Liberum downgraded its recommendation on The Restaurant Group (TRG) to ‘hold’ from ‘buy and put its target price under review.
“We are big fans of Wagamama and it does indeed transform the Restaurant Group,” the broker said.
“However we have (a) number of concerns: (1) the price looks rich at c.13x pre synergy enterprise value/earnings (EBITDA), (2) with imperfect information we calculate this deal is dilutive in year one (vs. guidance of enhancing) and return on invested capital exceeding weighted average cost of capital by year three is hardly overwhelming, (3) gearing up to over 2x does increase risk, (4) management stretch: executing a turn-around, integrating a large deal, investing in new digital channels, expanding internationally and embedding pub deals (with more deals likely), all cumulates to an awful amount for the management team to execute on.”
TRG said it plans to expand the Wagamama chain across the UK. It is exploring the option of converting at least 15 of its existing sites into Wagamama restaurants and considering growing the Asian food chain’s presence in concessions at airports.
Rights issue likely to be done at discount, says Liberum
The acquisition will be funded with £357mln in cash, £202mln debt and some of the money raised from a £315mln fully underwritten rights issue. Liberum expects the rights issue will be done at a meaningful discount to the current share price.
Following completion, the enlarged group intends to adopt a policy of paying a dividend covered two times by earnings before exceptional items.
Liberum said the deal structure is confusing, which raises further questions, but if it can be executed it sees upside to the company’s valuation.
“In summary (and excuse the crudeness of the analogy) but this is like putting on a new roof of a building, while doing an extension but the plumbing has not been fixed and the building needs a bit of a paint job,” it explained.
“Overriding this, we just don’t know what the cost to shareholders will be (potential rights issue dilution) and some will be disappointed with the dividend cut.”
Concerns about execution risk
The broker said normally it would be more negative on a similar scenario but it likes the Wagamama brand and its highly cash generative nature while it believes TRG’s management has done a good job in its turnaround of the core business so far.
However, Liberum said there are concerns about management stretching itself too far and execution risk with the deal, which comes at a time when the market dynamics are not ideal.
The restaurant sector has struggled as tough competition, weak consumer confidence and higher costs weigh on sales and margins.
Shares in TRG fell 3.5% to 237p in late morning trading.