It has been a long time since I visited a buffet-style restaurant. One of the last times was when my car caught fire and we used a nearby restaurant's phone to call the fire department. Fortunately, nothing that dramatic has happened at Ryan's Restaurant Group
The buffet-style restaurant company reported second-quarter earnings yesterday, and on the whole, good things were happening. While it missed estimates on a GAAP basis, that miss came from one-time charges, mostly increasing reserves for possible resolution of a class action lawsuit. Debt was reduced substantially from last year and free cash flow was well up.
Along with nearly every other restaurant (it seems), Ryan's reported declining same-store sales from last year. This led to a slight decrease in overall revenue, but improvements in gross and operating margins led to higher net income compared to last year. Free cash flow was about $6.9 million, well over last year's $1.1 million, but down from last quarter's $20 million. That was primarily because of lower net income and a significant payment of deferred income tax, relative to the first quarter. Without the one-time charges mentioned earlier, free cash flow would have been about $15.7 million.
The dramatic event for the quarter was the announcement that the board has agreed to merge the company with Buffets -- the operator of Old Country Buffet and Home Town Buffet -- which is owned by Caxton-Iseman. The private equity firm took Buffets private back in 2000. Shareholders of Ryan's will receive $16.25 per share in cash in the $876 million deal. That represents a 45% premium to the previous closing price of Ryan's stock and is a bit above where the stock currently trades. The deal is expected to close in this year's fourth quarter, so we can look forward to one more earnings release.
If you look more rigorously at Ryan's free cash flow (FCF) of $27.5 million for the 12 months ending in June, the purchase price partially makes sense. That level of FCF has 18% growth baked in for five years, assuming a 12% discount rate, which seems a bit high.
However, a major drag on FCF was the rather high level of capital expenditure of $47.6 million. In the first half of 2006, capex was only $11.6 million, as management cut back on store growth, compared to $36 million for the second half of 2005. If the lower rate had been used for all of last year and all else remained the same, then free cash flow would have been about $51.9 million. Using that, the $16.25 per share price has about 7% growth per year for five years baked into the price.
Does that make sense? Possibly. The combined, larger company could focus more on operating improvements to improve cash flows, with fewer capital expenditures on store openings and remodeling (as Ryan's had been pursuing). In addition, Caxton-Iseman could sell underperforming restaurants, since Ryan's owns most of its land and buildings. Based on this quick evaluation, the proposed price seems reasonable. Shareholders should be satisfied with the 45% premium, take the cash, and find another place to invest it.
Related dramatic events:
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Fool contributor Jim Mueller was forced to rapidly buy a car after that little incident but tells us no one was injured. He does not own shares of Ryan's. The Fool is investors writing for investors .