Restaurant Group goes all Wagamama
If your existing businesses aren’t performing well then the solution is simple: buy another business that is performing well for an exalted price! This appears to be the logic of The Restaurant Group (RTN) in its £559 million takeover of Wagamama (RTN latest share price 254p, market cap £510 million).
Great businesses create desirable products and services. If their products are sufficiently differentiated, they will experience robust demand. Apple Inc is a great example with the company developing a number of hit products.
Weak businesses, in my view, turn towards acquisitions. A large acquisition is generally a sign of failure. The acquiring company is admitting that it failed to recognize an emerging trend or develop a new product.
Apple Inc has seldom done deals, instead creating its market-leading products in-house (though its takeover of Beats for US$3bn in 2014 highlighted its failure up to that point to recognise the growing popularity of music streaming).
Wagamama is a class act
There is no doubt that Wagamama is a highly successful business with robust trading and strong growth.
Revenue increased at an annualised 17% from fiscal 2015 to 2018 while EBITDA increased by 14% per annum. The Restaurant Group (RTN) believes Wagamama could add 40 to 60 new UK outlets. This compares with 138 directly operated restaurants across the UK and the US as of August 2018.
The strength of the brand has allowed it to travel globally with another 58 franchised restaurants operating in Europe, the Middle East and New Zealand.
Three Wagamama dishes
Source: Wagamama website
The Restaurant Group’s weak position
As at 26 August 2018, TRG had 381 casual dining restaurants with Frankie & Benny’s the largest brand at 258 outlets. The group’s second largest brand is the UK’s largest Tex-Mex restaurant chain Chiquito with 85 outlets.
In my view, Frankie & Benny’s and Chiquito will remain firmly off-trend with consumers. Both brands are up against a host of stronger competitors that include Nando’s, Las Iguanas, Handmade Burger Co and Wahaca.
The Restaurant Group (RTN) has continued to experience weak trading. Like-for-like sales were off 2.2% in the first 42 weeks of 2018 while total sales were off 0.5%. In the 14 week period following the World Cup like-for-like sales were up 1.4%.
Frankie & Benny’s is not on trend
Chiquito: complete with Mexican hats
Wagamama deal metrics: £559 million enterprise value
The problem is not that Wagamama is not a good business. The problem is that The Restaurant Group (RTN) is paying a premium that reflects this. The total enterprise value (debt and equity) of the Wagamama takeover comes in at £559 million.
The cash element of the deal comes in at £357 million and the group is launching a £315 million fully underwritten rights issue. The net debt assumed as part of the deal comes in at a cool £202 million.
RTN estimates the takeover multiple at 8.7x last twelve month August 2018 adjusted EBITDA. However, EBITDA for this multiple factors in “cost and site conversion synergies” i.e. estimated savings that have yet to be realized.
Directors of RTN recommend that shareholders vote in favour of the deal and will do so with their minuscule 0.11% stake in the group. The 14% fall in The Restaurant Group’s share price since the deal was announced speaks for itself.
Assuming the deal goes through, the last twelve-month net debt to EBITDA ratio for RTN will come in at around 2.5X. This is not exactly a reassuring balance sheet position with Brexit just around the corner.
A company like Fulham Shore (FUL) is likely to make a stronger long-term investment in my view. Management own half of the business and the company’s two brands – Franco Manca and The Real Greek – have strong market positions (link).