Cara’s purchase of The Keg marks a significant milestone. It instantly becomes, in our opinion, the most valuable brand within Cara’s portfolio and warrants a re-rating of Cara’s earnings multiple. While EPS accretion from the deal for F2019E is just +2% by our calculations, our sum-of-the-parts valuation increases by about 15% to nearly $28. However, the near +10% increase in the stock following the announcement implies limited upside from here, in our view. CARA remains Neutral rated, with our price target increased to $28 (from $24 previously).
What’s The Event?
Cara is acquiring 100% of The Keg’s operating company, Keg Restaurants Ltd. (KRL), for $200MM through a nearly equal combination of cash and shares. The deal is valued at 9.6x LTM EBITDA and is expected to close this quarter.
The nuance of this deal, and where it differs from our previously published analysis (“Where Does It Grow From Here”, August 1, 2017), is that the Keg’s income fund (“the Fund”) will continue to exist. In the end, the price to cancel the royalty structure was deemed too rich, so Cara will continue to pay 4% of system sales to the Fund.
Though the continued existence of the Fund somewhat complicates matters, the important takeaway here is that The Keg has added a flagship brand that can strengthen same-restaurant sales (SRS) growth and potentially unit growth, too. Furthermore, The Keg’s CEO, David Aisenstat, will not only continue running The Keg, but will also manage Cara’s other upscale brands, including Milestones, Bier Markt and Landing, providing a boost to those brands.
To be sure, minimum wage increases (those already in place, as well as the specter of increases in other provinces) present a meaningful headwind, one that we believe will shave ~$13MM off this year’s EBITDA. But we stress that expanding the network by adding a premier brand with quality management is a big step in the right direction.