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Advances in Hospitality and Leisure The Effect on Shareholder’s Wealth Due to Focused versus Diversified Acquisitions in the Restaurant Industry Seonghee Oak, Michael C. Dalbor,

Article information: To cite this document: Seonghee Oak, Michael C. Dalbor, "The Effect on Shareholder’s Wealth Due to Focused versus Diversified Acquisitions in the Restaurant Industry" In Advances in Hospitality and Leisure. Published online: 12 Nov 2015; 189-201. Permanent link to this document: https://doi.org/10.1108/S1745-354220150000011011

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THE EFFECT ON SHAREHOLDER’S

WEALTH DUE TO FOCUSED

VERSUS DIVERSIFIED

ACQUISITIONS IN THE

RESTAURANT INDUSTRY

Seonghee Oak and Michael C. Dalbor

ABSTRACT

Mergers and acquisitions are frequent occurrences in the world of busi- ness. While a merged firm may convert an acquired asset to other brands, the restaurant industry tends to acquire the same brand name and does not change the name of the acquired assets. Acquisitions can prove to be a risky proposition in any industry. This study attempts to determine if a product-diversified acquisition in the restaurant industry is a value- creating decision. By comparing focused and diversified acquisitions, we try to find if focused acquisitions create value and that diversified acquisi- tions do not. Our initial expectation was that focused acquisitions create more shareholder value. We find that both focused and diversified acqui- sitions make significant positive abnormal returns for acquirers.

Keywords: Restaurant industry; restaurant mergers; acquisitions

Advances in Hospitality and Leisure, Volume 11, 189�201 Copyright r 2015 by Emerald Group Publishing Limited

All rights of reproduction in any form reserved

ISSN: 1745-3542/doi:10.1108/S1745-354220150000011011

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INTRODUCTION

Acquisitions may be motivated by cash-rich firms that diversify by adding another segment. However, free cash flow from surplus cash is not the main reason why hotel and restaurant firms are actively involved in acquisi- tions (Oak, Andrew, & Bryant, 2008). Economies of scale and complemen- tary resource hypotheses may better explain restaurant acquisitions. Many acquisitions reduce costs and achieve economies of scale. Acquisitions between firms with the same product types are motivated by economies of scale. On the other hand, many small firms are acquired by large ones that can provide the missing ingredients which are needed for the small firm’s success (Brealey, Myer, & Allen, 2008). Although small firms may have a unique product, they may lack sales organization or engineering required to produce or market it on a large scale.

Restaurant acquisitions tend to have two patterns. One is to acquire franchised units of the same type of product (e.g. fast food hamburger res- taurants acquire other hamburger restaurants). The other is to acquire dif- ferent brands and continue operations without any changes (e.g. a hamburger chain acquires a Mexican restaurant). The first one is seemingly more common than the second in the restaurant acquisition market. Hospitality acquisitions have been categorized by type of financing but pro- duct diversification impact through acquisitions has not been analyzed. A major growth strategy within the restaurant industry is through franchising (Park & Jang, 2013). Service firms will take time to grow because some part of franchising system may not be easily transferable to franchisees. In this study, we analyze whether two types of acquisitions are value-creating project for bidder shareholders by achieving the economies of scale.

LITERATURE REVIEW

The diversification literature shows mixed results about diversification on firm performance. The diversification discount is well known in corporate finance as a value-destroying decision. Shareholders can diversify portfolios on their own so diversification by a corporation may be a value-destroying project. Berger and Ofek (1995) report that corporate diversification yields a 15% loss in value as compared to stand-alone values. Lang and Stulz (1994) show that diversified firms have lower Tobin’s Q’s than undiversified firms. Choi, Kang, Lee, and Lee (2011) find that Tobin’s Q is lower for

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brand-diversified firms than undiversified firms in restaurant industry. The diversified brand strategy of U.S. restaurant firms may create inefficiencies in distribution economics or diluted marketing efforts. In addition, there may be no synergistic gains or there could be significant barriers of entry to overcome. Thus it is unclear if product diversification by U.S. restaurant firms creates shareholder value via acquisitions.

