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Restaurant buyers look for big deals

With the industry facing an uncertain future, investors are hunting big game while treading lightly around risk.
Photograph by Jason Little

Investors can’t seem to get enough of restaurants. Despite rising costs, shifting consumer dynamics and an influx of technology changing the very business model, private-equity firms and strategic investors keep putting their money into an industry still largely viewed as safe.

How they’re investing, however, has changed. In an unusually active summer for restaurant deals, numerous companies changed hands. Investors sought out unique and creative deals, coughing up sometimes sky-high prices to snag chains with unusual business models or a particularly loyal customer base. As a result, some brands saw massive valuations and large paydays, while others are still sitting, collecting dust and hoping for a buyer.

While strong chains can fetch top dollar no matter what the environment, the wide gap in valuations demonstrates that investors are interested only in safety. The changing dynamics of the restaurant business demand it.

Shifting dynamics

To understand investors’ mindset about the restaurant business, it helps first to understand where the business is right now: in a major state of flux. 

Four years ago, investors felt the industry was a safe bet relative to other consumer companies, believing restaurants to be relatively insulated from the e-commerce encroachment hitting retail or hotels. Since then, the industry’s growth has slowed. Same-store sales have generally been weak. And though chains such as McDonald’s, Starbucks and Chipotle Mexican Grill have reported stronger sales of late, traffic growth broadly has been elusive. 

At the same time, labor costs are up, which has damaged profitability while making it harder for companies to find workers.

Plus, consumers themselves are changing. They are ordering takeout more often, through delivery platforms; branded online, mobile or other digital options; or old-fashioned call-in. 

All of that has shifted the dynamics of the restaurant business. Investors are treading far more carefully. “There’s this whole new set of metrics that come into play,” said Blythe Jack, managing director with private-equity firm TSG Consumer Partners, at the Restaurant Directions conference in July. “It just got hard to be a restaurant investor.”

The fear of risk can be seen in the difficulty many restaurant chains are having finding buyers. Over the summer, several restaurant companies filed for bankruptcy protection after spending years trying to find buyers, including Perkins & Marie Callender’s and casual-dining operator Restaurants Unlimited. Likewise, Kona Grill filed for bankruptcy protection.

The filings did prompt the chains’ sale processes. Perkins and Marie Callender’s were split up, Landry’s bid on Restaurants Unlimited and The One Group is buying Kona for $25 million. But they generally went for prices less than the amount of debt on the books. Buyers are less likely to take bets on struggling chains in the current environment. 

A number of publicly traded chains, meanwhile, couldn’t find buyers after initiating sales processes, driven in part by activist investors, including Jack in the Box, Pollo Tropical owner Fiesta Restaurant Group and Potbelly Sandwich Shop.

Small growth concepts have also found a less receptive market recently. Five years ago, small fast-
casual chains could practically write their own checks as investors scrambled to find the next big thing. That has slowed dramatically in the past couple of years as investors have sought out bigger game.

“There’s certainly been a softening of the market,” says Jeff Brock, managing partner with private-equity firm Hargett Hunter Capital Management. “The size of the business maybe has more of an impact today on the preference of some of the sponsors and private-equity folks in particular. Deals move slower. Folks are being more selective.”

“For concepts that are able to have a cult following or a strong customer relationship, there’s a real story you can invest behind. It is an easier path to prosperity.” —Rahul Ketkar, H.I.G. Capital

Plenty of life

For all of the industry’s struggles, however, there are numerous examples of chains that find the right combination of food, service or convenience that gets customers flocking to their stores. Domino’s Pizza, for example, has doubled in size over the past decade, in part through its use of technology. Chick-fil-A has helped get customers excited about chicken sandwiches, which Popeyes Louisiana Kitchen proved in August when it sold out of its new chicken sandwich in about eight days.

Investors see this, and they search for companies that can replicate this success. And recently they’ve had their pick from a handful of such deals. 

Late last year, for instance, fast-casual salad chain Sweetgreen raised $200 million in a deal giving it a valuation of about $1 billion. It had fewer than 100 units at the time, so that valuation came to an eye-popping $10 million per location. Those locations, incidentally, are leased. 

But Sweetgreen is a highly popular, salad-centric concept that draws long lines and has taken its technology to a new level. And earlier this year, it made a surprising acquisition of a local Washington, D.C.-based meal delivery service called Galley Foods.

