Is the Guzman & Gomez IPO a $2.2B scam?

And if it is, how are our regulators allowing it?

I’m all for founders, (which is why I write this newsletter on my weekends) supporting start ups and scale ups, (which is where I have spent most of my time) as well as contributing to the growth stage of companies and eventual exits (which is what I’m focusing on now). Exits include trade sales and IPOs… and I’m all for founders and owners getting the very best exit they possibly can after years or decades of toil…

BUT

…surely each step of a companies journey must be done in compliance with the law, the accounting standards, and in good faith… which is why I feel compelled to share the below from The AFR, Michael Hutchens (the founder of Modano - Financial modelling automation for finance professionals who value their time) and ChatGPT4o… and I’ll leave it to you to draw your own conclusions from there.

To begin..

Here are some recent headlines from the Australian Financial Review (who I worked for back in the early 2000s):

• Investors scramble for Guzman y Gomez shares amid hot demand - June 4th Enormous demand for Guzman y Gomez shares ahead of the Mexican-themed restaurant chain’s ASX listing next week has meant some investors received just 10 per cent of the stock they wanted, sources say. Guzman y Gomez, which flagged a $2.2 billion listing earlier this month, has already increased its initial public offer by nearly $100 million to accommodate Capital Research Global Investors…

• Guzman y Gomez’s spicy burrito is a recipe for high growth - June 17th
  It’s easy to sound smart by being gloomy about the future of a stock, but the future of this Mexican-themed chain is positive.

• What past IPO disasters tell us about Guzman y Gomez’s $2.2b float - June 18th
  The Mexican fast-food chain float has split opinions among Sydney’s investing community, and revealed the deep scars inflicted by failed floats of the past.

What should we make of these articles from Australia’s leading publication on such matters?

I then read a truly epic linkedin post by Michael Hutchens. I reposted it immediately, and almost immediately got a phone call from my good old friend Chris who, after reading it, was ranting BIG TIME. (Chris used to call me to share his frustrations with traffic, banks or politicians.. over the decades of our friendship he has certainly mellowed, so these days I take note when something really gets him going)

Michael Hutchens post is so awesome I insist we all read it - see his linkedin post here - pasted below in full for ease of reading.

Can I suggest we all re-post to help Michael Hutchens spread the word?

“The upcoming Guzman y Gomez IPO will further cement the status of modern day public markets as a Ponzi-esque wealth distribution mechanism for a privileged few and in many ways not much different to online gambling websites.

It is also further proof that, more than ever, 'success' in business today flows from finance sector connections and the ability to hard sell a growth story, without any real consideration for business fundamentals or realities.

For those who haven't been reading the daily media articles - which are all a necessary part of a successful IPO hype machine - the company and its highly conflicted investors and advisors have decided that A$2.2 billion is a reasonable valuation of this business.

This is irrespective of fact that it is struggling to make money and would in fact have gone broke over the past year if it didn't quietly do a pre-IPO raising of A$135 million.

That raising valued the business at A$18 a share or A$1.76 billion, even though it was survival capital, yet somehow the business has increased in value by over 20% in 6 months to now be worth A$2.2 billion.

It's got to the point where I feel stupid, and know I'm being laughed at, when doing financial analysis of these IPOs - as I did for Adore Beauty Group and WeWork - because it just doesn't seem to matter anymore, but here's some comments anyway.

The A$2.2 billion values the business at over 30x forecast FY25 EBITDA, but as The Australian Financial Review notes this is pro forma EBITDA, which basically means their own interpretation of earnings for the purposes of getting their IPO away.

I spent some time reading their prospectus over the weekend, and I'm very thankful for my 25 years of financial analysis experience, as it's really quite tricky seeing the wood for the trees given that they provide multiple views of each financial statement - pro forma and statutory.

It turns out the their pro formas do cool things like shift lease expenses below EBITDA and ignore share based compensation (our old friend), such that a more cynical person could argue that their real FY25 EBITDA multiple is closer to 50x.

And this 2% ROI is a based on EBITDA, not NPAT, which is forecast to be negative for FY24 and only A$6 million on revenue of over $400 million for FY25 - which is better than their FY23 loss of A$2.3 million.

All while the current RBA cash rate is a whopping 4.35%.

