Jollibee Foods Corporation (PSE:JFC) recently disclosed it is acquiring 100 percent control of global coffee chain operator, the Coffee Bean and Tea Leaf (CBTL).
The acquisition of CBTL, which has over a thousand outlets globally, is expected to boost JFC’s total store network by 26 percent to over 5,700 outlets, making it one of the top restaurant companies in the world.
But the supposed good news turned out to be a disappointment to investors.
A few days before the announcement, the market started selling JFC shares, which resulted in the stock price losing as much as 17 percent, from P279.80 per share to a low of P231.
The sell down on JFC shares apparently was caused by fears that the consolidation of CBTL’s financials, which registered a net loss of $21.4 million or P1.1 billion last year, may drag the company’s earnings growth outlook.
Although the stock seemed to have recovered from its recent lows temporarily, there are still uncertainties on how CBTL will add value to JFC.
Should investors be concerned about JFC’s aggressive global expansion? What are the potential risks and opportunities of CBTL’s acquisition? Should you buy JFC stock at this level?
Here are the five things every stock market investor must know about JFC’s acquisition of CBTL:
1. Know the background of the company
The Coffee Bean and Tea Leaf (CBTL) brand is a coffee and tea shop owned by International Coffee and Tea, LLC based in Los Angeles, California.
The company was founded in 1963 by Herbert Hyman who introduced several innovations in the gourmet coffee industry. Among them were the company’s signature Ice Blended drinks and the selling of whole beans in the shop.
In 1996, the Hyman family sold the Asian franchise rights to Singaporean entrepreneurs Victor and Sunny Sassoon, who helped expand the company in Singapore and Malaysia. Two years later, the Sassoons bought out the Hymans and took the company global.
Today, CBTL operates a total of 1,189 outlets worldwide of which around 70 percent are franchised. Although CBTL is based in the U.S., about 75 percent of its outlets are in Asia and the middle east.
2. Know the financial track record
In 2018, CBTL reported that its total revenues grew by 4.1 percent to $312 million from $300 million the previous year.
CBTL’s retail revenues, which comprise 76 percent of total, grew by 2.2 percent to $238 million while franchise revenues, which contribute 10 percent of total, increased by 57 percent to $31 million.
Only wholesale revenues, which represent around 14 percent of total, declined by 8.4 percent from $47 million in 2017 to $43 million last year.
Gross margins ratio of CBTL, which is computed after deducting cost of goods sold, labor and related costs and occupancy costs from revenues, was 22 percent, higher than 19 percent from previous year.
It was the increase in interest expenses and operating costs that caused the company to report an accounting net loss of $21.4 million, though lower by 16 percent from previous year’s loss of $25.5 million.
Looking closer, however, if the non-cash expenses such as depreciation, amortization and impairments are taken out, CBTL generated positive cash earnings of $26.5 million, which is 109 percent higher than $12.6 million it made in 2017.
3. Know the terms of the transaction
JFC is acquiring CBTL for a total consideration of US$350 million, which will be financed by a combination of equity and short-term advances.
JFC will form a holding company based in Singapore through its wholly owned subsidiary, Jollibee Worldwide Pte Ltd in partnership with other investors from Vietnam with a capital contribution of US$100 million, representing its 80 percent equity share.
The balance of $250 million shall be funded by advances from JFC, which will be repaid in six to nine months from the proceeds of the preferred share offering of the new holding company.
JFC’s partners in this acquisition are members of the family that owns Viet Thai International Joint Stock Company (JTI). JTI is JFC’s joint venture partner in Superfoods Group of Business that owns and operates Highland Coffee and Pho 24 in Vietnam.
4. Know the valuation of the deal
Assuming the Enterprise Value (EV) of CBTL is equivalent to the purchase price of $350 million, the implied EV-to-EBITDA multiple used in this transaction is estimated at 13 times.
Given the median EV-to-EBITDA multiples of listed restaurant companies in US at 18 times, it appears that the acquisition of CBTL was valued at the low-end of the range.
Compared to the EV-to-EBITDA multiple of profitable companies like Starbucks, which has around 20.8 times and McDonald’s Corp at 18.9 times, the discount provided to CBTL’s valuation seems reasonable.
Moreover, the pricing of CBTL at $350 million was roughly equivalent to its latest revenue of $312 million, which implies an EV-to-Revenue multiple of 1.1 times, which is at par with industry median.
Again, compared to Starbuck’s EV-to-Revenue multiple of five times or McDonald’s at nine times, the valuation of CBTL given its financial situation appears sensible at only 1.1 times.
Using the computed cash earnings of US$26 million of CBTL in 2018 against JFC’s purchase price of $350 million, the estimated investment yield stands at an acceptable rate of 7.6 percent.
5. Know the investment opportunity
Given the positive cash earnings of the company, there is a strong likelihood that JFC can minimize the impact of CBTL’s accounting losses into their bottom line.
The challenge of JFC now is how to turn around CBTL’s finances back to profitability.
If everything goes right, CBTL can potentially enhance JFC’s long-term share price valuation.
A 10 percent increase in CBTL’s revenue keeping the same cost structure without improvement can increase its EV by at least 25 percent to $436 million.
In three to five years when CBTL is presumably profitable, JFC has disclosed it intends to do an Initial Public Offering (IPO) for their Singapore-based holding company, which can be potentially huge.
Furthermore, it is noteworthy that since bulk of the financing of the acquisition will be done through advances and eventually preferred shares instead of common shares, the huge investment in CBTL should not lower JFC’s return on equity through enlarged capital.
JFC over the years has kept a healthy return on equity (ROE)at 18 to 20 percent per year. High ROE of JFC has enabled it to price its stock at a premium over its historical book value per share.
The current share price of JFC at P252 per share is priced at 32 times earnings, which is historically low compared to its average Price-to-Earnings ratio of 40 times.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice firstname.lastname@example.org or follow him on Twitter @henryong888