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Is the Wagamama acquisition too rich for Restaurant Group?

Is the Wagamama acquisition too rich for Restaurant Group?

Just 60.4% of Restaurant Group investors backed its acquisition of Wagamama, but are they underestimating the company’s long-term growth potential on the back of the deal?

The market reaction to the announcement on 30 October was stark, as investors took fright at the £559 million cost of the deal and how it would be funded. Restaurant Group’s share price tumbled 13% on the day, and it has now sunk by 18% in total since the shareholders backed the deal at an extraordinary general meeting last month.

The purchase has been funded by £357 million in cash, mostly derived from a £315 million rights issue held last month, with the remainder coming from the use of a £220 million facility and the cutting of its dividend.

Despite the short-term impact, Martin Cholwill, manager of the Royal London UK Equity Income fund, is one of the investors who supported the transaction.

Royal London holds 11.4 million shares in Restaurant Group, worth around £25.9 million, and although many have baulked at the price paid, Cholwill believed the deal would drive both growth and cost savings.

‘We welcome the approval of the deal and look forward to seeing management deliver on the acquisition strategy,’ he said.

‘The Restaurant Group is paying a fair price for an excellent asset, and are well placed to generate cost and revenue synergies, which should earn them a high return on investment.

 

Is Wagamama worth it?

Citywire A-rated Alex Savvides, manager of the JOHCM UK Dynamic fund, which holds 5.1% of its assets in Restaurant Group, is another backer, pointing to the quality of Wagamama as an asset.

‘Announcing a deal of this size and ambition in the UK leisure space was never going to be easy in current market conditions. There is, as a result, much current debate and concern over the deal, some justified, some a little overstated,’ he said.

He pointed out that Wagamama had a number of traits beyond mere brand strength that underpinned its valuation, including sector-leading customer satisfaction scores.

In spite of being a well-known business, it has never saturated the market, having just 133 sites across the UK, compared to the 260 of its new Restaurant Group stablemate Frankie & Benny’s, and the 340 of rival Nando’s.

‘The brand does not seem over-extended – far from it,’ Savvides added.

Restaurant Group chief executive Andy McCue has publicly said that the business has scope to open another 40-60 outlets, and Cholwill flagged airports as a potential growth area.

He said: ‘Restaurant Group could roll out Wagamama into airports, where they are currently significantly under-represented.’

Savvides agreed, pointing out that Restaurant Group was already one of the leading food and beverage concession operators in UK airports.

‘Bringing Wagamamas into more airports – they currently only have three sites – and other transport sites would again drive further meaningful revenue synergy. The sites are in place and airports want a Wagamama.’

He noted that a well-located airport restaurant can produce three times or more the revenue of an average site.

 

Biting off more than they can chew?

The growth potential may be there, but it comes at a cost, adding a considerable debt burden.

For Alexandre Prost, proxy-voting service leader at independent corporate governance and shareholder advisory consultancy Pensions & Investment Research Consultants (PIRC), the board has not adequately addressed the risks associated with such a high level of debt.

She said: ‘In spite of the board’s assurances of the potential profitability of this endeavour, the risks and adverse implications for shareholders appear too great to overlook.’

Savvides said he accepted concerns about the debt and loss of the dividend but stood by the deal.

‘However, given the synergies we expect and the combined cash generation and partial dividend utilisation to do the deal, we were prepared to back management,’ he added.

He said that within 18 months, the business would be well below being two times leveraged and under one times within three years.

 

Looking to the future and online

One area that has been barely mentioned in the post-deal debate, according to Savvides, is the online opportunity.

McCue, along with a number of his senior team, joined the firm in 2016 from Paddy Power, a business renowned for the strength of its digital marketing skills.

‘The CEO of the Restaurant Group is young and ambitious, but also thinks digitally. As the food business moves online, these skills are necessary,’ Savvides said.

He added: ‘But, more importantly, his [McCue] view of the rapidly evolving delivery market is key to this deal. Scale is and will be increasingly important in both partnering with and standing firm against the delivery companies.’

Savvides noted that while online growth at Wagamama was already strong, it was only coming through Deliveroo, leaving lots of opportunities to increase sales further.  

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Alex Savvides
Alex Savvides
20/164 in Equity - UK (All Companies) (Performance over 3 years) Average Total Return: 36.31%
Martin Cholwill
Martin Cholwill
23/92 in Equity - UK Equity Income (Performance over 3 years) Average Total Return: 24.04%
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