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Morning Briefing for pub, restaurant and food wervice operators

Thu 5th Oct 2017 - Update: Deltic tables Revolution merger plan, Busaba boss steps down
Deltic tables Revolution merger plan: Deltic Group has published its proposed terms for a merger with Revolution Bars Group. The merger proposal provides for a combination under which existing Revolution shareholders would own 65% and Deltic shareholders 35% of the enlarged and listed group. The enlarged group would be run by the current Deltic management team. The enlarged group should benefit from approximately £6.8 million of currently identified pre-tax cost synergies and approximately £0.9 million of pre-tax financing synergies. The enlarged group is expected to be highly cash generative and financed conservatively with gearing no higher than 1.5x “adjusted Ebitda”. A statement from Deltic said: “There will be no change to Revolution’s existing dividend policy. A transaction can be expedited rapidly and without significant incremental cost. A merger with Deltic offers the opportunity to accelerate Revolution’s strategy set out at the time of its IPO. Deltic believes that significant value will be created for existing Revolution shareholders.” The statement was dismissive of Revolution management “defeatist” response to cost headwinds. It stated: “Deltic believes that such headwinds are already well known in Revolution’s operating market and that Revolution’s response to mitigate them has been slow and defeatist. Deltic believes Revolution is a great business in its own right, which a more focused and effective management team can exploit alongside Revolution’s excellent operations staff to restore underlying profitable growth through simple stand-alone measures, including enhancing margins and cutting out excessive head office costs. That leading industry operators such as Deltic and Stonegate can reach this conclusion is a poor indictment of the decision to recommend the Stonegate offer, where ostensibly returning the IPO value to shareholders is seen as the best outcome for Revolution shareholders, rather than identifying it as the opportunistic offer Deltic believes it more rightly is. Ever since Deltic’s first approach to Revolution, Deltic has been disappointed by Revolution’s level of engagement: a short initial delay in granting Deltic access to due diligence as required under the Code; an instant dismissal of the idea that a merger could be in the interests of Revolution shareholders; and finally, once tabled, a complete rejection of Deltic’s formal merger proposal with an indication that there was no scenario under which a Deltic/Revolution merger would be more attractive than the Stonegate offer. Only belatedly, subsequent to Deltic’s announcement on 20 September 2017, has Revolution indicated any interest in conducting due diligence on Deltic but whilst also reconfirming that its directors’ interest in pursuing Deltic’s proposal had not changed. Given the attitude of Revolution towards Deltic’s proposal, Deltic did not at that time see any merit in providing due diligence access. Accordingly, Deltic has determined that the merger proposal, improved from the only proposal tabled to Revolution’s board, is best shared directly with Revolution shareholders as it is they who ultimately need to determine the future of Revolution rather than its directors. In order to enable Revolution to form its own opinion on the merger proposal, Deltic has also now granted due diligence access on its business to Revolution. Deltic believes the merger proposal represents a compelling value creation opportunity for Revolution and its shareholders and would welcome the opportunity to engage with the board of Revolution on a constructive basis with the goal of consummating a transaction in the event that the scheme vote on Stonegate’s proposal lapses or is adjourned and/or Deltic chooses not to announce a firm intention to make a cash offer for Revolution.” A line in the merger proposal also explains why Deltic’s owner Ranimul is prepared to grant Revolution’s shareholders 65% of the ownership of the merged company. It states: “Ranimul considers that its merger proposal should result in sharing a disproportionately favourable merger ratio and synergies to the benefit of Revolution’s shareholders, and is willing to do so not least because it demonstrates Ranimul confidence in the future potential of Revolution and current low implied value. By combining the businesses and extracting the synergy opportunities, Ranimul believes the merger proposal creates the opportunity to grow a business with a value very significantly in excess of that represented by Stonegate’s offer over the two years following a merger becoming effective.”

Busaba Eathai chief executive Jason Myers steps down: Busaba Eathai chief executive Jason Myers is set to leave the business at the end of November. In a note to colleagues, he stated: “It is with heavy heart that I announce I will be leaving the business in the next few weeks, officially at the end of November. I have had a wonderful almost four years with Busaba and am proud given very difficult challenges faced that we managed to grow the business by 25% each year, improved the brand, empowered our talented colleagues to do remarkable things. The thing that will stay with me forever is the magnificent people I have had the honour to work with at both head office and in restaurants, and with our valued partners supplying our business, and you are all the reason I have got up motivated every day. I can confirm I have never stopped believing or fighting for Busaba as I believe it’s a wonderful business that just needs a new direction and financial structure. Sadly for me the journey is over but Busaba will go on – I wish the banks and investors all the luck in the future.” Terry Harrison, the former consultant for Soho Investments and Snog frozen yoghurt, has been working at Busaba Eathai since August and is its interim managing director.

Morgan Stanley – we think there’s room for 530 more Costa sites in the UK: Morgan Stanley leisure analysts have issued a note in which they argue there is room for circa 530 more Costa sites in the UK. The note stated: “With weak like-for-like sales and mounting concern over market saturation, we look into how much more room Costa Coffee has to expand in the UK. Morgan Stanley’s AlphaWise team sourced the locations of Costa and its competitors, split the market into six clusters, and assessed its potential to “reinforce” (existing presence but low market share), “invade” (no presence, but branded competition established), and “colonise” (no branded coffee shops but a market opportunity based on minimum population levels). We think Costa has room for around 530 additional stores in the UK, equating to circa four years of growth. Our estate analysis shows that Costa has greatest market share in smaller wards in the UK: almost 70% share in the smallest towns compared to 20% in the most active urban centres. Over 60% of the expansion opportunity (>300 stores) would be for Costa to gain a presence where its competitors have one and it does not, suggesting low cannibalisation risk. A further 30% (>150 stores) could be gained by reinforcing its position in areas where it already has a presence, but its market share is lower than we would expect. Minimum 25% upside potential to Ebit. This suggests circa 2,600 stores, close to its target of 2,500. It is also equivalent to Starbucks’ density in the US. Assuming current average UK equity/franchise Costa store economics of £70k Ebit, these units could add £37m or 25% to Ebit, but 50% more if they were all equity stores. Our work does not consider upside from more sites at travel hubs and drive-thrus which are larger units with less high street exposure. And we exclude upside from Express machines and International (where there is much to prove). But much relies on like-for-like sales. If like-for-like sales weaken further, whether due to the UK economy, the circa 40% of stores on the high street, or competition, we wouldn’t rule out Costa slowing its expansion, despite there being a clear opportunity. Shares are pricing in minimal growth. Whitbread trades at a circa 35% discount to its sum of the parts proxy on price to earnings. The share price implies 4x F19e Ebitda for Costa (stripping out Premier Inn at 11x), suggesting zero growth priced in. Or applying our target 10x multiple to Costa implies 8x for Premier Inn, low for a property-backed hotelier.”

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