The value-destroying effects from diversification have been shown in event studies (Martin & Sayrak, 2003). Bradley, Desai, and Kim (1988) find abnormal returns to acquirers of −2.93% from mergers. Agrawal, Jaffe, and Mandelker (1992) show acquirers lost 10% in the 5 year post- merger period. Loughran and Vijh (1997) report acquirer performance differs depending on payment and acquisition type. Stock-financed mergers have negative abnormal returns of −25% and cash tender offers earn abnormal returns of 61.7% in the five year post-acquisition period.

Andrade, Mitchell, and Stafford (2001) report that on the day of the bid announcement, selling shareholders earn an average return of 16%. The buyer and seller combined return increases by about 2% on average. The stock price for acquiring firm shareholders typically declines. It may be due to aggregating all the merger announcements. A study of restaurant acqui- sitions shows that bidder’s wealth gains are insignificant (Chatfield, Dalbor, & Ramdeen, 2011). In the baking industry, DeLong (2001) sepa- rates bank mergers into two categories: focused versus diversified. His focused merged sample creates 3% bidder shareholder wealth but the diver- sifying sample does not create value.

On the other hand, in the large manufacturing industry segment brand- diversified firms tend to have higher Tobin’s Q than undiversified firms (Morgan & Rego, 2009). Rumelt (1986) investigates firm performance by the degree of diversification. The performance of single product firms increases. Related product firm performance peaks with moderate diversifi- cation. Unrelated product firm diversification shows a decline. In the casino industry, the degree of product diversification and firm performance is an inverse U-shaped relationship (Kang, Lee, & Yang, 2011). Firm perfor- mance improves due to economies of scope but declines because benefits are outweighed by increased internal transaction costs and managerial information-processing demands beyond internal capabilities. In this study, we measure how bidder shareholders obtain gains through acquisitions using an event study. Considering the U-shaped relationship between diver- sification and firm performance in other industries, it is an empirical ques- tion whether restaurant focused or diversified segment acquisitions create value or not.

191Shareholder’s Wealth due to Focused vs. Diversified Acquisitions

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The hospitality literature examines geographic diversification issues. According to Lee and Jang (2007), hotel segment diversification improves a firm’s performance but does not contribute to profit growth. Kang and Lee (2014) show a positive and significant effect of geographic diversification on firm performance for U.S. lodging firms. Economies of scale, the learn- ing effect, risk reduction and market power across diverse geographic loca- tions may be greater than the associated costs for geographic expansion in the hotel industry. International diversification can be value creating. Oak and Dalbor (2009) find that international hotel acquisition announcements create shareholder value for the bidders. Economies of scale outweigh the costs such as competition and cultural clashes. Bank mergers focusing on activities performed and geographic location in the United States tend to be value creating (DeLong, 2001). The market distinguishes value-creating mergers among several other types of mergers.

Focused acquisitions could create value by including the replacement of less efficient with more effective managers, or from the increase of market power or economies of scale. An earlier acquisition study of related indus- tries (those that share the same Standard Industrial Code) shows positive abnormal returns for bidders (Morck, Shleifer, & Vishny, 1990). However, restaurant industry performance tends to be lower as the brands are more diversified (Choi et al., 2011). It is unclear if either focused or diversified acquisitions within the restaurant industry create value.

For acquisitions, dominant brand strategies are those that force the tar- get brand to disappear altogether (Ettenson & Knowles, 2006). The merged entity adopts the name and symbol of the lead company when the lead firm has a stronger reputation. The merged company is positioned as an upgrade for the employees and customers for the less prestigious brand. However, it can damage the morale of the target firm’s employees, who must not only adjust to the disappearance of their firm, but also adjust to different group dynamics. Target customers may fear that their relationship with the target firm will be lost. Investors fear the risk arising from integra- tion. In our sample, small franchisees are absorbed into large franchisors and use the acquirer’s brand name (often franchisees in the restaurant industry had the same brand restaurant like acquirers and after the acquisi- tion the absorbed franchisees do not change the brand name).

Using both the acquirer’s and target’s names makes the firm’s new orga- nization visually identifiable. Both sets of employees feel valued and custo- mers are comfortable since the products of both firms remain the same as before. Investors get signals of a strong cooperative partnership in which the best of both firms will be leveraged. On the other hand, some customers

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could have the perception of forced switching. Investors could have opera- tion conflicts (who runs the firm and who will make decisions?) and strate- gic conflicts (where is the new organization going from here?). In our sample, some of full service restaurants are absorbed into other full service restaurants and use the target name independently.

