By Taslim Ahmed
“JAB has to have bigger plans in coffee for this deal to make sense”. Pablo Zuanic on Keurig.
JAB Holding Company agreed to acquire Panera Bread Company for about $7.2 billion (20.3% premium), expanding its coffee and breakfast empire.
The fast-casual industry sits between full service restaurants and fast food. The U.S Fast Casual sub-industry has 7.7% market share in the restaurant industry. This low base has helped fuel an industry CAGR of about 10% since 1999. Major players include Starbucks, Chipotle, Panera, and Shake Shack.
Company Overview & Analysis
JAB Holding Co. is a private equity firm domiciled in Luxembourg. The company is focused on acquiring premium brands in the consumer goods industry, particularly, the coffee industry; it is a global player in the coffee industry with a 41% market share in the prepackaged-coffee segment. The company owns (wholly and partially) several premium brands including Keurig Green Mountain, and Jimmy Choo.
Panera Bread Co. is a bakery-café concept with operations in the U.S. and Canada. The company operates through three segments: Company bakery-café operations, franchise operations, and fresh dough and other products segment.
Selected Financial Data
The company’s ROA moves from 10.6% pre-acquisition, to 1.78% post-acquisition due to an increase in goodwill. The ROE is incomputable as we have no data on the deal financing.
Economies of Scale: Reduction in cost of food and paper products. The writer expects synergies as JAB owns similar operations. Cost is 25% of revenues.
No reduction in admin costs (6% of revenues). JAB has seven employees.
Brands under JAB may be sold in Panera stores.
Optimized Capital Structure (JAB): Increasing interest rates and low debt to equity ratio support leveraging, as higher cost of equity vs. debt.
Growth Opportunities (Panera): We assume growth opportunities are limited as it is difficult to assume growth was constrained by a dearth of capital given the 26.8x coverage ratio.
The Bear case appears more likely as the risk-free rate is expected to increase. It is also obvious that the value of the company is strongly based on the expected growth rate. As seen above, the company has suffered declining profitability despite increasing revenues, hence the conservative steady state growth rate of 2% (based on expected US GDP growth rate). Evidence of the company’s inability to grow further is the price driven nature of its growth i.e. increasing Bakery-Café sales growth (4.2% in 2016) driven by price increases (2.3% in 2016).
The company was valued at 50.6x PE, and 2.6x PS, and 19x P/CF compared to industry average 26.1x PE, 2.6x PS, and 16.1x P/CF. The figures suggest either a depressed net income for Panera (due to extraordinary expenses), or a poor competitive position relative to its peers. The former is more likely. The effect of decreased earnings on net income, and consequently on our DCF, is tempered by positive extraordinary items in the form of increased accrued expenses leading to higher Free Cash Flow (FCF).
There appears to be little unsystematic risk attached to this deal as the company has a stable and loyal customer base confirmed by stable same store sales. However, Increased interest rates will affect the profitability of the deal (opportunity cost), given the high price paid; the only question is by how much?
The profitability of this deal will depend on two major factors: the assumption of substantial debt, and the synergies the company will provide to sister brands. It is unlikely that the company will not take advantage of the debt opportunities given the use of debt in previous acquisitions, and its desirability in this case. The Writer believes the company was acquired above fair value and the success of the deal rests, disproportionately, on interest rate developments over the next few years. The low post-acquisition ROA also necessitates a debt fueled acquisition.
The valuation does not take account of the synergies that will be gleaned from this acquisition including capital structure optimization, and stronger bargaining power as there is insufficient information to draw upon.
1 Simplified Cost of Debt: We use Effective Interest Rate.