Sysco Market Cap: $24.43bn (as of 26/02/2016)

The companies

Sysco

Founded in 1969 and headquartered in Houston, Sysco (Systems and Services Company), together with its subsidiaries and 200 distribution facilities (US, Bahamas, Canada, Ireland), focuses on marketing and distributing a range of food and related non-food items to the foodservice and food-away-from-home industry, serving restaurants, hospitals, schools, hotels and other foodservice customers. Throughout their history they developed into one of the largest broadline food distributors thanks to their geographical expansion and acquisitions that included “SERCA Foodservices” (Now Sysco Canada), “Asian Foods” in North America and “Pallas foods” – Ireland’s largest food distributor as well as “Crossgar Services” that enabled them to expand to Ireland. In second quarter of 2014, Sysco wanted to merge with US Foods for a $3.5bn. The deal was subject to regulatory approval. However, in June 2015 the US Court ruled out the possible merger on the grounds of the 75% control of US market that combined entities would have, which couldstifle the competition. This caused some disruptions in the company, but Sysco continued to show healthy financial results:

The company has generated, in FY 2015, $48.7bn in total revenue and $1bn in FCF, compared with $46.5bn in FY 2014 sales, with a CAGR of 4.36% in the last five years. With the FCF of $1bn and 46th consecutive increase in dividends, the company appears to be quite stable, while their growth comes from the acquisitions.

Brakes Group

Brakes Group was founded in 1958 by three brothers that supplied poultry to caterers. Soon, the company started further development and did not seek away from investments. Starting from the few French acquisitions in the 1990s, the further expansion continued also in 2000s with acquisition of M&J Seafood and the merger of their company “Cearns & Brown” with “Watson & Philip” to form Brake Grocery. In 2002 Brakes was delisted and taken private. However, this did not impede the continuation of its acquisitions, including “Pauleys,” “Wild Harvest” and others. Finally, Brakes was acquired by Bain capital in 2007 for €1.3bn in order to consolidate its food and distribution businesses. Its growth is rather strong, having its sales and EBITDA 5-year CAGR of 5%. Furthermore, with EBITDA margin of 5.6% it shows better results than Sysco with 4.8%. Most of the turnover that Brakes generate comes from large chains (70%) while the rest comes from the independents. However, with respect to Sysco, Brakes is a rather small player, having $5bn of sales, which is approximately 10% of what Sysco generates.

Present also in France, Sweden and Ireland, Brakes Group has been generating strong cash flows in these countries during the last years consolidating its position in the food and transportation industry.  In Sweden the company covers 50% of the foodservice market and in France almost 20%.

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The deal

Earlier this week, the US player Sysco, announced it had reached an agreement to acquire Brakes Group, in a transaction that values the UK player formerly owned by Bain Capital $3.1bn in Enterprise Value (EV), which includes $2.3bn in net debt to be refinanced. The deal, which is still subject to regulatory approval, is expected to close by July 2016, and implies a valuation multiple of 12x the target’s FY 2015 EBITDA of $260m, which will be financed through a combination of new debt issuance and cash on Sysco’s balance sheet ($5.1bn as of FY2015 end).

Overall, after the integration process, the merged group will have annualized sales of around $55bn.

The foodservice market

Currently the broader foodservice market in UK is estimated to be worth c. £50bn and is dominated by three companies: the unlisted Brakes, which boasts 22% market share, the South African Bidvest, a bigger conglomerate with operations in EMEA and 21% market share in UK, and the smaller Booker Group that, in the foodservice segment, has £0.4bn in revenues (10% of the group sales), which the management wants to double before 2018. Other small specialty players are currently eroding leaders’ market share, but overall the sector is expected to grow steadily in the coming years.

Sysco has been looking for a UK foodservice player since 2011, when it approached the South African conglomerate Bidvest to acquire its food distribution business, in a deal that could’ve been worth $4bn. Back in time Bidvest was also target of Brakes Group, and the two have been trying to merge several times, in order to create the largest UK player in the industry.

From a preliminary valuation standpoint, we compared the exit multiple achieved by Bain Capital in its sale of Brakes to the current trading EV/EBITDA multiple of one its competitors, Booker, which currently trades 17.5x its EBITDA. If this was to be applied to Brakes’ $260m EBITDA, would give an implied valuation of $4.6bn. However Booker participates only marginally in the same business of Brakes, so the metric is hardly applicable.

Deal rationale and market reaction

Even if the deal is expected to be immediately accretive after the integration of Brakes Group, the market reacted with Sysco’s share price down 5% after the announcement. This is mainly because the deal is rather conflicting with the overall group’s strategy, and will only provide the company with a foothold in the UK market.

Few synergies are expected from the integration, given the minimal geographical overlap between Sysco and Brakes, basically determining only a change in the ownership structure of the target and a marginal threat for its UK competitors.

Also Sysco’s management declared the minimal synergies achievable post-integration, however we believe that Brakes’ group will benefit quite a lot from the transaction as it will shift from a financial buyer – Bain Capital, to a strategic buyer and industry leader – Sysco.

Brakes’ capital advantage

The UK company will maintain a certain degree of independence, pursuing the actual’s management strategy and retaining its top executives, but it will gain higher flexibility to pursue its goals. Looking at Brakes’ capital structure it is remarkable how the company was a levered player (5.8x leverage ratio), but through the acquisition it will decrease its leverage, as well as have access to cheaper capital. This will allow the company to better compete with players that have a net cash position, such as Booker, reporting a cash surplus of £147m in FY2015.

Market reactions

Probably the unfavorable market reaction is due to Sysco’s shareholders perception: the company will have to borrow extra $1.5bn, mainly to complete the planned $3bn buyback, thereby increasing its leverage. Furthermore, the minimal integration and the lack of overlap are a major driver of the stock’s underperformance: Sysco only operates a small business in Ireland, so Brakes will remain a standalone company. Last but not least, the operational risk, in a country that faces economic and political uncertainty, could have been a catalyst for the 5% plunge.

Sysco’s perspective and potential upside

Sysco’s investors ultimately were focused on improving performances in the company’s home market, with the strategic goal of 3% growth in volumes compared with flat growth in the last 5 years.

We believe that Sysco’s management is looking at the big picture: with spending at hotel, restaurants and bars in the UK growing at 5% CAGR in the last three years and food-away-from-home, representing only 40% of the market in UK vs 52% in US, giving room for significant upside.

Moreover, from a more company specific view, EBITDA margins at Brakes – probably due to the cost cutting action by the financial owner – show better efficiency compared to Sysco (5.6% vs 4.8%), difference that could also be explained by the greater complexity of a bigger conglomerate like the US company. This could allow Sysco to integrate efficiency measures and improve its low margins, which will be further eroded by smaller players in US.

 

Advisors

Deutsche Bank has provided financing and sole financial advisory to Sysco, while Goldman Sachs advised Bain Capital and Brakes Group on the transaction.

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