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Kona Grill Finally Hires a New CEO

Kona Grill (KONA) has long been a favorite concept of Stone Fox Capital with its blend of sushi with western foods, but it clearly lost its way over the last couple of years due to questionable management. Last Monday, KONA announced a new CEO plus a new BOD member. Positive signs that they've finally got quality management on board to turn the concept around. KONA was always criticized for being run by a hedge fund manager instead of an industry expert. Now we'll see.

Mr. Buehler was the Chief Executive Officer of LS Management, Inc., the owner and operator of the Lone Star Steakhouse & Saloon/Texas Land and Cattle Steak House restaurant concepts, as well as Lone Star Business Solutions, an external accounting, IT and HR provider, where he served from July 2007 to May 2009. Lone Star Steakhouse & Saloon consists of 141 company restaurants, 5 domestic franchise restaurants, and 10 international franchise restaurants, while Texas Land and Cattle Steak House consists of 28 company restaurants.

KONA just reported Q3 results that included a devastating 9.9% drop in comps. The market has turned to where most competitors are reporting more manageable 2-3% drops, but KONA is still reporting numbers matching the highs of the recession. This trend clearly must turn and quickly for KONA to be a good investment.

Just getting a new CEO with the same old board that approved numerous questionable deals involving the old CEO wouldn't have been enough to get us re-interested in this concept. The good news is that KONA also brought along a new member to the BOD replacing a long time member. Mr. Bakay is from BBS Capital Management that recently bought an 11% stake in KONA providing ample support for a much needed shakeup.

Considering both of these industry experts are willing to invest their careers, money, and time into KONA at this low point suggests that the concept indeed has a chance at turning around.

Kona Grill's Potential
KONA operates 23 restaurants in the casual dining segment with over $80M in revenue. This revenue level is after a couple of devastating years of drops in comps so the revenue number could easily expand much higher without growing stores. Up until the recent quarter, KONA still had decent restaurant operating margins of over 17% and prior to this last 12 months they were usually in the 20%+ range.

Long term, the concept can easily be expanded to 100 stores based on comparable concepts like Cheesecake Factory (CAKE) and even the 150 store concept that the new CEO oversaw at Lone Star Steakhouse.

With a market cap of under $30M, KONA offers an appealing valuation prospect if the new CEO and BOD can turn the company around. Right now its a gamble considering they have very little cash or financing available. At just $3M they have very little flexibility in this liquidity crunched environment. They also have limited debt providing for the opportunity to lever up the balance sheet without diluting existing shareholders as the lending market returns. Not having debt is a big benefit at this point in their development as most concepts are usually highly levered by this point in the growth cycle.

Private Equity is also lurking with the recent purchases by BBS Capital and the ever present Mills Road that has made 2 offers in the past that the previous management team turned down.

What's amazing is how under followed they've always been considering the IPO and the potential. With the 2 stores in development, a good CEO could easily up this company to over $100M in annual revenues yet the stock constantly trades under 10,000 shares daily. Even this big news was followed by slim trading making it very difficult for big investors to move in and out of the stock. So any new capital via shares or debt would likely expand the following and help liquidity.

Until the market pricing improves though, the Interim CEO and BOD definitely took the correct path to slow down expansion. Expansion for expansions sake isn't wise. It needs to be done profitably and KONA has lacked profits since becoming public. KONA finally has SG&A under control at a low 7.5% of revenue and with margins getting back to 17%+, they could easily hit 10% cash flows or EBITDA. That would be huge since they lack liquidity. Posting profits would also turn a new page on this investment and eliminate any downside risk from here.

Can the new CEO and modified BOD return KONA to the fast growth realm? Purchases in the low $3s look very appealing, but we wouldn't recommend chasing until we see more details from the new management.

Disclosure: Adding shares in the low $3 range.


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