TRG gambles big on Wagamama deal

If there was a crude four-part playbook for chief executives/investors looking to turn around a business, I would say that The Restaurant Group’s (TRG) Andy McCue has got to stage three with the company’s approach for Wagamama.

Stage one: Paint/refurbish everything. Stage two: If that doesn’t work, change the management team. Stage three: If that doesn’t work buy something, preferably the bigger the better, but definitely better, this will confuse reporting, confuse everybody and disguise underlying poor performance. And finally, stage four: If that doesn’t work blame said deal and previous management or both. Like I say crude, but not too far from approaches taken.

Former Paddy Power boss McCue, who was brought in as chief executive two years ago, has spent the majority of that time seeking to rebuild volumes at TRG’s struggling Frankie & Benny’s and Chiquito brands by cutting menu prices and improving food quality and service. He has also looked to phase out the Coast to Coast brand, converting many sites to a new flame-grill concept called Firejacks.

Whilst the c510-strong group’s more traditional leisure park and retail park outlets have suffered in-line with the rest of the casual dining market, solace has been found in the performance of its successful Brunning & Price gastropub business and airport concession divisions. Both have continued to trade well - now accounting for 51% of group earnings, and TRG has been keen to further strengthen its pubs arms. In May, it acquired Ribble Valley Inns, a group of four pubs, for £900,000, then in August the group announced a £14.9m deal to buy Food and Fuel, the group of 11 pubs and café bars in London. I understand it remains in talks to acquire the 22-strong Peach Pub Company, with heads of terms on the deal thought to have been agreed.

I thought that TRG would take a breather after the Peach deal to let its new acquisitions settle in and give the turnaround strategy for its Leisure Division further time to yield sustainable results. I even suggested it should consider a name change, such was the direction of traffic.

It was thought that one of the established, international private equity groups would come out on top of the process for Wagamama, which was launched through Goldman Sachs earlier this year. KKR, CVC, Cinven and L Catterton were all linked to the process, and it is interesting that TRG has outbid what I would describe as serious private equity players to jump to the front of the queue to acquire a much-admired business. TRG has said it will make a cash payment of £357m on the back of a rights issue fully underwritten by JP Morgan and Numis and take out a £220m facility underwritten by Royal Bank of Canada to fund the £559m deal. On top of the cash payment, it will also assume Wagamama’s net debt of £202 million.

To be fair to McCue there have been no half measures here, he has targeted the best performing business in the sector, a space that he knows all too well isn’t conducive to generating the levels of performance that Wagamama has been generating – 228 consecutive weeks of trading ahead of the market and counting.

Since momentum was put back into the business by former chief executive David Campbell and built on by outgoing chief executive Jane Holbrook, has reported average annual like-for-like revenue growth of 9.6% since FY 2015 – again significantly ahead of the market.

The majority of analysts have agreed with McCue that it could be a transformative deal for TRG, but some have also questioned the price. Paul Hickman at Edison Investment Research said that arguably, an 8.7x multiple flatters, especially as it includes synergies but not their cost. He said: “Investors may blink at 13.2x pre-synergies (£559m/£42.5m). True, Wagamama shines: recent LFL sales c +8%, healthy Asian food, good delivery product, international potential. Cynically one may ask the right price for a good leisure brand? Maybe, on 10x, £420m. Allow synergies, but maybe holders are being asked for £100m+ (50p) for a strategic repositioning.”

McCue has obviously decided that it was getting to a point that it was better to kill (consolidate) than be killed (be consolidated). He was unsurprisingly keen to map out what TRG would be getting for its money. As he put it, Wagamama, has a “differentiated proposition aligned to structural growth trends” something TRG’s restaurant brands arguably haven’t got or been able to capture.

Wagamama is the leading pan-Asian restaurant brand in the UK, a proven concept with 133 sites, with a selective and well-invested estate (c50% of sites refurbished over the last three years). It offers attractive site economics and so far has no tail to its estate. It also has an international business spanning 23 countries, comprising 58 franchise sites in Europe, Middle East, New Zealand and five company-operated sites in US.

And what about that alignment to customer trends? It certainly ticks the boxes for speed, convenience, healthy and delivery. It also has a loyal and attractive customer base – over indexing with younger, affluent customers and resonates with customers focused on healthy eating who eat out frequently and are taste conscious.

McCue also believes a combined business has multiple avenues for growth. He stated that there is headroom for another 40-60 Wagamama sites in the UK. “The 133 UK restaurants it has today is quite modest for a national chain,” he added. I would argue that there is still expansion opportunities for the right brands but the days of 100-plus strong mainstream restaurant brands maybe coming to an end. But that is an argument for another time.

A successful deal would of course return TRG to UK high streets. Under former chief executive Andrew Page, TRG moved its estate to retail and leisure parks, as well as transport hubs, rather than the high street. On announcing his departure at the start of 2014, Page said that the decision to move off the high street was “blindingly obvious” in retrospect. “The logic behind it was clear: there was bags of growth in eating out, but my concern was that everyone would see that and throw capital at it. We wanted to capture the demand, but mitigate the supply side: we looked for areas with barriers to entry.”

Times have indeed changed, and McCue is returning TRG to the high street with a proven concept, the question is whether he can take Wagamama into a part of the market where it is not proven – said leisure and retail parks. As part of its strategy for Wagamama, TRG plans to boost profits by converting up to 15 of its existing leisure outlets to the brand. I would worry that would seem to many, when a test of one or two sites may be less of a gamble, especially if these are already, as imagined, under-performing units.

