Founder George Quek plans to take his F&B company private. With challenging times ahead for the business and a seemingly attractive offer on the table, should minority shareholders snap it up like his famous pork floss buns?

SINGAPORE (Feb 28): Market watchers are usually disappointed when homegrown public companies choose to delist, given the Singapore market is suffering from a dearth of major listings. Therefore, news that another high-profile local company — BreadTalk Group — could be on its way out must have been pretty hard to swallow for some investors. 

This time though, the privatisation move might be the best thing to do given BreadTalk needs time and space away from the public eye to reorganise and restructure its business after it expanded rapidly with the help of debt. 

But unlike Hyflux which collapsed under a huge pile of debt, BreadTalk’s major shareholders have the capacity and wherewithal to restructure its debt consisting of outstanding bonds and bank loans, provide sufficient working capital to survive, and eventually embark on a more sustained pace of growth. 

On Feb 25, a group of investors led by George Quek, founder and executive chairman of the BreadTalk, put forward an offer to buy out the minority shareholders and delist the household name that runs bakeries, cafes, foodcourts and restaurants across multiple brands and locations. 

In many previous privatisation deals, minorities are justifiably aggrieved with controlling shareholders bilking them with a low-ball privatisation offer. In this case, some analysts covering this stock are urging minority shareholders to accept the offer. Others say Quek’s privatisation move could be partly triggered by financial covenant breaches of BreadTalk’s $100 million 4% five-year notes. 

Besides Quek, parties in concert include his wife, deputy chairman Katherine Lee, and Thai-listed F&B company Minor International, which is a long-time substantial shareholder. They own direct stakes of 33.99%, 18.62% and 14.2% respectively but with other related parties, they form a bloc of 70.53%. 

BTG, the takeover vehicle used by the trio, has offered to acquire all of the issued shares of BreadTalk it does not already own or control at 77 cents apiece. This translates to a premium of about 19.4% at its Feb 21 closing price of 64.5 cents. The offer price also translates to a premium of 30.1% over the one-month volume weighted average price (VWAP); a premium of 24% over the threemonth VWAP; and a premium of 25% over the six-month VWAP as of the same date. 

BreadTalk says the offer price represents an “attractive cash exit opportunity” for shareholders to liquidate and realise their entire investment at a premium to the prevailing market prices. 

Year to date, BreadTalk’s share price has fallen by 1.52% to a last traded price of 64.5 cents on Feb 21 before the offer was made. At this level, the counter is trading at a rather rich multiple of 41.5 times historical earnings, which values the company at $363.64 million. The company’s share price reached a peak of $1.20 back in 2018. In contrast, other F&B stocks such as Koufu Group, was down 5.1% over the same period. Kimly Group, dogged by an on-going probe by the Commercial Affairs Department of the Singapore Police Force, was down 8%. 

A technical breach 

In the weeks leading up the privatisation announcement, investors were bracing for negative news from the company. On Jan 16, BreadTalk issued a profit warning, citing poorer performance in its major markets China and Thailand has caused its 4QFY2019 ended December to sink into losses. The Covid-19 outbreak has merely added to woes, especially so for its Hong Kong businesses, which had already suffered for months from the street protests. A fortnight after the profit warning was issued, the resignation of the company’s group CFO was announced, less than half a year after the previous group CEO resigned. 

Late in the evening of Feb 24, BreadTalk announced it had posted a loss of $8.1 million and $5.2 million for 4QFY2019 and FY2019 respectively. Announcement of the privatisation offer followed half an hour later. But, what was more revealing was a separate filing in between those two announcements stating that the company was in a “technical breach” for a $100 million fixed rate notes carrying a coupon of 4% due 2023. 

According to the company, changes in accounting rules, specifically, the adoption of SFRS(I) 16, means BreadTalk failed to pass certain thresholds stated for this tranche of notes. For FY2019, the company adopted SFRS(I) 16 (Leases) for the accounting treatment of its leases to keep in line with new accounting standards. The adoption of SFRS(I) 16 generally results in the frontloading of lease-related expenses into the profit or loss account, unlike the previous standard of accounting for leases on a straight-line amortisation basis. This, in turn, affects other line items reported in its FY2019 financial statements, the company says. 

Under the new rules, as a result of the poorer 4QFY2019 numbers, its accumulated profits for FY2019 decreased by 44.6% to $67.8 million from $96.1 million in FY2018. 

Under the terms of this tranche of notes, the ratio of BreadTalk’s consolidated total borrowings (net of cash) versus consolidated tangible net worth — the gearing ratio excluding intangibles — has to be lower than or equal to 3:1. If SFRS(I) 16 was not applied, the ratio would have been 2.91:1. Under the new rules however, the ratio is now 3.55:1 and therefore busted the threshold. This was mainly caused by a drop in the company’s consolidated tangible net worth, which was required to be equal or more than $75 million. Under the new rules, this amount works out to be $53.282 million. Without the new rules, it would have been $65.073 million. 

