Is BreadTalk's S$80m offer for Food Junction worth the dough?

WAS it nostalgia that led BreadTalk founder and chairman George Quek to buy back the food court operator Food Junction, which he had a hand in founding, at a seemingly high price?

Mr Quek and a few Taiwanese partners set up Food Junction in the 1990s to run Singapore's first chain of modern food courts.

Subsequently, Mr Quek founded BreadTalk in 2000, opening its first outlet at Bugis Junction and launching its signature pork floss bun that drew long queues.

In 2003, BreadTalk listed on Sesdaq of the Singapore Exchange (now replaced by the Catalist board). That same year, it decided to set up food courts in China, which led Mr Quek and his wife to sell their substantial stake in Food Junction to avoid a potential conflict of interest. Mr Quek also had to resign as a non-executive director of Food Junction, which he did with a "heavy heart", he told media then.

Last week, in a teleconference briefing with analysts, following several reports that called BreadTalk's S$80 million offer for Food Junction exorbitant given the latter's paltry earnings, management clarified that Food Junction's weak net profit for the first half of 2019 of just S$3,183 was due to several factors that would no longer persist once the acquisition is completed.

This is because BreadTalk would not be taking over Food Junction's head office, so this would eliminate the high cost amounting to S$3 million of the latter's centrally-located headquarters. Food Junction had also been told to shut down several unprofitable direct-operated stalls before the acquisition announcement. Hence, the impairment costs of these stall closures that contributed to its weaker H1 FY19 results are not likely to continue.

In addition, BreadTalk's management said that Food Junction had opened a premium food court - Five Spice - at Jewel Changi Airport in April this year. Five Spice incurred start-up costs but had only two months of revenue to show for H1 2019.

Doing the math, management also compared Food Junction's FY18 enterprise value-to-Ebitda ratio prior to the adoption of the SFRS 16 accounting standard to other listed peers, and deemed the acquisition price at 7.6 times to be in line with competitors such as Kimly and Koufu. Kimly's EV/Ebitda ratio, for instance, was 10.3.

This approach at valuation differs from what some analysts have adopted. DBS analysts Alfie Yeo and Andy Sim did not consider a "price-to-earnings" multiple comparison appropriate due to Food Junction's FY18 losses and thin earnings in H1 2019.

Comparing the headline price-to-book valuation, they found it to be "on the high side" at 6.5 times, exceeding Koufu's three-plus times. As BreadTalk will need to draw down about S$50 million in debt to finance this deal, they expect interest costs to affect earnings.

Another niggling worry is value inflation. What are the justifications for the current price tag of S$80 million considering that Auric Pacific Group had valued the food court operator at S$30 million in 2013 when it made a cash offer for the remaining 39 per cent stake in the company that it did not already own?

That offer went through successfully and Food Junction was delisted. In 2017, the Riady family offered to buy out Auric Pacific, which besides owning Food Junction food courts, also runs Delifrance cafes and manufactures Sunshine Bread, at S$1.65 per share, in a S$48.3 million takeover bid.

One possible explanation for the S$50 million difference in valuation could be that Food Junction in 2013 was a much larger and more complicated entity which, according to Auric Pacific's past annual reports, also used to run casual dining restaurants and outlets, including Toast Junction in Singapore and Lippo Chiuchow Restaurant in Hong Kong.

At the point of acquisition, it was also managing and operating ME@OUE, a rooftop restaurant at Collyer Quay, but the group subsequently went through a major rationalisation and closed down non-performing food courts and restaurants to cope with the tighter labour market conditions.

Compared to six years ago, Food Junction today probably has a trimmer structure and is in a better state of health now.

But it doesn't mean it has shied away from expanding where it makes sense. Besides the food court at Jewel Changi Airport, it opened a food court at Century Square last year and another at Great World City this year. It is planning to open another food court in Malaysia in 2020.

BreadTalk's acquisition of Food Junction may carry additional benefits beyond the raw numbers.

For one, the deal will firmly secure BreadTalk's position as the third biggest player in town, with 26 food courts against NTUC Foodfare and Kopitiam's combined 62 outlets and Koufu's 47 outlets.

As for Mr Quek, there is probably the sweet sense of coming home to a company that he had helped to build some 26 years ago.