This article is part of the On the Margin blog.
For at least three years, investors have been pushing Bob Evans Farms Inc. to spin off from BEF Foods, its packaged food business.
Bob Evans strongly resisted this idea. Even a proxy battle, sparked by major shareholder Sandell Asset Management, couldn’t get the company to split its two businesses.
In March, Bob Evans CEO Saed Mohseni explained the company’s reluctance to sell: The packaged food business has given the company a higher valuation.
“Bob Evans’ restaurant company trades at a much higher multiple than most restaurants with a drop [same-store] sales,” Mohseni said at the time.
In the end, the packaged food business was just too profitable to spin off. The restaurants were too big of a challenge to continue as a public business. Thus, on Tuesday, Bob Evans chose to sell his restaurants to the usual buyer of the big chain Golden Gate Capital for 565 million dollars.
The multiple Golden Gate will pay for the restaurant business is “just north of 8x” cash flow. However, the 300 properties included in the transaction likely inflated the value of the business.
On the way to becoming a packaged food company, Bob Evans Inc. buys Pineland Farms Potato Company for $115 million, while selling its restaurants. Bob Evans will belong to a private equity group known for buying up restaurants, such as California Pizza Kitchen and Red Lobster.
“The sale of Bob Evans Restaurants allows the business to focus on Bob Evans Foods, the fastest growing and most profitable segment of the business,” Mohseni said during a conference call Wednesday morning.
Think of it this way: In the third quarter ended Oct. 28, Bob Evans Restaurants generated $219.8 million in sales, up from $230.7 million a year ago. BEF Foods generated half of that, $102.1 million, versus $99.5 million.
Still, BEF Foods generated an operating profit of $18.7 million, compared to $13.5 million for the restaurant division.
Which company would you rather have: the one with an 18% operating margin and growing sales, or the one with a 6% operating margin and declining sales?
The restaurant business is not easy. Bob Evans’ decision to focus on packaged foods illustrates this point. Bob Evans Restaurants has 28,000 employees. The food side employs around 1,000 people. The restaurant side accounted for “most” of the general and administrative expenses of the combined company.
The restaurant industry faces profit and sales challenges in the coming months. While the restaurant division has worked hard to buck the trend in its same-store sales — simplifying the menu, focusing more on breakfast and customer service — consumer demand for chains of Restaurants, especially on-site restaurants, remain low.
Labor costs, on the other hand, are rising due to the demand for low-skilled labour. The food cost deflation that restaurants have enjoyed for the past two years is likely to end in the near future. This will cause profit problems – unless consumers suddenly start spending in chains again.
And the restaurant business is particularly troublesome. According to MillerPulse, traffic in the casual dining industry, including family restaurants like Bob Evans, is down 21 over the past 22 months. This includes a terrible 5.3% decline in December.
Meanwhile, packaged food companies are simply more valuable than casual and family restaurants and, frankly, the difference isn’t particularly narrow.
In October, Sandell compiled a group of Bob Evans contestants. Their enterprise values averaged about 7.9 times cash flow, roughly equal to the sale price Bob Evans got.
Packaged food companies, meanwhile, averaged multiples of 13.2.
As if to illustrate this, investors cheered loudly at the news of the sale. The stock soared more than 25% on Wednesday, topping $60.
It was a historic record for the title.
Nation’s Restaurant News Senior Financial Editor Jonathan Maze does not directly own any stock or interest in any restaurant business.
Contact Jonathan Maze at [email protected]
Follow him on Twitter: @jonathanmaze