Air Canada's so-called repudiation of its food service contract with Cara Operations looks like a bad thing, but in reality it couldn't have come at a more opportune time for the restaurant company. Why? Because it plays right into the hands of Cara's controlling shareholders, the daughters and niece of former chairman and CEO Paul Phelan, who are trying to take the company private at a favourable price. In the end, anything that drives the cost down is a good thing.
The decision to jettison the contract with Cara has been described by some as a "surprise" move by Air Canada -- but it can hardly be all that surprising that a insolvent airline would try to renegotiate its food service contract. After all, it has already declared all its other commitments to be void, including the terms of its financial agreements with various bondholders and its contracts with its own employees, to the point where it wants to renegotiate its pension plan.
In other words, the idea that Air Canada might try to use its protection from creditors to work out a more favourable deal with Cara, one of its largest suppliers, is about as surprising as a crowded airport terminal at Christmas time. In fact, the only thing that is really surprising is the suggestion that Cara might lose the Air Canada contract altogether. Despite the selloff that the news triggered in Cara's stock, the chances of that happening seem to be fairly remote.
National Bank Financial analyst David Newman, for example, says he believes Air Canada may try to negotiate a lower price for the contract, but that the airline is likely to stay with Cara because it doesn't have a choice. "We are confident that Cara will remain the provider of in-flight catering and commissary services for AC," he said. "Air Canada has little recourse but to deal with Cara, given its well-established network of 11 flight kitchens... dominating the Canadian landscape." Competitors "do not have the bench strength to compete."
Mr. Newman says he expects that even a large cut in the profit margin on the Air Canada contract would not have a huge impact on Cara's bottom line, which implies that "the implications of Air Canada's announcement are relatively minor." In fiscal 2003, the contract only amounted to about 12 per cent of the restaurant operator's overall revenues, and about 7.5 per cent of Cara's operating cash flow, the National Bank analyst said in his report.
Catering -- not just to airline passengers, but to schools, hospitals and other institutions -- used to be a much larger part of Cara's business. Until a year or so ago, the company controlled Beaver Foods, one of the largest institutional catering companies, as well as Cara Health Services. Both of those units have been sold and the company bought -- after a divisive and drawn-out takeover battle -- control of Second Cup, the gourmet coffee chain. Most of Cara's business is now food retailing, through Second Cup, Harvey's, Swiss Chalet and the new Outback Steakhouse and Milestone's chains.
That's one reason why Mr. Newman believes Cara's stock is worth more than the $7.50 the Phelan family was originally offering -- an offer it now says is under review as a result of the Air Canada news. Not only is the Air Canada contract not really in jeopardy, the National Bank analyst says, but the fact that Cara is more of a restaurant operator now means its stock is worth more than when it was half restaurant company and half institutional catering company. And according to the analyst, shares of competing chains have been trading higher, which means Cara deserves more (his target is $8.50).
The attempt to take the company private now becomes a tussle between the Phelan family -- that is, daughter Gail Regan, her sister Rosemary and niece Holiday Phelan, who control the voting shares and a chunk of the common shares -- and Len Racioppo, a fund manager with Jarislowsky Fraser, who owns enough of the remaining common shares (80 per cent) to block the proposed bid, something he has said he intends to do unless the price is raised from $7.50. Ms. Regan's brother Paul David Phelan, who is estranged from his sisters, also owns common stock and wants a higher price as well.
A price of $7.50 for the stock no doubt looked like a slam dunk for the Phelan family earlier this year, when shares of Cara hit a low of about $5. In fact, over the past two years, the stock has had an average price in the mid-$6 range - although it got up to the mid-$7 level last year, after the company recorded a large windfall as a result of the sale of its hospital catering unit. But given Mr. Racioppo's resistance, and the perception that the company is worth more now because of its restaurant focus, the Phelans may have trouble making their bid work -- even with the negative taint from Air Canada's contract move.