Macaroni & Cheese, Steak Stroganoff, and Indonesian Peanut Sauce. The offerings aren’t exactly low cal— large portions pack up to 700 and 800 calories. And for those who find all those noodle and vegetable dishes too exotic, there’s comfort fare like a Wisconsin Cheese Steak and a BBQ Pork Sandwich.

Food snobs cotton to restaurants that challenge their sensibilities, with molecular gastronomy, exotic ingredients, and tyrannical chefs who demand you eat whatever they put on your plate. By contrast, Noodles & Co. exudes a sort of Midwestern nice sensibility. “We have purposefully chosen a range of healthy-to-indulgent dishes to satisfy carnivores and vegetarians,” its prospectus notes. “We believe our variety ensures that even the pickiest of eaters can find something to crave, which eliminates the "veto vote" and encourages people with different tastes to enjoy a meal together.”

But here’s the thing. While Wall Streeters might not want to have a closing dinner at Noodles & Co., it does possess many of the attributes investors look for in a solid investment. There’s veteran management: Chief Executive Officer Kevin Reddy, who has run the company since April 2006, is a former chief operating officer of Chipotle, another Colorado-based fast-casual chain that exploded. Unlike social media companies, Noodles & Co. has a profitable, simple business model—it sells dishes for more than it costs to buy the ingredients, labor, and overhead. (It owns most of the restaurants but also franchises some.) And it has shown impressive growth.

As of April 30, there were 339 Noodles & Co. restaurants, 288 owned by the company and 51 owned by franchisees, in 25 states and D.C. Between 2008 and 2012, years in which topline growth was hard to come by for consumer-facing companies, Noodles & Co. saw revenue practically double, from $170 million to $300 million, while operating income rose eight-fold, from $2 million to $16 million. In 2012, it opened 45 new outlets and it expects that 50 new Noodles & Co. restaurants will open this year. And the restaurants that are open are reporting healthy same-store growth: 4.8 percent in 2011, and 5.4 percent in 2012.

Noodles & Co. provides a great example of a company that has prospered in the recession and in the slow-growth aftermath by providing solid value, focusing on operations, and offering greater choice in areas that have traditionally been food deserts. There are no small plates or beggar’s purses filled with sea-urchin foam here. Just noodles.

And ultimately that may be what really confounded the Wall Street bankers. Noodles & Co.’s menu is almost entirely based on carbohydrates. And everybody knows that Masters of the Universe won’t go near a bowl of carb-laden pasta— unless they’re loading up for a triathlon.