Expect more restaurant acquisitions in 2024

After two slow years, activity is beginning to pick up. But there is a “flight to quality” as buyers, and bankers, look for sustainable performance.
A California Wingstop operator fetched what many believe is a record multiple for a franchisee. | Photo: Shutterstock.

The market for mergers and acquisitions has improved in the past few months and is gaining momentum towards the end of the year, potentially setting up for a more robust 2024.

That at least was according to speakers at the Restaurant Finance & Development Conference in Las Vegas last week. Buyers and sellers are coming together on valuations as the business readjusts to higher interest rates and lower profit margins.

“There’s momentum building in the market,” said Josh Benn, managing director with the investment banking firm Kroll. “There’s a lot of additional activity.”

But that market won’t be equal. “It’s a very selective market,” he said. “There’s a flight to quality.”

Buyers want brands that have shown strong performance in recent years, particularly when it comes to traffic. “It’s difficult to sell a business when traffic is negative,” Benn said.

The M&A market was as active as any in recent memory in the second half of 2021. As fast-food restaurants recovered more quickly than anybody expected, and profitability improved, valuations soared. Companies, including chains and franchisees, were selling for historically high multiples.

That came to a screeching halt toward the end of the year as inflation picked up steam and the U.S. Federal Reserve started raising interest rates to get it under control. Deals for restaurants slowed to a crawl as interest rates increased. The fourth quarter of 2022 “was among the quietest periods of time I can remember,” Benn said.

That slow market continued in the first half of 2023. That follows overall M&A trends. M&A value declined 44% in the first six months of the year, according to Bain & Co., which cited the macroeconomic environment and interest rate uncertainty for the slowdown.

The biggest challenge in the market has been the gap in demands between buyers and sellers. Sellers have wanted prices akin to the sky-high valuations paid in 2021. But buyers, noting thinner margins and higher interest rates, won’t pay that.

“People are pining for 2021 valuations,” said Mark Wasilefsky, head of franchise finance for TD Bank. “They just aren’t there.”

But the same Bain report also suggested that deals would return more quickly than many expect, citing a desire to get deals done on the part of both buyers and sellers. And many financiers expect them to readjust to the realities of higher interest rates, particularly given that the Fed is likely done raising interest rates.

As it is, more deals have been done lately. Benn noted that $11.5 billion worth of restaurant deals were announced in the third quarter, or 80% of the deals for the full year. Then again, the bulk of that ($9.6 billion) came from one company, Subway. Still, he said, there is life.

Darden Restaurants acquired Ruth’s Chris, completing the deal in June. Fogo de Chao, which hoped to go public in 2021 before that market collapsed for much of the same reason, was sold to Bain Capital.

But the market is bifurcated and two recent deals help illustrate just how different it is. Pollo Tropical was recently sold to Garnett Station Partners for $8.50 per share, below its 52-week high at the time and only a modest premium on its trading price. The chain was on the market for nearly two years as buyers were concerned about its ability to expand outside of Florida, as well as its level of capital expenses.

Meanwhile, a bidding war erupted over the Wingstop franchisee Far West Services and sources say it was sold for what is believed to be a record valuation multiple for a franchisee, above 10 times EBITDA, or earnings before interest, taxes, depreciation and amortization.

And some of the companies that end up on the market may also illustrate that difference. The thinning margins that have scared off some buyers are also pushing a lot more companies into bankruptcy, which prompts deals on its own as lenders look to recoup what they’re owed.

With debt less available and interest rates elevated, many companies are struggling to refinance their debt and could end up in the same position. “There’s more distress in the market,” Benn said. “There could be a lot of forced activity.”

That said, lenders say they are ready to make loans, even if they’re being pickier and their terms are tougher and the loans are more expensive. Buyers may have to put more equity into their deals to get something done, but that should encourage more acquisitions.

“We’re still in business,” said Todd Maldonado, managing director with BMO. “I think it’s going to be much more prolific.”

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