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Did BreadTalk Overpay for Food Junction?

Jeremy Chia

Last week BreadTalk Group Limited (SGX: CTN) announced it would open its wallet to shell out S$80 million for Food Junction. My colleague Royston described some of the salient points of the acquisition in an earlier article. In this article, I’ll take a deeper look at whether BreadTalk is overpaying for the food court operator. 

Compared with previous transactions

In 2013, Auric Group successfully privatised Food Junction (which was a listed company back then) by buying the remaining 39% stake in Food Junction that it did not already own. At that time Auric Group made an offer valuing Food Junction at S$30 million.

In 2017, Lippo’s Riady family successfully privatised Auric Pacific Group, valuing the company at S$48.3 million. Auric Pacific Group, besides owning Food Junction, also runs Delifrance cafes and manufactures Sunshine Bread.

On the surface, an S$80 million price tag on just the Food Junction segment of Auric Pacific Group sounds expensive, given that the whole company was successfully bought for S$48.3 million just a couple of years ago.

Looking under the hood

However, upon further research, I found that Auric Pacific Group’s 2017 privatisation offer was probably unfairly low. At that time, CIMB Research, the sole research house covering the company, said the offer price was “not favourable” because it was 15.8% below its target price for the stock.

In addition, Auric Pacific Group was in a net cash position of S$81.3 million. The S$48.3 million valuation was, therefore, even less than the company’s net cash balance.

As for Food Junction’s $30 million valuation in 2013, the Business Times explained that the difference in valuation could be that Food Junction was a much larger and more complicated entity back then. Since it was privatised, Food Junction closed down non-performing food courts and restaurants to streamline its operation, putting it in a better financial position. 

2019 H1 earnings not a good indicator

Food Junction reported paltry earnings of just S$3,183 in the first half of 2019. However, BreadTalk said the earnings will be boosted in the future due to a few reasons. For one, BreadTalk will not be taking over Food Junction’s head office, which would eliminate a cost amounting to S$3 million per year.

BreadTalk has also told Food Junction to shut down several unprofitable direct-operated stalls before the acquisition announcement. Hence, these stalls will not be a drag on profits in the future.

In addition, Food Junction opened a premium food court in Jewel Changi Airport in April this year. The group incurred hefty start-up costs including one-off renovation works but have only accounted for two months worth of revenue for the first half of 2019. Because of all of these factors, the S$3,183 earnings figure will likely improve drastically in the second half of 2019.

Other valuation metrics

According to BreadTalk’s management, the purchase price gives Food Junction an enterprise value-to-EBITDA (earnings before interest, tax, depreciation, and amortisation) ratio of 7.6 times based on 2018 results. This is in line with other food court operators such as Kimly Ltd (SGX: 1D0) and Koufu Group Ltd (SGX: VL6), which have EV-to-EBITDA multiples of 6.9 and 10.3 respectively.

However, Food Junction’s price-to-book valuation of 6.5 times is higher than Koufu’s 3.5 and Kimly’s 3.0. But the price-to-book valuation may be justified if Food Junction can deliver a comparatively higher return on equity (ROE) over the long-term. 

Foolish conclusion

On the surface, S$80 million appears to be a steep price to pay for a company that only earned S$3.183 in the first half of the year. However, if we take a closer look at the numbers, it does not seem that extravagant after all. Plus, investors should not discount the possibility that the acquisition might provide economies of scale to BreadTalk.

That being said, investors should also note that BreadTalk will need to draw down about S$50 million in debt to finance the deal. The higher interest cost will most likely impact earnings down the road.

It will also weaken BreadTalk’s financial position, which was already weak to begin with. It had a net-debt-to-equity ratio of 64% as of 30 June 2019. Investors will need to watch this space carefully as – if BreadTalk is not careful – it could find itself ending up with a liquidity crisis.

More reading

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia does not own shares in any of the companies mentioned.

Motley Fool Singapore 2019