Description

Italian “Sibling Rivalry” Masks Autogrill Normalized Free Cash Flow

The “Optical Underdog” in the demerger will reveal an entity with huge transformational capabilities led by a Proven, Empire-Dismantling, Shareholder Friendly and Aligned CEO

Autogrill (AGL:IM) demerged yesterday into two separate listed entities on October 1, 2013: World Duty Free (WDF:IM) and Autogrill (AGL:IM).  World Duty Free is a good business which I believe is a straight forward analysis and somewhat undervalued relative to a somewhat overvalued Dufry, its closest competitor, but does not possess the explosive reversal of fortune, hyper-contrarian bet on best-in-class management that “new” Autogrill does.  I forsee a dramatic step-change in free cash flow (explained below), paving the way for implementation of a series of transformational events that will unlock an explosive increase in shareholder value in the coming 24-30 months.  I would be guessing if I tried to estimate what the upside would be, as I imagine we all would, given the numerous possibilities available to AGL (to be noted that management actively pushed from the deconsolidation of “the empire” after a history of value-creating acquisitions and few disposals).  Also to be noted that both businesses possess intelligent and value enhancing M&A opportunities on a standalone basis that together were less easily achievable.

Market Dislocation:

Why is a concession burning cash?  Because Autogrill is a complex group, assembling the precise pieces was not obvious, and I have not seen the explanation offered in any initiation reports.  Some digging revealed obscene rental costs of an estimated 17% of revenues along the Italian motorway concessions (roughly €1bn revenues accounting for €170mm of annual cash flow and €50mm of capex) attributable to legacy rental agreements entered into with its “sister company,” the leading highway operator and Benetton holding Atlantia (ATL: IM).  Importantly the majority of these agreements come due within the next 24-30 months, and more importantly, there is no corporate governance confusion forcing renewal whatsoever (Tondato has the full-backing of the Benetton family and has committed to the market to exit this business entirely if healthy cash generation is not feasible). 

Management: "As good as it Gets"

A bit about management: CEO Gianmario Tondato is among the best managers not only in Italy but globally.  He possesses the attributes of an innovator, a brilliant and extremely disciplined m&a visionary, and an excellent retailer.

(1) he is as efficient as any CEO I have ever seen – Autogrill has been operated with less than 0.5% Overhead margin since he has been CEO (not a typo), down from 25% of sales at IPO.  (2) He has incredible vision, courage, timing, discipline, and ability to integrate assets thoughtfully but ruthlessly.  He is stylistically among the most anglo-saxon managers you will find in Italy, butfrankly better than most anglo saxon managers, particularly when you consider he began with the portfolio that is now the "pig" of the Group, and everything else, including the buildup and spinoff of World Duty Free, was his creative reallocation of resources away from the structurally declining busineses he inherited (3) Unlike many retail managers that modify the business model and forever alienate the customer, or to the contrary cut costs and run the retailer into the ground, Tondato has his finger on the pulse of trend innovation. A bold move such as this demerger would have sparked tremendous speculation for impending value creation potential had it come from a manager with a global reputation commensurate with Tondanto’s proven capabilities.  Tondato is egoless, avoids the spotlight, and is almost neurotically shy in interacting with investors (but he appears to be changing!).  So please, if you want to be confident in the opportunity, press to speak or meet with him directly, and bypass IR and the CFO (obviously having done your homework in advance).

Additionally, unlike most family held Italian companies, Tondanto has more than earned the full trust and support of the Benetton family to implement his vision.  Here, in my view, he is dismantling an empire to give each company a chance to enter into transformational transactions, as well as capitalize on timing.  As you will see below, the value implicit in exiting the Italian motorway business is greater than the current market capitalization of the new Autogrill.  Beginning in 2016 the majority of truly extortionist, legacy, long-term rental contracts will expire (unsurprisingly which emanate from sister company Atlantia, the Benetton publicly traded highway operator in Italy and more recently abroad, where Legacy Autogrill retail outlets were originally built.)  I personally hope Tondato exits this business entirely, because his ability to generate value with a less capital intensive platform, immune from the vicissitudes of benzene prices, would allow him to demonstrate his potential to its fullest.

The “New” Autogrill:

Post demerger, Autogrill is the world’s leading operator in food and beverage services for travelers. It operates via restaurants located in airports, motorway service stations, and railway stations. Autogrill often operates concessions on behalf of prestigious brands (Starbucks, Burger King, etc) under long-term (sometimes exclusive) contracts in a given outlet. AGL runs its businesses (both restaurants and retail shops) through concession contracts with landlords (the owners of the airport or the motorway). AGL pays a concession fee to the landlord and is fully responsible for the outlet’s P&L. The average AGL concession contract has a duration of around 8 years. As opposed to a typical retail setting, one based in an airport or along motorways enjoy a favorable “captive demographic” and, as a result, high visibility with regard to FCF generated during the concession period. AGL enjoys very high market shares in the F&B business within North American airports and along Italian motorways. Among the main competitors there are private companies, such as Elior and SSP.  In particular, EQT, the Swedish Investment Fund owned by the Wallenberg Family has brought in one of the most talented retail turnaround CEOs I have ever come across – Kate Swann – to maximize their recovery value on an asset with more than 6 turns of leverage.  The debt, coincidentally, must be repaid starting in 2016.  A combination at the right price between AGL and SSP would yield a very interesting combination, as the customer overlap base, and therefore negotiating leverage, becomes something of great value, aside from the synergies generated in complimentary geographies on cost of goods and headcount.  AGL is active in 22 out of the top 25 US airports, accounting for 68% of US traffic. AGL is the leading operator, ten times the size of its largest competitor. In North America AGL particularly operates renowned brands (80% of its revenues) and only partially through proprietary brands.

 Risks:

This investment requires an investor base with the ability to become confident enough in the explosive upside that macro volatility prior to portfolio reshuffling does not phase them. 

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