By comparison, San Antonio-based Whataburger is a more traditional fast-food burger chain. But the sale of a majority stake over the summer to BDT Capital Partners was arguably the year’s more notable deal. The Dobson family held control of the chain for 69 years as it gained a cult following in Texas akin to the one In-N-Out Burger enjoys in California. Loyal Whataburger customers reacted accordingly. The chain’s Facebook post on the sale generated thousands of comments, mostly from Texans disappointed by the sale.

Yet it’s that exact cultlike demand that generates enthusiastic investors. The Whataburger deal was similar to the 2014 sale of Chicago-based cult favorite Portillo’s for $1 billion when it had just 38 units.

“For concepts that are able to have a cult following or a strong customer relationship, there’s a real story you can invest behind,” says Rahul Ketkar, a vice president in the New York office of private-equity firm H.I.G. Capital. “It is an easier path to prosperity.”

Buyers get creative

These weren’t the only buzz-generating deals of recent vintage. Over the summer, Ares Management invested in upscale casual-dining chain Cooper’s Hawk Winery & Restaurants.

Sources told Restaurant Business that the deal gave Cooper’s Hawk a valuation of close to $800 million. Like Portillo’s, the chain had fewer than 40 units at the time of the sale. That gave it an eye-opening valuation of as much as 26 times earnings before interest, taxes, depreciation and amortization, or EBITDA.

Cooper’s Hawk was able to generate that kind of multiple because it thinks about the restaurant business differently than others, much like Sweetgreen and Portillo’s. The chain is anchored by an ultrapopular wine club that serves as both a recurring source of revenue and a loyal group of customers, enabling the chain to grow in areas where other restaurants fear to tread. The chain has used that club to help it triple in size over the past five years.

The Sweetgreen, Cooper’s Hawk, Whataburger and Portillo’s deals all came from private-equity firms that were willing to pay far higher than normal valuations to get their hands on unique concepts. 

Private-equity companies had a record amount of “dry powder” in 2018, or capital they could put to work making acquisitions or investments, according to a recent report by investment firm Bain & Co. That means there are more investment groups with cash to spend. With interest rates low, investment firms might be willing to push the needle on valuations when a good concept comes to market. 

“There’s always going to be demand for top-tier restaurants,” Ketkar says. “But there’s a ton of money in private equity right now. And these are pretty unique, differentiated concepts.”

But strategic buyers haven’t ignored the market, either. And many of them are getting just as creative in their search for growth.

In July, highwayside family-dining chain Cracker Barrel announced an investment of up to $140 million in eatertainment concept Punch Bowl Social. That deal includes this nugget: the right to buy Punch Bowl outright.

While that deal might have been an unusual combination of staid midscale concept and hip urban chain, it’s not that strange when you think about it, according to Punch Bowl founder Robert Thompson, who initiated the deal in January. “Cracker Barrel is an iconic brand,” Thompson told RB after the deal was announced. “Punch Bowl talks daily about becoming an iconic brand in its own right.”

The most creative deal, however, has to go to The Cheesecake Factory, which agreed to pay $353 million for Arizona-based Fox Restaurant Concepts and the remaining stake in North Italia.  Cheesecake has been toying with alternative chains for some time to supplement its flagship 200-unit chain—which generated just 3.4% system sales growth in 2018, according to researcher Technomic.

The Fox deal not only gives Cheesecake the full ownership of another growth vehicle in North Italia, in which it already owned a minority stake, but it also gives the chain an “idea lab” in Fox, enabling it to tap into the mind of one of the industry’s most creative people: FRC’s founder and CEO, Sam Fox.

Pushing the market

The summer of restaurant deals seems to be pushing more companies to consider sale processes. Sources have said a couple of chains have recently entered the market, hoping to find investors or outright buyers. Church’s Chicken, for instance, has been on the market for months. 

In some cases, companies are exploring a sale because the public markets haven’t  worked. Del Taco, the Lake Forest, Calif.-based Mexican fast-food chain, for example, is considering a sale after getting inquiries from potential strategic or financial buyers. Stock in Del Taco has not moved much since it was taken public in 2015, even though its same-store sales frequently outperformed larger rival Taco Bell.

Casual-dining chains have also opted to jump into the market. “Recent transactions for companies in the upscale casual-dining segment make this potential path more attractive now as we contemplate how to best position the company for the future,” said Lonnie Stout, executive chairman of casual-dining chain J. Alexander’s, in a statement.

The Nashville-based company had previously resisted demands from activist investors that it consider a sale. But after seeing a summer of deals in which chains of all sorts received attractive valuations from all kinds of investors, J. Alexander’s changed its mind. 

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