In response to queries by the Singapore Exchange, BreadTalk says as of Feb 26 evening, the trustee of the notes has not asked for early repayment despite the technical breach. BreadTalk reiterates that the technical breach is not indicative of any cash flow impact on the group and the company is expected to be in a position to pay interest payments on the notes as and when such interest payments are due. The company says its interest cover — which is its Ebitda to interest expense ratio — is 9.5 even under SFRS(I) 16, hence it can meet coupon payments. Moreover, although BreadTalk is in a net debt position, it has cash of $157 million as of Dec 31, 2019. 

In any case, by delisting and privatising BreadTalk, BTG believes the move will provide “more flexibility” to address the challenges facing the company. This will also provide it with better maneuverability to manage the business and optimise the use of the company’s management and resources, it adds. 

In the offer announcement, BTG says it intends to review and streamline BreadTalk’s business activities. It also aims to refocus on and strengthen core business activities and explore potential corporate actions, such as the disposal of non-core property assets. 

Sell-side analysts who cover BreadTalk, agree. Revenue between FY2018 and FY2019 increased by 9% to $664.9 million, and increased 10.1% to $170.4 million for 4QFY2019. But the company was clearly struggling with higher costs. The 4QFY2019 losses of $8.1 million was a sharp reversal from earnings of $8.8 million recorded in the year earlier period. Correspondingly, FY2019 losses of $5.2 million was a bright splotch of red versus earnings of $15.2 million for FY2018. 

Given the disappointing FY2019 results as well as the bleak prospects hurting consumer stocks amid the Covid-19 outbreak, DBS analyst Alfie Yeo is in favour of the offer. He tells The Edge Singapore, “A delisting will allow them time to improve the business without having to answer to minority shareholders.” 

But what about the company’s financial covenants? Yeo says that by being a private company, there could be more flexibility to resolve this issue. “There could be some things going on at the back-end, but we won’t know the details. No matter what, [the company] will have to seek a waiver or pay off its creditors,” he says. 

A win-win? 

Despite all its achievements as a homegrown enterprise with a significant regional footprint, BreadTalk in recent years has struggled with hefty start-up costs of new brands, as well as its bid to continue with its overseas expansion drive. 

Quek, the founder, remains the near-iconic person in charge. However, the top management team under him went quickly through the revolving door. BreadTalk’s group CEO Henry Chu officially resigned on August 15, 2019, citing personal health reasons, and left the company at the end of the year. He was appointed only in July 2017. Chu took over the group CEO job from Oh Eng Lock, who held the post from Jan 2011 to July 2017. Within months of Chu’s resignation on Jan 31, group CFO Chan Ying Jian, who wore another hat as the group CIO, quit as well. 

At one point, Quek, on top of his chairmanship, had assumed responsibilities of the group CEO, CFO and CIO functions concurrently, which drew the attention of regulators. Citing the Code of Corporate Governance, Singapore Exchange Regulation (SGX RegCo) says there should be a clear division of responsibilities between the leadership of the board and management. SGX RegCo also warns that no one individual should have unfettered powers of decision-making.

The company clarified on Feb 6 that Quek has no intention to assume the additional role of group CFO permanently and that there has been an active search. On Feb 26, the company announced that Chong Chow Pin — who used to hold similar roles at Innovalues and Jaya Holdings which were once listed — was made the new group CFO. 

However, BreadTalk says it has no plans to find a replacement for the position of group CEO. The role and responsibilities of group CEO will be undertaken by deputy group CEO Jenson Ong and group COO William Cheng. They will assist Quek in his role as group CEO. Both Ong and Cheng were promoted to their current roles last year. 

Quek and his team will have their hands full. The company needs to grow, but its near-term focus has to be on dealing with the fallout from the Covid-19 outbreak. This is because its brands are more discretionary than staple and it has stakes in big markets hurt most by the outbreak, such as China and Hong Kong. 

As of press time, the Covid-19 outbreak has killed nearly 2,800 people wordwide and a vaccine has yet to be discovered. If the current situation persists or worsens, BreadTalk is likely to suffer. “The outbreak of Covid-19 has added further challenges to the group’s operations,” the company says in its outlook statement. 

And some market watchers agree BreadTalk’s challenges are unlikely to go away anytime soon, but are about to get worse. The way RHB analyst Juliana Cai sees it, the group’s F&B retail business is highly exposed to markets that are disrupted by the virus epidemic. 

She notes that for FY2019, 56% of the group’s revenue was from Singapore, while another 31% from China and Hong Kong. She expects revenue in Singapore to dip 3.5% this year while China and Hong Kong might suffer a bigger drop of more than 10% from 2019. 

“This would have a negative impact on operating leverage. There may also be more store closures in FY20 in the bakery division, and a slower turnaround from the 4orth division,” she adds, referring to a business unit that manages the various new, smaller brands and franchises BreadTalk also operates highend bakery Wu Pao Chun and China bubble tea chain TaiGai.

Lawrence Loh, associate professor at NUS Business School, believes this is the right time for the company to be taken private by Quek. “The privatisation is indeed a well-timed initiative to help reconfigure the whole company,” he says. “By being private, the company can then go on to make quick decisive moves, tap on its enormous potential to innovate and venture into new businesses, new markets.” 

