Aramark Holdings (ARMK) made its public debut on Thursday, December 12. Shares of the leading provider of food, facilities and uniform services to the education, healthcare and business industry ended their first day with gains of 13.5%.
The premium valuation, very thin margins and very high leverage incurred by the firm make me very wary to invest at the moment. The offering is a well-timed exit by private equity sponsors, and I would not advise to pick up any shares at these levels.
The Public Offering
Aramark provides food, facilities and uniform services. Key customers of the company include educational institutions, healthcare organizations as well as sports and leisure organizations.
The company focuses on North America in which it holds the second market position, while it serves 19 other countries as well. The company employs about 267,000 workers supplying millions of end consumers.
The company serves 500 million meals per year to 5 million students. On top of that, Aramark serves 2,000 healthcare facilities, caters to a 100 million sport fans per year, while placing 2 million people in uniforms every day.
Aramark sold 36.25 million shares for $20 apiece, thereby raising $725 million in gross proceeds. 28 million shares were offered by the company which thereby raised $560 million in gross proceeds, while the remainder of shares were being sold by selling shareholders.
Initially, bankers and the firm set an initial price range of $20-$23 per share. Shares were eventually sold just at the low end of the preliminary initial public price range.
Some 16% of the total shares were offered in the public offering. At Friday's closing price of $23.83 per share, the firm is valued at $5.5 billion.
The major banks that brought the company public were Goldman Sachs (GS), Morgan Stanley (MS), J.P. Morgan (JPM), Credit Suisse, Barclays, Bank of America/Merrill Lynch (BAC) and Wells Fargo Securities (WFC), among many others.
The company operates with three major business units. The North American business generates roughly two-thirds of total revenues and operating earnings. The international activities and the uniform business generate the remainder of sales and earnings.
The company was founded back in 1959 and is a well-respected business often appearing on the most admired list to work for. In 2007, the business was taken private by funds affiliated to GS Capital Partners, Thomas H. Lee Partners and Warburg Pincus.
For the year of 2012, Aramark generated annual revenues of $13.50 billion, up 3.2% on the year before. The company posted net earnings of $104 million, up 23.8% on the year before. As such, Aramark reports very thin margins of just 0.8%, partially the result of operating in a very competitive industry, as well as resulting from the high leverage. For 2012, interest payments totaled $457 million.
For the first nine months of this year, revenues came in at $10.43 billion, which is up 3.2% compared to last year. Net earnings fell by a third towards $30 million as a result of general margin pressure. The company operates with $98 million in cash and equivalents. Total debt stands at $6.22 billion, resulting in a net debt position of around $6.1 billion.
Gross proceeds of $560 million from the offering will be used to repay indebtedness. This includes term loans maturing in 2016 that carry a rate of 3.5% over Libor, making them quite expensive. Deleveraging will improve Aramark's earnings a lot. On average, the firm pays about 7% in interest rates over its debt position. The debt repayment could boost earnings by about $35 to $40 million on a pre-tax basis.
With the equity in the business valued around $5.5 billion, Aramark is being valued around 0.4 times annual revenues and 53 times last year's earnings.
As noted above, the offering of Aramark has been a modest success. The company priced the offering at $20 per share, some 7.0% below the midpoint of the preliminary offering range. Ever since, shares have seen a decent first day jump, trading some 10.8% above the midpoint of the preliminary offering range.
Aramark operates in a highly diversified market segment, which is very fragmented on top of that. While the company is a leader, and has strong name recognition notably with students, the industry remains very competitive, resulting in a continued squeeze on margins. The very high leverage employed as a result of past private-equity ownership has squeezed out every last drop in GAAP earnings.
Note that private equity owners bought the firm for $8.3 billion, which includes debt, back in 2007. The consortium financed the purchase with $1.7 billion in cash, and the remainder in debt. At last week's offer price, they stand receive $4.6 billion on their equity investment, incredible returns over this time period.
I remain very wary on this offering. The current valuation is very high. This is partially on the back of the high leverage employed, which impacts GAAP earnings. At the same time, the operating performance, notably in terms of profitability so far in 2013, has been disappointing.
Besides competition, very thin margins and the high leverage employed, the valuation is a clear risk to this offering. The private-equity sponsors made a great deal in this offering, which combined are sufficient reasons for me to be very cautious and remain on the sidelines.