TRG will also look to further leverage the brand in concessions both in the UK and internationally, and by optimising the potential within international markets. Wagamama is certainly under indexed in UK transport hubs at present, with only three sites at present. A fourth is set to open next year in Heathrow Terminal 3. TRG would hope to leverage its relationships in this sector, it currently has a presence in 14 airports, to accelerate Wagamama UK concessions.

It also said the multi-pronged growth strategy would also include piloting pan-Asian ‘food to go’ offerings and that it expects to pilot a “food-to-go” format in London with a view to using it in concessions. Rival YO! Sushi has already expressed a desire to make its mark in the food-to-go market, whilst I understand PizzaExpress is also developing its own smaller format. Wagamama is understood to have been exploring the development of a smaller format, on and off, for a number of years, and earlier this year trademarked the name Kura, which is thought was lined up for said new concept.

Then there is delivery, with Wagamama arguably the leading player in this category in the sector. How much its dependence on delivery sales is helping it produce sector leading like-for-like sales is certainly a point of conjecture and it is certainly not alone in this respect. TRG for its part has worked with Deliveroo and UberEats on Frankie & Benny’s and Chiquito respectively and has launched its own virtual brands in Burger Burger and Kiss Ass Burrito, but adding Wagamama to this mix would take it to a whole new level, in one leap.

An acquisition, as McCue states, would make the combined group well positioned to invest behind structural growth in the delivery space including through delivery-only kitchens (where Wagamama has an early-mover advantage), in digital capabilities and in online brands. Overall, an enlarged group would derive c70% of outlet EBITDA from high growth segments – pubs, Wagamama and concessions, as the company’s traditional brand’s are pushed further to the margins.

Wagamama also has a strong culture of self-improvement and continued evolution, with an experienced management team set to be led by the impressive Emma Woods. I would argue here that its two very different cultures you’re trying to blend and that’s where further challenges will come. Allowing Wagamama to remain a genuinely autonomous company, as McCue claims it will be, will be an important part of whether this deal is ultimately successful. The fact that TRG has already decided to convert 15 existing sites and calculated c£22m of synergies does put a slight question mark against that autonomy point though.

A penny at this stage for the thoughts of David Campbell, Mitchells & Butlers (M&B) and the Casual Dining Group (CDG). One piece of speculation around Campbell’s departure was that he fell out with Duke Street, which with Hutton Collins as a minority investor, bought Wagamama in May 2011 for £215m from Lion Capital, because at the time he wanted to do a deal closer to c£500m. If that is the case, is the price difference now worth the extra time and hassle? Duke Street, which is set to generate a return of 3.4 times its money, would probably say yes. As for M&B, it ran the rule over Wagamama in the same process from which Duke Street emerged the winner. What a sliding doors moment that was for the sector.

Finally, the audacious move by TRG, must put pressure on its nearest rival in terms of estate and strategy, Casual Dining Group, to up its own differentiation/consolidation efforts. Has backer Apollo got the appetite to fund a further deal? And is there anything worth it making the effort for? It is thought that the Steve Richards-led group looked at a couple of smaller Asian-style concepts last year, with Busaba Eathai and the Thai Leisure Group coming on to its radar. Perhaps a play for the fast-growing and impressive, Business Growth Fund-backed Giggling Squid would be in order. Said concept is proving adept at picking up and successfully converting established high street-based, casual dining-branded sites to its brand. TRG’s bid for Wagamama could finally set off the wider consolidation play the sector has been expecting.

That is of course if the deal gets the greenlight from TRG shareholders. Judging by the fall in its share price on the announcement of the proposed deal and some grumbling from pockets of shareholders, that might not be so straightforward. The dilution from the rights issue allied to a proposed cut in the dividend concerned the market, sending TRG’s down by 51p, or 17.2%, to 246¼p in morning trading.

“I’ve heard of self-help but this is more like self-harm,” one of top 20 shareholder told the FT, who described the price as “top dollar — more a seller’s price than a buyer’s”. The shareholder went on to say that the group’s turnaround “was coming along nicely” before yesterday’s announcement. “Now we load up the debt at a time when I would have preferred to keep the balance sheet as strong as possible,” the shareholder told the newspaper. “I think it entirely possible that we will vote against the transaction.”

So, the Class 1 deal could be voted down at the November GM, but surely the shareholders have to ask themselves, what other option did McCue and the company have. Where was TRG heading pre the possible acquisition of Wagamama? The trading update provided yesterday, showed a decline in like-for-like sales of 2.2% in the first 42 weeks of this year, although it said that there had been an improvement in the 14 weeks since the end of the World Cup, when like-for-like sales grew by 1.4%.

There is also Wagamama’s loyal consumer base to keep onside, with some already worried that the ever-evolving Wagamama and the stuck-in-the-past Frankie & Benny’s would seems uneasy bedfellows.

Holbrook stressed that there were a number of drivers of the group’s performance, adding: “You’ll laugh but our big theme is love, and we have got this initiative called ‘love yourself, love your people, love your guest’. We have made a conscious effort to stop talking about sales as the most important thing in the business and concentrating more on people taking good care of themselves.” The first sign that this “love” has gone out of the business and sales have been pegged back and it is clear where the finger will be pointed.

A successful acquisition of Wagamama, would at least give TRG’s management options and more cards to play/levers to pull. McCue has played his hand and he will hope he gets the backing to create a group with the brands, capabilities and scale to capitalise on multiple growth drivers, and enabling the creation of significant shareholder value at the same time. Let’s see if TRG’s shareholders will let McCue play what could be a high risk, but ultimately winning card.