“Of course, the group can stick to their fundamental businesses, including restaurants and bakeries. But this does not mean that it should be stuck in these areas,” adds Loh. “Moving forward, they have to think of more innovative things in order to keep in line with the industry transformation, and apart from their new offerings, they will be better able to take risks.” 

“When a company is private, it doesn’t have to cater to too many voices or demands. Instead, it can be well-focused on taking risks, innovating and venturing out of their core businesses,” he adds. 

RHB’s Cai says the privatisation is a good time for investors to cash out. “FY19 result was below ours as well as the Street’s expectations. On top of that, we think that the outlook would remain challenging in 2020 against the backdrop of this Covid-19 outbreak,” Cai tells The Edge Singapore in an interview.

“So we recommend and expect shareholders to accept the offer. The offer price of 77 cents per share is 15% above our previous sum-of-part valuation for the group so we think the cash offer is attractive,” adds Cai. 

Yeo of DBS agrees. He notes that the offer price is higher than what BreadTalk shares could fetch from the open market in the past eight months. Shareholders will find it difficult to hold out for higher counter offers, he says. 

He calls the offer a win-win for both Quek and minority shareholders. The Queks and Minor International aside, the next largest BreadTalk shareholder is a US fund manager Paradice Investment Management, which, according to Bloomberg data, holds just 4.99%, versus the 70.53% already held by the offerors. As such, it is tough for the minorities to mount a challenge by either rejecting or forcing a higher offer price, says Yeo. 

Once Quek receives acceptances to increase his shareholding to above 90%, he can then refuse to unwind the free float and suspend trading of shares as the free float is below 10%. “At that point in time, the only way for shareholders to realise their investment would be to accept the offer. Most remaining shareholders would by then also accept the offer,” says Yeo. 


A temporary ‘perfect storm’

Analysts might have an easy time persuading BreadTalk’s minority shareholders to take the offer and walk. However, they need to try harder when it comes to shareholder Rusmin Ang.

When the markets were all jittery during the European debt crisis back in 2012, he scooped up BreadTalk shares at a bargain price of 24.5 cents. He knew then that the company’s margin was “razor thin” but was won over by its ability to generate high cash flow. 

Ang describes the privatisation news as “devastating”. He knows retail minorities are not like big institutional investors who are able to influence the vote easily. Nevertheless, he has vowed to vote against the offer. “It is definitely a bad timing for us to exit our investment. The company is being hit by a perfect storm, which, I think are mostly temporary issues,” he laments. “As a retail investor, I would be voting against the deal. But from my past privatisation experiences, the odds are against me.” 

Ang is aware of the company’s deteriorating operating financials over the last couple of years, which he believes was because of mismanagement. “Shareholders have collectively paid for the expensive mistakes made by the previous management but with the privatisation, there is no way minority shareholders can ride out the storm together,” he adds. 

He takes the view that setbacks are common in businesses, and BreadTalk is no exception. But, these setbacks do, and will, pass. Recalling the group’s inventory writeoffs, provision for doubtful debts, premature outlet closures and the most recent slowdown on the back of the Covid-19 virus outbreak, Ang says that his primary concern is the timing of the privatisation.

“Why would anyone choose to privatise a company given all the bad news being reported one after another? Is it a fair deal for minority shareholders to accept the deal at such terrible timing?” he says. 

Artistic founder 

The story of founder Quek is a familiar one of a homegrown entrepreneur. The former army regular was not in the F&B business right from the start. Quek, who had formal training in arts and whose flair in this field is well-known, was selling his own engraving of wood and metal pieces when he met Katherine Lee, who would become his wife. 

In the early years, BreadTalk was winning over consumers with their innovative take on what they sell. The pork floss bun is but the most notable example, and one gets the sense that the creativity flair permeates throughout the company. 

However, as BreadTalk grew as a listed company, Ang observes that the company has been putting “too much focus” on numbers. For example, former CEO Henry Chu stated in early 2019 that BreadTalk’s aim is for an 8% profit margin and $1-billion market cap for FY2022. “I believe numbers are important, but, whenever I turned up at their meetings, the focus is often on numbers and it is almost as if the company has lost its soul,” says Ang. 

He is also concerned that BreadTalk is juggling too much with the growing number of brands and franchises, where there is persistent hefty start-up costs to commit and therefore a drag on the bottomline. Apart from the core BreadTalk and Toast Box brands, the recent additions include Japanese tea and bakery brand Nayuki, Taiwanese bakery Wu Pao Chun and Chinese bubble tea brand TaiGai. 

“I think BreadTalk would be better off focusing on their core F&B brands and selling their franchising licenses like what Domino’s Pizza did by scaling their brands around the world,” says Ang. “It is obviously easier said than done, but I believe the odds are a lot higher.” 

He is holding out hope that the privatisation will not go through, as a turnaround plan is already in motion and that Quek is confident of pulling off. “Otherwise it makes little sense for privatisation,” says Ang.