Restaurant Group cut by Citi and Liberum as Wagamama deal raises questions

31st Oct 2018 10:01

(Sharecast News) - Restaurant Group was under the cosh again on Wednesday as Citi downgraded the stock to 'neutral' from 'buy' and Liberum cut it to 'hold' from 'buy' on the back of its acquisition of restaurant chain Wagamama.Citi said it sees the strategic rationale for the deal, adding that Wagamama is a good brand. However, it argued that the 17% share price fall challenges the economics of an already expensive deal."Assuming a rights issue at 200p, a circa 20% discount to the closing price of 246p, the company would have to issue 140m shares at the TERP (theoretical ex-rights price), compared to our initial assumption of circa 113m."This in turn calls into question whether the deal will deliver material earnings per share accretion before FY21E, despite factoring the planned synergies."Citi went on to question whether investors will support the deal given the deterioration in accretion, which it "cannot believe was anticipated by the company or its advisors".The bank has a 270p price target on the stock.Liberum also said the deal makes strategic sense and transforms Restaurant Group."However, we have number of concerns: (1) the price looks rich at circa 13x pre synergy EV/EBITDA, (2) with imperfect information we calculate this deal is dilutive in year 1 (versus guidance of enhancing) and return on invested capital exceeding weighed average cost of capital by year 3 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."In addition, Liberum said the deal is complex and creates confusion as to what the Restaurant Group investment case is."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. 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."Restaurant Group - which owns Frankie & Benny's and Chiquito's - announced on Tuesday that it had agreed to buy Wagamama for £357m in cash, giving an enterprise value of £559m, in a deal that will be funded through a combination of cash, a £315m rights issue and a £220m debt facility.At 1000 GMT, the shares were down 6.1% to 230.80p.