Different segments in the restaurant industry have different operational characteristics. For example, full service restaurants have more labor costs than family/buffet or fast food restaurants. Additionally, full service restau- rants rely less on advertising for market penetration (Kim & Gu, 2003). When two different quick-service brands share the same space, it combines a high return on investment and increases unit profitability (Kim & Gu, 2003). In addition, cobranding by fast food chains penetrates markets when a single concept cannot be supported by the local population.

However, there is no evidence about how shareholder’s wealth is affected by product diversification acquisition. The net present value to A of a merger with B is measured by the difference between the gain and the cost of merger. The gain is the synergistic gain of the combined entity and cost is cash payment (or the value of shares in the new company received by the shareholders of the selling company) minus present value of B. Managers know the acquisition synergistic gain and announce that publicly (Bernile & Bauguess, 2011). Publicly available operating synergistic fore- casts by managers are often explicitly associated with cost savings. On the other hand, insiders seldom project revenue increases.

METHODOLOGY

Our sample consists of domestic U.S. acquisitions announced by publicly traded acquirers from 1982 to 2004 where both acquirers and targets are identified by SIC code 5812 (restaurant firms) as reported by the Securities Data Company (SDC). All the acquisitions were successfully completed.

To identify whether acquisitions are focused or diversified, we divide the sample into two. When the firm acquires the same type of product segment, it is labeled as focused. When the firm purchases the different type of seg- ment business, it is categorized as diversified. Acquisition announcements are collected by SDC and we inspect specifics on each deal in news stories and published press releases. We use the event date at SDC on which the acquirer’s first bid is announced.

Of the 477 acquisitions listed by the SDC, we were able to use 256 deals. Some deals were unable to be identified by the product segment category.

193Shareholder’s Wealth due to Focused vs. Diversified Acquisitions

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While focused acquisitions were 175, diversified acquisitions were 81. Some deals were excluded because of a lack of adequate descriptive information. Due to the lack of stock data, we ended up using 156 focused and 56 diver- sified deals.

Restaurant firms are categorized as follows: hamburger, contract, pizza, family, chicken, seafood, Mexican, dinner house, snack, cafeteria, buffet and others. Menu diversification brings operational problems such as increased inventories and higher labor costs (Khan, 1999).

This study uses the market model to measure the market reaction to acquisition announcement. We used a market model similar to other hospi- tality studies. Brown and Warner (1985) use the ordinary least squares regression market model to calculate excess returns.

Ajt = Rjt − α̂j − β̂j × Rmt

Rjt is defined as the observed arithmetic return for security j at day t. Ajt is defined as excess return for security j at day t. Rmt is the return on both the CRSP equally weighted market indexes over day t. α̂j and β̂j are estimates of αj and βj by regressing Rjt on Rmtover the estimation period preceding the event window. The estimation period ranges from t = �255 to t = �46, which is relative to the initial date of acquisition announcement day t = 0. For every day in the event period, the excess return (Ajt) is averaged to make the sample mean:

ARjt =

PN

j = 1 Ajt

N

where N is the securities number in the sample and t is the trading day rela- tive to the event day. From 30 days before to 30 days after the acquisition announcement, the cumulative abnormal return (CARjt) is:

CARjt = X30

t = 30

ARjt

Non-parametric rank test used the significance of CAR (Corrado, 1989; Nicolau, 2002; Oak & Dalbor, 2009). The rank sum test is useful under

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highly non-normal distributions and avoids the misspecification problem of parametric tests whereby the event date excess return variance increases (Oak & Dalbor, 2009). Accordingly, we propose the following research hypotheses:

Research Hypothesis 1. Focused restaurant acquisition announcements positively affect the results of the acquirer.

Research Hypothesis 2. Diversified restaurant acquisition announcement positively affect the returns of the acquirer.

DISCUSSIONS

We used 156 focused and 56 diversified deals. Focused deals in the U.S. res- taurant industry are more than twice for diversified deals in 20 years. Table 1 shows the mean abnormal returns of the focused acquirers. On the day of acquisition announcement, focused acquirers have positively signifi- cant abnormal returns of 2.02%. This supports research hypothesis 1 and the focused strategy positively affects the stock returns of acquirer. Table 2

Table 1. Mean Abnormal Returns for Focused Acquisitions.

