In 2013, David Karam approached his fellow Sbarro board members with some bad news.
The New York-style pizza chain had only emerged from Chapter 11 bankruptcy protection two years earlier. But it still had too much debt, and it didn’t have enough earnings to pay for it.
“I took over [as CEO] in March of 2013,” Karam said on my podcast, A Deeper Dive. “Our first board meeting … was in April of 2013. I immediately said, ‘Listen guys, we’re going to have to take this through a second restructuring.’”
Bankruptcy is not fun. It is expensive. It damages a company’s reputation, especially when it’s paired with store closures. Companies lose control of the ownership process, as lenders seek to get something for what they’re owed.
The buyers more often than not are bottom-feeding investors who often cut back on marketing and other investments in a bid to generate a quick return. The result usually breeds a zombie chain and almost never yields the promised comeback.
And here Sbarro was about to file a second one in two years.
“Brand turnarounds don’t work very often,” Karam said.
Yet rather than destroy the chain, the second filing would ultimately rid Sbarro of much of what led to its first bankruptcy, including its immense level of debt and a real estate strategy that capped the locations the chain could expand its restaurants into. Maybe more importantly, the company focused on what it was all about: large slices of pizza.
Sbarro decided to focus on pizza by the slice. | Photo courtesy of Sbarro
A mall story
Italian immigrants Gennaro and Carmela Sbarro opened an Italian deli, known as a salumeria, in Brooklyn in 1956, serving dishes Carmela learned growing up in Naples.
That included slices of pizza, which became popular among hungry workers on their lunch break. The pizza was so popular that the couple opened a second location focused just on that product. Sbarro the pizza chain was born.
Sbarro opened its first mall location at Kings Plaza Shopping Center in Brooklyn in 1970.
Pizza had been exploding in popularity throughout the U.S. But it was largely limited to urban areas or restaurant chains like Pizza Hut and Shakey’s that were focused on dine-in service. Delivery had yet to take hold.
Malls, which were also exploding, would prove to be a perfect spot for Sbarro’s on-demand, pizza-by-the-slice business model. Customers were hungry after a busy day of shopping and a slice of pizza or a stromboli seemed a natural fit.
(Check out our podcast with David Karam.)
Sbarro grew with mall culture, becoming a fixture selling slices in food courts and in airports. It went public in 1985 but the Sbarro family took the brand private in 1999. And then in 2007 it was sold to a private-equity firm, MidOcean Partners. The company had about 1,000 locations.
MidOcean did what private-equity firms do: Use debt to buy the chain. Debt is vital for restaurants, but too much can leave companies with little room for error if something bad happens, like the economy or, say, consumer frequency in your preferred locations.
That’s exactly what happened to Sbarro. The economy entered a brutal recession shortly after the acquisition that led to absolute cuts in restaurant spending. But it was worse in shopping malls. People cut back on spending, which means fewer people looking for a slice of pizza amid a shopping excursion.
Sbarro filed for bankruptcy in 2011, with $500 million in debt. It emerged the next year, and Karam joined the company’s board.
A Sbarro in a Las Vegas mall. | Photo by Jonathan Maze
A reset
Karam for decades was the owner of Cedar Enterprises, one of the largest franchisees in the Wendy’s system. And he spent more than three years as the chain’s president.
When he took over as Sbarro CEO in 2013, the brand had multiple issues, not the least of which was its debt level. Sbarro’s first bankruptcy reduced its debt level, to $130 million, but it wasn’t nearly enough.
And earnings were falling. In 2013 the company generated just $4 million in EBITDA, or earnings before interest, taxes, depreciation and amortization. Interest payments on its debt, which was about $148 million that year, were $17 million alone.
But the brand also had that mall problem. “It had been owned by private equity for a while,” Karam said. “It had become heavily indebted and hadn’t really crafted a growth strategy beyond the malls. By then we all knew what was happening with e-commerce and the oversaturation of malls in America.
“So when I came in, it was a challenging situation. It was kind of a tired brand. And we had to take it through a second restructuring just because it was struggling under a massive burden of debt.”
The fix wouldn’t come quickly, either.
Sbarro had tried to establish itself as an “Italian eatery,” with a broad menu of Italian dishes beyond simply pizza by the slice.
The problem? Consumers knew Sbarro as a pizza concept.
It’s difficult for restaurants to broaden consumer perception of what they are about. The U.S. restaurant industry is saturated. Consumers increasingly view restaurants for specific types of menu items.
You can call yourself an Italian eatery and add more pasta to your menu, but consumers still view you as a pizza place and they’ll take the slice.
“We really struggled to figure out how we grow this brand again, because at the time they considered themselves an Italian eatery,” Karam said. “We did a lot of consumer research. The recognition of the brand was phenomenal. But what people really knew Sbarro was for pizza, New York-style pizza, and specifically pizza by the slice.
“I kind-of figured that’s a pretty good place to call home.”
“We have a debt-to-EBITDA ratio of one to one. When I started it was probably 150 to 1.” -David Karam
Less debt, more focus
It would take a while, and feature a couple of failed ideas, but Sbarro reconfigured its brand position to focus on what the chain is known for, pizza by the slice.
“It’s the segment of the market that we really historically have dominated,” Karam said. “By far, we’re the biggest player in that space today.”
The problem, however, is that there are only so many places where consumers get pizza by the slice.
There are a lot of places U.S. consumers can buy pizza. But in contrast to the early days of Sbarro’s history, the bulk of that pizza is consumed at home. Consumers either have it delivered or, more likely, they go and pick it up.
There are more competitors, too. The convenience store Casey’s and the warehouse retail giant Costco are likely two of the six biggest sellers of prepared pizza in the U.S., for instance.
Few of them operate in malls, but that limitation has not gone away. “It just didn’t give us much of a growth opportunity,” Karam said.
But there are other places where consumers might want a slice of pizza. Convenience stores, travel centers, truck stops, universities, casinos, military bases and other venues. “We’re playing in categories,” Karam said.
The tightened focus and the broadened real estate strategy has helped the company expand, in the U.S. and globally.
The company now has about 800 locations. It remains smaller than it was at its peak, but it’s adding locations every year. It expects to add 140 to 150 locations worldwide this year.
In fact, Karam can’t tell exactly which location was the 800th, or even what type of concept it was. “We did a press release with all the above,” he said. “We opened a store in a military base in Fort Campbell Kentucky. We opened a mall location in California. We opened a convenience store in Oklahoma and a convenience store in the United Kingdom.
“So we’ll let them fight over who got the 800th.”
Note one of those was in a mall. “We want to be in malls,” he said. “But malls globally are only about 25% of our growth. It’s a different business today.”
That difference is also evident on the balance sheet. Karam has since acquired the chain. It is back to being family owned. And it has little debt. “We have a debt-to-EBITDA ratio of one to one,” Karam said. “When I started it was probably 150 to 1.”
That should help it avoid its dual-bankruptcy fate.
“Hopefully I have a chance to pass it on to the next generation of family members and just continue to manage the brand for the long run,” Karam said.