But there are so many other things a horrible cynical person could get stuck on, like the fact that the CEO doesn't even want to be in the business anymore and has only returned to do the superyacht IPO sales jig, or the fact that of the $335.1 million raised $135 million will go to existing shareholders and millions more to their advisors.

This means that over 40% of the raising is going directly to existing shareholders at a valuation almost 50% higher than the $15 per share valuation put on the business this week by Morningstar's Johannes Faul...

Just to be clear, GYG is a no tech business that justifies a 5x+ revenue multiple, even though they're claiming in interviews that their parallel food production lines are revolutionary. Adam Neumann would be proud.

GYG is actually a hugely capital intensive, staff intensive, and inventory intensive low margin business that requires constant cash to scale, and is operating in saturated markets with huge competition, both in Australia (with Zambrero, etc.) and the U.S. (with Chipotle Mexican Grill, etc.).

So while, yes, the food tastes great, it's an extremely risky business to scale with minimal moat.

Probably the best case that could loosely be put forward to support GYG's self-valuation is the performance of Chipotle, which currently has a market cap on the Nasdaq of USD$87 billion on annual revenue of ~USD$10 billion and NPAT of ~$1.3 billion.

Chipotle owns all of its stores, has much higher and more stable margins, and is established.

But its valuation also makes no sense, which leads me back to the Ponzi nature of public markets created by central banks.

And who wouldn't want to IPO a company in these markets?”

…

Then a question was posed:

…

'“Michael, they are using post-IFRS16 treatment of operating leases, where lease liability is now recorded on balance sheet as a debt-like item, and lease expenses are recorded partially in deprecation and partially in interest paid. If that is the case, lease liability should be added to debt to determine enterprise value - not sure if this has been done” - Roman Luchkovsky

…

Which Michael answered:

…

“Roman Luchkovsky, CFA thanks for this comment. I wonder if those maintaining the accounting standards ever considered that EBITDA multiples would become so central to IPO valuation pitches, and that by allowing these re-classifications they’ve effectively fundamentally changed the hypothetical value of businesses?

I guess the important thing is that comp metrics are like-for-like, so if all other comps are based on the same treatment then it’s fair, otherwise it’s very misleading.

What’s also interesting is the divergence here between any sort of fundamental valuation and public market comps, such that even using the cash rate as a discount rate it would be hard to justify the value implied using public market comps.

This is the absurd reality of the world today with the public markets basically a Ponzi scheme. 🤷‍♂️” - Michael Hutchens

…

I asked ChatGPT4o to summarise if the Guzman y Gomez IPO meets the international accounting standards, and if not, how so.. here is the answer:

…

“The Guzman y Gomez IPO fails to meet international accounting standards for several key reasons:

1. **Exaggerated Valuation**: The IPO sets the business valuation at A$2.2 billion, despite the company struggling to make money and requiring a pre-IPO raise of A$135 million to avoid bankruptcy. The valuation increased by over 20% in just six months without corresponding financial improvements.

2. **Pro Forma Financials Manipulation**: The use of pro forma EBITDA, which is a subjective interpretation of earnings, inflates the company's financial health. This version of EBITDA excludes lease expenses and share-based compensation, making the financial situation appear better than it is.

3. **Misleading Financial Metrics**: The real EBITDA multiple is closer to 50x, not the stated 30x, due to these accounting adjustments. The projected ROI is based on EBITDA, not net profit after tax (NPAT), which is expected to be negative for FY24 and only marginally positive for FY25.

4. **Questionable Allocation of Raised Funds**: A significant portion of the IPO funds (over 40%) is allocated to existing shareholders and advisors, rather than being used for business growth, raising concerns about the true purpose of the IPO.

5. **Inconsistent Accounting Treatments**: The post-IFRS16 treatment of operating leases should add lease liabilities to the debt, impacting the enterprise value. This inconsistency can mislead investors about the company's financial leverage and health.

6. **CEO's Lack of Commitment**: The CEO's apparent disinterest in the business and focus on the IPO undermines investor confidence.

These points collectively suggest that the IPO prioritizes financial engineering over business fundamentals, likening it to a Ponzi scheme and casting doubt on its adherence to robust accounting standards.” - ChatGPT4o

…

The summation of this article I leave to you.

If you’d like to know my thoughts or share yours, send me a message.