CAKE – THE ACQUIRER OR THE ACQUIRED?

Yesterday, CAKE’s CFO Doug Benn made what I thought were some interesting comments about restaurant acquisitions in response to a question at an investor conference.  When reading Mr. Benn’s response below, it is important to remember that he is speaking from experience as he was the CFO of RARE when it was acquired by Darden in October 2007.

Question:  Strategically how does the company think about acquisitions going forward, does that become a more important element over the next couple of years or...

Answer:  I think capital allocation is the big question for us, I think next year it’s going to be rather easy, we have $125 million with debt, there is a guaranteed result when you pay down your debt, you know exactly what's going to happen, and then after that there is only the limited number of things that you can do.  The company is going to generate substantial free cash flow, acquisitions would be something that we would consider, but be very careful about generally in our industry, maybe in a lot of industries, but certainly in the restaurant business, the acquirer is not the one that makes well in this acquisition, so you got to be very careful, you're either buying a company that is in trouble when you have to fix it and you got a good deal on it or you're potentially overpaying for something that's working very well. It's something that we would look at, but not something that's imminent at all.

I understand that this was merely an off-the-cuff remark and I may be reading too deeply into his comments, but I find this response to be somewhat telling of how Mr. Benn feels about RARE’s decision to sell out to Darden and subsequently, how he feels about Darden now.  He says that the “acquirer is not the one that makes well,” which in my scenario would be Darden.  He does not say it but that might imply that it is the acquired company that makes out well in the deal, which again, in my scenario points to RARE.  In selling to Darden, RARE received a premium multiple just as trends at LongHorn were beginning to soften.  Trends have obviously deteriorated further since then so what did Darden get out of the deal?

Again, this is just my interpretation of what he was saying!  But, I do think Mr. Benn makes a valid point.  Restaurant acquisitions/mergers do not typically make a lot of sense because like he said, companies are often forced to overpay for assets or buy underperforming assets that require a lot of money to fix (if they can be fixed at all).

Regarding CAKE, I think Mr. Benn’s less than positive view of restaurant “acquirers” means we don’t have to worry about the company making any acquisitions any time soon.  Instead, CAKE’s future earnings growth will come from a return to positive same-store sales growth and new unit growth as he outlined in his presentation yesterday.  This growth plan may not bring about immediate results as it relies on increased consumer spending and job growth, but I think an acquisition would only complicate matters both in the near-term and long-term.