Investors in Whitbread (WTB) should be in line for a cash windfall if plans to sell Costa Coffee to The Coca-Cola Company are approved. The cash sale – which sent Whitbread's shares up a fifth on the day – was agreed at an enterprise value of £3.9bn, with a “significant majority” of the £3.8bn cash proceeds returned to investors, according to chief executive Alison Brittain. However, the deal has come as somewhat of a surprise. Management said in April – following pressure from activist investor Elliott Advisors – that the timing was not right even for a demerger because the group was in the midst of a three-year turnaround plan.
Some of the proceeds will also go towards paying down debt and investing in the expansion of Premier Inn in the UK and Germany. Ms Brittain called the deal a “substantial premium” to what could have been raised via a demerger.
Based on the deal valuations, it looks as though Whitbread has agreed a good price. The £3.9bn enterprise value represents a premium of 16.4 times Costa’s cash profits in the year to March 2018. This compares with Starbucks' current 13 times enterprise value to cash profits valuation, and the implied valuation of nine times cash profits of Costa based on its expected earnings for 2019. In terms of comparable deals, JAB paid 15 times cash profits for Pret a Manger earlier this year. Numis analysts had valued Costa at £2.9bn, or 12 times cash profits, meaning the deal is £1bn accretive. They reckon around £2.9bn could be returned to shareholders once you strip out £100m on transaction costs, up to £350m on the pension deficit, and £500m to cover expansion and redeem short-term debt.
Some might wonder why Coca-Cola is willing to pay such a substantial premium for the coffee chain. The group’s president and chief executive James Quincey said hot beverages is one of the few remaining sectors where Coca-Cola does not yet have a global brand. Costa will allow the company to break into that market, and the global scale of Coca-Cola will allow for vast expansion of the coffee chain.
However, the timing of the deal has some analysts torn. Joshua Mahony, market analyst at IG Group, called the deal a “shrewd move” at a time when governments are beginning to crack down on products with high levels of caffeine. Even if coffee is immune to such regulation, the UK coffee market could be nearing a saturation point with growing competition. Helal Miah, investment research analyst at The Share Centre, called the move “astute” at what could be a peak in the cycle after a couple of decades of strong growth in the coffee market, especially considering that Whitbread bought Costa 23 years ago for £19m.
But Mr Miah added that some might think the sale is premature since Costa’s expansion in China is just starting to take off. At the full-year results in April, Whitbread announced it had bought out its joint venture partner in China, and was targeting 1,200 stores there by 2020. At the first quarter of the current financial year, the group had 459 stores in China, and was aiming to open 100 more by the year-end. While no figure was given, management said like-for-like sales in China were growing.
The sale of Costa leaves Whitbread's management free to focus on expansion of Premier Inn in the UK and Germany. Premier Inn is the largest network of hotels in the UK, with 800 locations comprising 72,000 rooms. It has increased its capacity by more than a third over the past four years, and there’s 85,000 more rooms in the pipeline, with return on capital consistently above 13 per cent. The German hotel market is 35 per cent larger than the UK but is currently fragmented, with around three-quarters owned by independent operators. Whitbread is aiming to have 32 hotels in Germany with 6,000 rooms by 2020-21.
