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The Esplanade Keg Restaurant in Toronto on Jan/ 23, 2018.Christopher Katsarov/The Canadian Press

As soon as Prem Watsa invested in Cara Operations Ltd. in 2013, the restaurant owner started playing the acquisition game.

In a little more than four years, Cara, which controls brands such as Swiss Chalet and Harvey's, acquired a coterie of chains from my suburban teenage years: restaurants such as East Side Mario's, New York Fries and the Pickle Barrel. The rationale was to buy similar companies, slash costs on the back-end, and then benefit from economies of scale.

But in its latest deal with Keg Restaurants Ltd., announced on Tuesday, Cara is as much the target as the acquirer.

Read more: Cara Operations set to swallow upscale competitor the Keg

Unlike in previous transactions, the Keg holds serious sway in this new partnership. Its chief executive, David Aisenstat, will continue to run the steakhouse chain, which will operate as its own entity within the broader company. He will also take control of three of Cara's upscale brands, including Bier Markt, and join Cara's board of directors. Typically, when Cara does a deal, it's viewed as the dominant buyer. This time, the transaction is explicitly labelled as a merger.

And a merger of what, exactly? Mr. Watsa's Fairfax Financial Holdings Ltd. already owned a majority stake in the Keg. It appears the joint owner is cobbling two investments together to make some magic happen. And in this scenario, it's Cara that needs the partnership. The stock market reaction on Tuesday says it all. Cara's stock jumped nearly 10 per cent. The Keg's publicly traded royalty units dropped nearly 4 per cent.

How Cara got here is a fascinating case study. When Fairfax invested in the company in 2013 and combined it with Prime Restaurants right after, it seemed like a lucrative opportunity. Mr. Watsa recruited Bill Gregson, who had turned around the retailer the Brick, to be Cara's CEO, and paid him handsomely for his efforts.

Cara went public in the spring of 2015, and when its shares started trading, Mr. Gregson's stock options were worth $60-million. The stock then soared for the next six months, climbing more than 50 per cent.

Two months later, it had lost almost all its gains. It hasn't really recovered since.

Canadians don't love Cara's chains as much as they used to. The company's total sales have been soaring, but that's mostly because it kept acquiring – which meant it was buying growth.

Investors looked past this problem for the first six months that Cara was a public company because management was making serious improvements on the cost front. Labour expenses were slashed through measures such as improved scheduling, and there was hope that a campaign to renovate run-down restaurants and then market them more effectively would turn things around.

Eventually the hype fizzled. Some short-term investors cashed in their fast gains, then weak same-restaurant sales became a major issue – particularly in Western Canada.

When Cara reported earnings in November, 2016, total sales had jumped 14 per cent, driven by its acquisitions of New York Fries and St. Hubert. Same restaurant sales, meanwhile, fell 2.3 per cent from the year before.

"Casual restaurants face difficulties generating traffic gains as the model in its current form struggles to appeal to the younger demographic," CIBC World Markets analyst Mark Petrie wrote in a note to clients in March, 2017. "Changes to the business model can help to stem these declines, but they may take time to reach a sizeable scale."

Cara's management team has tried to turn the tide, doing everything from its early restaurant renovations to teaming up with delivery services such as UberEats, Just Eat and Skip the Dishes to inking digital partnerships with driving app Waze, The Weather Network and the Scene loyalty program.

Raymond James analyst Kenric Tyghe has credited management for these "herculean efforts," but after Cara last reported earnings in November, he noted the company still has huge hurdles to clear: An aggressive cost-cutting campaign to offset lower revenues could dilute diners' experiences; menu innovations, such as a Harvey's build-a-bowl for more health-conscious consumers, "is in essence thinly-veiled food cost-cutting, which, in our opinion, is rubbing customers the wrong way;" and "a lot of what has been done is pay-to-play and just gets them in the game (a.k.a they are playing catch-up)."

"Without M&A, generating earnings growth will be difficult," CIBC's Mr. Petrie wrote to clients after that earnings report.

Two months later, Cara is merging with the Keg, whose organic sales are rather lucrative. With some luck, the Keg's management team can apply some of its smarts to Cara's higher-end chains. At the very least, the combination will mask some of Cara's woes, buying Fairfax some breathing room to turn things around.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 4:00pm EDT.

SymbolName% changeLast
CM-N
Canadian Imperial Bank of Commerce
+1.3%50.72
CM-T
Canadian Imperial Bank of Commerce
+1.13%68.67
FFH-T
Fairfax Financial Holdings Ltd
-0.54%1460.1

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