Thu 18th Sep 2014 - Simon French – Restaurant Group should merge with M&B Simon French – Restaurant Group should merge with M&B: Simon French, the former Panmure Gordon leisure analyst now at Cenkos Leisure, has argued that the Restaurant Group should seek to merge with Mitchells & Butlers to solve the latter’s operational underperformance problems. Issuing a ‘Buy’ note, he said: “The Restaurant Group is the best-in-class operator in a highly competitive sector, in our view. H1 results showed impressive 15% Earnings Per Share growth from 2.5% like-for-like sales growth, highlighting the attractive operational gearing in the model. The group can generate self-funded double-digit earnings growth from circa 40 net new openings per annum, 2-3% like-for-like sales growth and 20-30bps margin expansion. However, it has earned the opportunity at creating something bigger: we would urge merging with Mitchells & Butlers to create the UK’s pre-eminent eating and drinking out group. At the start of 2009, The Restaurant Group share price slipped intraday below 100p; shareholders have since been stunningly rewarded. The group has pushed Frankie & Benny’s into the top tier of UK casual dining brands (with PizzaExpress and Nando’s) whilst in recent years has evolved Chiquito and created Coast to Coast as scalable brands. Combined with Garfunkel’s, Concessions and a high quality pub-restaurant business the group has developed the foundations to double in size over the next eight to ten years. The group’s operational success and balance sheet discipline presents, in our view, the solutions to M&B’s problems of operational underperformance, high leverage and insufficient cash flow to pay a dividend. Whilst Restaurant Group has built its success on disciplined organic growth we see no fundamental reason why it shouldn’t seek to merge with M&B; nor do we see many reasons why MAB should not consider it (see ‘Your Round’, published 18 September 2014). For the combined entity we estimate c£60m synergies, pro-format net debt to Ebitda of 2.9x and a market cap of circa £3.9bn. The Restaurant Group doesn’t need to merge with Mitchells & Butlers. We believe its valuation is undemanding, trading on a 2015E adj EV/Ebitdar of 8.7x for three-year CAGR in EPS of 11.5%, with a long-term track record of forecast upgrades will lead to ongoing market outperformance. But we believe it should merge with Mitchells & Butlers. In our view the combined entity would command a premium rating with the Restaurant Group offering the solutions to Mitchells & Butlers problems of operational underperformance, over leveraged balance sheet, lack of dividend and illiquid share register. We think both stocks could rise circa 31% initially if a nil premium, all-share merger was pursued.” In a separate buy note on M&B, he said: “Superficially Mitchells & Butlers remains a challenging business to invest in. Investors continue to pay for past mistakes of a highly leveraged balance sheet, insufficient cash generation to pay dividends and a lack of liquidity. It hasn’t helped that the turnaround strategy has taken longer to take hold than would have been hoped for. However, the group retains impressive assets and the stock is inexpensive with significant self-help potential. We believe progress could be accelerated by merging with The Restaurant Group. We initiate coverage with a ‘Buy’ recommendation. As Alistair Darby approaches his two-year anniversary as CEO (on 8 October) – and whilst the shares are up circa 33% – he will be aware that progress has been slower than hoped for. Staff turnover is at record lows and net promoter scores are improving but like-for-like sales growth and margins have been slower to respond leaving the group’s operational performance lagging the peer group. It has developed a sensibly-paced growth strategy now augmented by the acquisition of 173 pubs from Orchid. The group has developed two nationwide brands in Harvester and Toby Carvery that still have plenty of growth potential reflecting their well-defined proposition and mass market appeal. The challenge for the group is turning around its 415-unit Heartland segment consisting of Sizzling Pub Co, Crown Carveries and unbranded pubs under the Oaktree banner. These have become caught up in a highly competitive value food market with price used a blunt instrument to protect volume.”