Here comes the next wave of chain bankruptcies

With leases due, more chains like California Pizza Kitchen could end up filing even as sales increase, says RB’s The Bottom Line.
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Bottom line

Last week, California Pizza Kitchen declared bankruptcy, and in the process revealed that it hadn’t paid most of its leases, or interest payments, for four months and still lost a ton of money.

And on Monday, Matchbox Food Group filed for debt protection and made it known it wants better deals from its landlords or it would use the bankruptcy process to close some of its 12 restaurants.

Oncoming lease negotiations between restaurant chains and landlords represent the next major hurdle in the industry. Chains, particularly those owned by private equity groups and other investors, could end up filing for bankruptcy in considerable numbers in the coming months as they look at close locations.

To be sure, a lot of the restaurant chains currently struggling to pay off leases also happen to have private equity sponsors and, not coincidentally, a lot of debt.

Private equity groups frequently take risky financial strategies. The coronavirus has exposed that risk for a lot of them, putting chains that might have weathered the storm into bankruptcy, like, say, CEC Entertainment or the aforementioned California Pizza Kitchen, or CPK.

Still, the relationship between restaurants and landlords has become a major focal point during the pandemic.

When states began shutting down dine-in service in March, many expected a rash of bankruptcies as companies, with a fraction of their pre-coronavirus revenues, were unable to make rent or debt payments.

They frequently received breaks from both landlords and lenders, which has helped keep many companies out of bankruptcy. Of course, some bigger chains like The Cheesecake Factory and then Starbucks forced the issue, but for the most part companies were willing to work together.

But that only goes so far, and landlords in particular have bills of their own to pay. Ultimately, leases come due, and restaurants have to think hard about their locations. That’s setting up a situation in which many companies have to get out of leases.

“There’s going to be a bloodbath,” Aziz Hashim, chairman of Ruby Tuesday owner NRD Capital, told me back in May. His own chain has sped its closing timeline.

The problem is most acute with casual dining restaurants, which rely most heavily on in-restaurant dining and beverage service. In most of the country, such restaurants are at 50% capacity at best, and while they can add outdoor seating that’s not always available or convenient, depending on the location.

Yet some fast-casual chains are in the same situation. As we reported last month, Potbelly told landlords for 100 locations it wants to close that it could file for bankruptcy if enough of them refused to buy out their leases.

Edwin Sheridan, a board member at Matchbox, basically told landlords in the company’s announcement of its bankruptcy filing on Monday that if they didn’t give out better terms the chain would close some of its units.

“We aim to work with the landlords for each of our locations to find agreeable terms that will allow us to keep our restaurants open and continuing serving our customers,” Sheridan said. “If that is not possible, we will be forced to close locations.”

California Pizza Kitchen also suggested that it has been negotiating with landlords. But it also has a heavy debt load and has struggled to generate cash going into the pandemic.

The casual dining pizza chain operated with more than $400 million in debt. The company said in a bankruptcy filing it has faced a liquidity crunch for the past two years. It was also looking for a buyer.

COVID-19 interrupted the sale process, sales plunged, and the company lost money. While CPK generated cash in June, even with same-store sales down 40%, it still generated a cash-flow deficit of negative $18.9 million between March and June, “despite not having paid any interest on prepetition debt or rent on the majority of the restaurant portfolio.”

To weather the current environment, the company said, it needed cash and a “marked adjustment to its operations.”

CPK has worked with Hilco Real Estate to negotiate with landlords and has received some $6.1 million in concessions over the next three years. However, “the company is still on a path to right-sizing its lease footprint” and is still in negotiations.

California Pizza Kitchen is certainly not the last bankruptcy, either. One name to watch: Red Lobster.

In March, Moody’s Investors Service downgraded Red Lobster’s credit rating, citing “material deterioration” in its earnings and credit metrics. Last week, Debtwire reported that the company hired an advisor to explore strategic alternatives.


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