PenderFund

Panera Bread – When News of a Take-Out at a Premium is Bittersweet

Written on . Posted in Featured Company, Pender Blog

As we reflect on the announcement that Panera Bread, a holding in several of Pender’s funds, is about to go private thanks to a takeover by European holding company JAB, we are left feeling somewhat bittersweet. While this development is probably perceived as terrific news by most market participants, we believe some investors with a longer time horizon may feel differently.  So why would the take-out of Panera, at a decent premium, be less-than-ideal news?

The Playing Field
The vast majority of stocks in the investable universe are “close the discount” stocks. Hold them for 10 years and they will tend to “bob around” from time to time. While there are potential trading opportunities along the way, at the end of the day, investors as a group are not much further ahead than when they first started. Simply put, if the underlying business does not increase intrinsic value materially over time, neither will the stock. Investors need catalysts to drive an attractive rate of return for a business that fails to grow value at a satisfactory pace. Take-outs remain one of the best catalysts to make money on “close the discount” stocks. The quicker the discount is closed, the higher the IRR of the investment. Pender has demonstrated an exceptional track record in identifying companies with take-out potential, especially in small cap stocks.

On the other hand, ongoing business momentum, when also under-appreciated by investors, is the catalyst for “compounder” stocks. Interestingly, if you excluded all “compounders” out of the stock market indices over time, the benchmark returns would be close to zero. Logically, the stock market can’t go up much if it consists primarily of mediocre companies that are unable to grow their business value over time. The stock market goes up over time because the returns of compounders more than offset the anchor created by the much larger group of run-of-the-mill firms in the market. Following through on this line of reasoning, Charlie Munger was clearly referring to compounders when he opined “The big money is not in the buying and selling … but in the waiting”. Historically, Panera has been a compounder. The stock vastly surpassed the market because its business value compounded at a very high pace, but this was not fully appreciated by investors who undervalued the stock. We expected this track record to continue.

Finding a Winner
As we know, Panera made heavy forward-thinking investments over the past several years (Panera 2.0, delivery, Panera-at-Home, Rapid Pick up etc.) (read a prior Pender blog post). The inflection point for the big payback was finally in sight. Panera just pre-released their Q1/17 results and its underlying store performance was once again far ahead of its peers. The business is just starting to fire on all cylinders. The tailwind from these investments and ongoing business momentum would likely have carried the business (and the stock) to much higher levels over the next five years or so. It could have been a fun ride. When investing in compounders, the most important part is to not stop the compounding process, either by selling too early (by the investor himself) or being taken out (by a third party like JAB). It’s as if Starbucks was taken out in 2010 for an attractive take-out “premium” at the time, just as its heavy investments was paying off and the business was taking off again. Investors were probably better off letting Starbucks continue to compound in value instead of taking a theoretical high bid at the time (e.g. a three to four “bagger” over six to seven years vs. a one-time 30% take-out premium in 2010). Unfortunately for public investors of Panera, the compounding process for this wonderful business has now stopped. That is why we find the news “bittersweet”.

Still, PNRA has provided a very satisfactory return since we first started accumulating shares in late 2013. If we sold our stake today, we estimate the IRR of our PNRA investments would be about 20% annualized vs 11% for the S&P500 (note the return would be even higher if measured in CAD). The good news is that Panera was a high conviction “best idea” for Pender – it is the largest holding in both the Pender Value Fund and Pender US All Cap Equity Fund so it has definitely moved the performance needle in a positive way. Panera was a gem. We thank Panera founder/CEO Ron Shaich and his team for their superlative performance and wish them much luck with JAB. We are now tasked to find a replacement for PNRA…

As a final word on investing in compounders, we are reminded of a quote by investor George F. Baker. To make money in stocks you need “the vision to see them, the courage to buy them and the patience to hold them.” We would only add that patience is the rarest of the three.

Felix Narhi,
April 5, 2017

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