The history of major acquisitions by U.S. companies is clear: they usually fail. Decades of history judged in different ways by different analysts all point to that same conclusion. And on Monday, investors projected that a major swing by Sysco, the world’s largest away-from-home food distributor, will not prove that history wrong. Sysco stock fell 15%, losing about $6 billion in equity value, after the company said it would pay $29 billion for ‘cash-and-carry’ leader Restaurant Depot.
A Big Deal for Sysco
Beyond broader trends, there is a number of reasons for caution. One is simply the size of the deal: The $29 billion purchase price is about three-quarters of Sysco’s market capitalization on Friday afternoon. Sysco (and other major distributors US Foods and Performance Food Group) have done reasonably well with smaller, so-called ‘tuck-in’ acquisitions over the past few decades, but this move is a clear step-change up.
Sysco will take on heavy debt to finance the cash portion of the deal. It’s giving away nearly 20% of the company to existing Restaurant Depot owners (including 94-year-old founder Natie Kirsh and private equity firm Leonard Green & Partners) as well. This is not a deal that necessarily will drive Sysco into bankruptcy if it fails, but it’s one that could crush Sysco stock for years if it disappoints. And quite clearly, investors are worried that it will do exactly that — particularly because Sysco is making this deal at a time of huge macroeconomic uncertainty, to which Restaurant Depot’s local customers are particularly exposed.
The Case for the Deal
There’s one notable aspect of the trading in Sysco stock as well: at first, investors were relatively neutral toward the deal. In premarket trading Monday, shares were down just a couple of percent. But as the day wore on, the selling accelerated (shares have only stabilized in trading Tuesday).
That in turn suggests Sysco management didn’t make a strong enough case to investors for the deal. But in many ways, the logic here does make sense.
Restaurant Depot has been an incredible business: it has grown profits for 30 consecutive years. That includes 2020; Sysco chief executive officer Kevin Hourican noted in an interview on financial network CNBC that while his company’s business had been ravaged, Restaurant Depot’s had actually benefited. Rough estimates for the C&C channel (in which restaurant customers pick up orders at a Restaurant Depot warehouse instead of having them delivered in a Sysco truck) suggest Restaurant Depot owns about 25% market share. That’s actually higher than Sysco’s in distribution (currently about 17%). And because RD doesn’t have the fleet of delivery trucks and drivers that Sysco does, its profit margins are higher. Sysco is paying a high price relative to earnings, but Hourican makes a reasonable argument that Restaurant Depot is worth paying up for.
Meanwhile, Sysco has essentially zero presence in cash and carry, so this deal moves it into that channel and opens up an entirely new group of potential customers. Local restaurants could at this point choose between going to Restaurant Depot for savings (often 15-20% versus delivered options) or to Sysco for better service. As Hourican noted on the call with analysts detailing the acquisition, customers presumably could go back and forth as well: shifting to Restaurant Depot if an accident or an unusual stock-out required urgent replacement of a specific item, or moving to Sysco as business grows and more detailed service is necessary.
This seems to be a deal that moves Sysco aggressively into the local market segment it has long seen as attractive, and in a smart way. Restaurant Depot is already a strong business; Sysco believes that access to its supply chain could make it even stronger, and larger. Hourican projects that under Sysco ownership, Restaurant Depot could add something like 125 locations nationwide over the next two decades, which on its own would add a few percentage points of annual sales growth for the business.
The logic, then, is that the acquisition will add organic growth for legacy Sysco, improve reach for Restaurant Depot, and add inorganic gains as well. It’s not hard to see why Hourican and the Sysco board went ahead here.
Investors Fret
But it’s also not hard to see why the market is nervous. Again, the history of acquisitions is grim, and the larger the deal, the lower the rate of success seems to be. But in this particular case, there are questions which don’t seem to be entirely answered.
The first is why this deal was done now. The timing of the decline this week seems particularly unfortunate for Sysco shareholders, which suffered through a few lost years before shares finally saw a rally to all-time highs last month. Investors were optimistic that Sysco was finally turning the corner in the post-pandemic environment. Long-running plans to improve sales force retention and training were playing out; in fact, on Monday’s call, Hourican cited further success there and tipped fiscal third quarter (calendar first quarter) results that were better than analysts were anticipating.
And so, investors are asking why the deal was done instead of Sysco simply looking to benefit from improved execution. The answer from Hourican is that, essentially, the company had to wait: Sysco has been in some kind of discussion with Restaurant Depot for years, and in part, the timing seems to be based on when Kirsh (the 94-year-old founder who, according to the Wall Street Journal, still owns a majority of the company) chose to sell.
Still, for some shareholders, the story they were buying no longer exists: Instead of simple execution, Sysco now needs aggressive financial engineering and some help from the external economy. For other shareholders, the very fact that Sysco went with such a big acquisition suggests that maybe the public commentary about sales force efficiency is potentially overblown; they no doubt are asking why a business with a path toward significant internal improvement felt the need to make such a large, risky, and external-looking move.
The related question is if Kirsh knows something that Sysco doesn’t. It is obvious to anyone paying attention to any economic news that moving aggressively into the local restaurant end market right now is at the least a high-risk maneuver. There are fears that the combination of inflation and the ‘K-shaped economy’ will add significant pressure on mom-and-pop locations for years to come. Kirsh presumably has a closer line and better insight into his customers than anyone else. Investors do have to at least question whether he’s looking to get out of the business before it turns south.
Does 1 + 1 = 3?
But even structurally, the success of this deal might come down to one longer-term question, which is if the combination of the two companies actually makes the combined company bigger in terms of sales. Restaurant Depot will be run as a separate unit. There are some possible cross-selling opportunities in terms of one-off replacements, and Hourican has promised further initiatives in the future. Yet the reason Restaurant Depot has grown so consistently for decades is precisely because it has taken share from the likes of Sysco in the first place, and because its customers specifically choose to avoid the fees and minimums required in the delivery channel of the distribution space.
If that continues, then basically, the ‘new’ Sysco is just the old Sysco plus a new, independent business under its corporate umbrella. And that, in turn, means the success of this acquisition will depend on whether Sysco paid the right price here. Again, we have decades of history to suggest it probably didn’t — and, so far, not enough evidence from Hourican and Sysco to convince the market otherwise.
Vince Martin is an analyst and author whose work has appeared on multiple financial industry websites for more than a decade; he’s currently the lead writer for Wall Street & Main. As of this writing, he has no positions in any companies mentioned.
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