Before plunging into Cara Operation Ltd.'s initial public offering, a deal expected to be worth about $200-million, investors must answer a crucial question: Is one year of results enough?
Since Cara, the parent company of restaurant chains such as Swiss Chalet and Harvey's, restructured in late 2013, an massive undertaking that included buying Prime Restaurants and making Fairfax its major shareholder, the organization has been upended. New managers were brought in to offer fresh ideas, and the early results of their efforts have been encouraging. Existing store sales jumped 2.6 per cent in 2014.
But it's only been one year since they started. And that's a big problem, because we can't be sure the sudden success will continue. In some ways, this deal looks like it's straight out of the age-old IPO playbook: Go public when the story looks juicy, forcing public investors to cross their fingers. (Lately that approach hasn't been kind to Canadians who buy big deals).
What Canadians could really use is another 12 months, during which Cara's management could prove their turnaround has legs.
But every banker knows you must strike when you have the chance, and right now Cara's window for a deal couldn't be any wider. The Canadian market is nearing its all-time high again, driven by a massive rotation out of resources and into consumer stocks. The S&P/TSX Composite Index's consumer discretionary subsector is up about 20 per cent in six months, which inevitably boosted Cara's valuation.
The company's managers have also put in piles of work, led by Bill Gregson, the man who turned The Brick around– and made boatloads for Fairfax in the process. Since he joined Cara in 2013, the company has embarked on an extreme cost-cutting mission, slashing 15 per cent of its head office staff and closing unprofitable restaurants. Cara is now also marketing its brands extensively, relying less on third party consultants in favour of spending heavily on its own advertising. Managers attribute this to the pickup in same-store sales.
Late last year Cara also hired Ken Otto, Boston Pizza International's chief operating officer, who is now responsible for the Harvey's, Swiss Chalet, East Side Mario's and Montana's brands. (This is a probably a good time to disclose that I've very publicly stated my affection for Swiss Chalet).
What Cara really needs now is to lower its heavy debt burden. At $278-million, it amounts to four times earnings before interest, taxes, depreciation and amortization. The bulk of this comes in the form of a bank credit facility, most of which comes due in 2017. Scotia Capital, BMO Nesbitt Burns and RBC Dominion Securities are the lenders, which is why they are also underwriting the IPO.
Instead of nearing that deadline and hoping that the markets will stay hot for a public offering, Cara is selling stock now, using the proceeds for debt repayment. (Cara hasn't confirmed the size of its IPO, citing a quiet period enforced by regulators, but the company disclosed that it intends to pay down $185-million worth of debt with the deal's proceeds.)
You can't say the IPO is a money grab. Fairfax and the Phelan family, who founded Cara, will remain major shareholders– though they hold multiple voting shares, giving them power over anyone who buys in now. And because the new funds will be used to pay down debt, the company's balance sheet will be in much better shape for the new investors after the IPO. (Fairfax's initial investment in 2013 also went toward reducing leverage.)
But by even Cara's standard's, it's a quick turnaround. The company initially planned on going public within three to five years. That much more conservative timeline is now being blown out of the water.