Day N Mean Abnormal Return Rank Test Z

−30 156 0.06% 0.273 −29 156 −0.05% 0.338 −28 156 −0.36% −0.431 −27 156 0.34% 1.413* −26 156 −0.35% −1.100 −25 156 0.80% 1.616** −24 156 −0.22% −0.162 −23 156 0.06% 0.289 −22 156 −0.65% −1.283* −21 156 −0.02% −0.011 −20 156 0.29% 1.125 −19 156 0.05% −0.145 −18 156 −0.09% 0.071 −17 156 −0.66% −2.022** −16 156 −0.22% 0.257 −15 156 −0.72% −0.911 −14 156 0.09% 0.516 −13 156 −0.59% −1.736** −12 156 0.29% 0.041 −11 156 −0.13% −0.765

195Shareholder’s Wealth due to Focused vs. Diversified Acquisitions

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Table 1. (Continued )

Day N Mean Abnormal Return Rank Test Z

−10 156 0.00% 0.213 −9 156 0.03% 0.097 −8 156 −0.28% −0.772 −7 156 0.59% 0.962 −6 156 0.86% 0.517 −5 156 −0.26% −0.245 −4 156 −0.40% −0.478 −3 156 −0.64% −1.548* −2 156 0.35% 1.648* −1 156 −0.62% −1.788** 0 156 2.02% 4.229***

1 156 1.06% 1.479*

2 156 −0.29% −0.831 3 156 0.76% 1.451*

4 156 −0.61% −1.030 5 156 −0.18% −0.809 6 156 −0.52% −1.853** 7 156 0.24% −0.142 8 156 −0.25% −1.057 9 156 0.16% 0.400

10 156 −0.32% −0.213 11 156 0.57% 1.199

12 156 0.47% 0.201

13 156 0.05% 0.299

14 156 0.00% 0.034

15 156 −0.34% −0.704 16 156 0.03% 0.848

17 156 −0.25% −0.836 18 156 −0.41% −0.495 19 156 −0.09% −0.875 20 156 0.29% 0.550

21 156 −0.54% −1.604* 22 156 0.04% 0.135

23 156 −0.14% −0.169 24 156 −0.06% −0.421 25 156 −0.16% −0.471 26 156 −0.10% −0.281 27 156 −0.46% −0.886 28 156 −0.05% −0.074 29 156 −0.25% −0.810 30 156 0.31% 0.949

*, **, ***Significant at the 0.10, 0.05 and 0.01 levels using a one-tail test.

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Table 2. Mean Abnormal Returns for Diversified Acquisitions.

Day N Mean Abnormal Return Rank Test Z

−30 56 −0.34% 0.058 −29 56 −0.11% 0.291 −28 56 −0.65% −0.811 −27 56 −0.59% −0.896 −26 56 0.15% 0.876 −25 56 −0.38% −0.692 −24 56 −0.65% −0.459 −23 56 0.02% −0.193 −22 56 −0.03% −0.454 −21 56 −0.40% −0.127 −20 56 0.03% −0.479 −19 56 −0.45% −0.329 −18 56 0.31% 1.650** −17 56 0.39% 1.051 −16 56 −0.30% −0.551 −15 56 0.36% 0.028 −14 56 −0.32% −0.495 −13 56 0.21% −0.507 −12 56 1.05% −0.389 −11 56 −0.90% −0.941 −10 56 −0.13% −1.052 −9 56 0.51% 0.042 −8 56 −0.68% −0.700 −7 56 −0.11% 0.187 −6 56 −0.20% −0.675 −5 56 0.12% −0.234 −4 56 −0.61% −0.499 −3 56 −0.49% −1.001 −2 56 0.26% 0.511 −1 56 0.83% 0.747 0 56 0.81% 1.903**

1 56 0.23% 0.253

2 56 0.01% 1.268

3 56 −0.62% −0.284 4 56 1.03% 1.376*

5 56 0.14% 0.386

6 56 −0.60% −2.411*** 7 56 −0.28% −0.713 8 56 0.41% 1.514*

9 56 −0.32% 0.675 10 56 0.42% 1.168

11 56 0.59% 0.730

12 56 0.07% −0.577 13 56 −1.13% −2.639***

197Shareholder’s Wealth due to Focused vs. Diversified Acquisitions

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shows the mean abnormal returns of diversified acquirers. On the day of the acquisition announcement, diversified acquirers have positively signifi- cant abnormal returns of 0.81%. This also supports research hypothesis 2. Diversification is a value-creating project for the acquirer. Both focused and diversified acquisitions increase shareholder value for acquirers.

For the focused acquisitions, the abnormal return from one day prior to the announcement to the announcement day is 1.64% (Table 3). The research hypothesis is supported for the (−1 to 0) day period. The cumula- tive abnormal returns for the (−30, −2) day period is −3.94% but insignifi- cantly negative. Those in the (+1, +30) day period are insignificantly negative at −0.30%. It appears that focused acquisition announcements do not have significant information diffusion prior to the acquisition announcement.

For the diversified acquisitions, the abnormal return from one day prior to the announcement to the announcement day is 1.39% (Table 3). The research hypothesis is supported for the (−1, 0) day period. The abnormal returns for both the (−30, −2) day period and the (+1, +30) day period are negative and insignificant. Information diffusion cannot see prior to diver- sified acquisition announcement.

Table 2. (Continued )

Day N Mean Abnormal Return Rank Test Z

14 56 −0.27% −0.543 15 56 0.41% 1.833**

16 56 0.51% 0.180

17 56 0.15% −0.146 18 56 −1.07% −0.891 19 56 0.68% 0.927

20 56 −0.66% −0.238 21 56 0.37% −0.658 22 56 −0.08% 0.322 23 56 −0.03% 0.387 24 56 1.42% 2.740***

25 56 −0.92% −1.918** 26 56 0.64% 1.384*

27 56 0.02% −0.207 28 56 −0.93% −0.813 29 56 0.28% 0.111

30 56 −0.76% −0.323

*, **, ***Significant at the 0.10, 0.05 and 0.01 levels using a one-tail test.

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Diversification in this study is diversification within related product firms which is different from conglomerate diversification with non-related products. The bidder’s gains may be from firm performance improvement due to economies of scale. Although Choi et al. (2011) report a value decline for brand-diversified firms, our study shows that product diversifi- cation creates shareholder value. Chatfield et al. (2011) report insignificant gains of bidder but our study supports significantly positive bidder’s gains of both focused and diversified strategy. Different segments in the restau- rant industry require different management skills due to different opera- tional characteristics but there may be more synergistic gains and some positive acquisition returns through diversified acquisitions. Cobranding two different brands may increase profitability and lead to effective market penetration. Publicly available operating synergistic forecasts by managers may achieve positive gains via acquisitions.

CONCLUSIONS

This study examines whether or not shareholders of U.S. restaurant firms gain wealth when focused or diversified acquisition is announced. No pre- vious studies in hospitality have focused on diversification issues using an event study methodology. The most important finding in this study is that both focused and diversified acquisition strategies have positive abnormal returns for acquirers on the day of announcement.

The limitation of study is that the data set lacks the recent acquisition transaction. Private equity has been used in the 2000s for restaurant

Table 3. Mean Cumulative Abnormal Returns for Acquisitions.

Days Surrounding the

Announcement

N Mean Cumulative Abnormal

Returns

Rank Test

Z

A. Focused acquisitions

(−30, −2) 56 −3.94% −1.261 (−1, 0) 56 1.64% 1.874** (+1, +30) 56 −0.30% 0.528 B. Diversified acquisitions

(−30, −2) 156 −1.81% −0.415 (−1, 0) 156 1.39% 1.727** (+1, +30) 156 −1.04% −1.098

**Significance of a generic one-tail generalized sign test at 0.05 level.

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acquisitions and it may impact the diversification strategy of restaurant acquirers and their returns.

This study only uses restaurant industry. It may be fruitful to examine acquisitions in other segments of the hospitality industry such as hotels and casinos. It may also be interesting to see if other factors such as size or per- iod of time play a role in restaurant acquisitions.

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201Shareholder’s Wealth due to Focused vs. Diversified Acquisitions

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