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As the restaurant industry collapses, private equity stands to benefit

With valuations reset, investment firms not busy rescuing their existing companies could snap up restaurants at bargain prices, says RB’s The Bottom Line.
closed restaurant
Photograph by Jonathan Maze

the bottom line

Valuations for restaurant companies, and many other companies for that matter, have taken an absolute beating in recent weeks. That includes both publicly traded companies whose stock prices have fallen and privately held companies that are no longer as viable as they once were.

For private-equity firms, this might be an opportunity—even as their own holdings have struggled and many are spending investment cash to keep them afloat.

This dichotomy was illustrated in a Bloomberg article Tuesday. Apollo Global Management, a big private-equity firm that has routinely invested in the restaurant business, held a meeting with investors described as “upbeat,” even as it acknowledged the value of its holdings had declined.

In short, according to Bloomberg, the fund is tracking more than 250 distressed assets it views as potential investment opportunities. The firm has a substantial amount of cash, or “dry powder,” that it could use to pursue deals.

Private equity’s role in the restaurant business will be notable in the coming months and years as the industry struggles and its valuations are reset after years of considerable growth.

On one hand, many private-equity firms will be busy working to shore up their existing investments.

On the other, valuations have come down to the point that many investment firms could see real opportunity to pick up companies at depressed valuations. That could reshape ownership in the restaurant industry.

Private equity is all over the restaurant business. Investment firms own a lot of brands, especially midsized concepts. And as many as 40% or more of the largest restaurant franchisees have private-equity ownership.

Both of these groups are especially vulnerable in the current market.

Full-service chains face something of a reckoning as many of them furlough workers and close their seating areas. They are getting about 15% to 20% of their normal sales and aren’t typically built for the takeout and delivery services that are the only things going.

The same is true for franchisees. In a sign of just how severe the current crisis is, franchisors quickly stepped in to provide royalty relief, and now KFC owner Yum Brands is giving operators breaks on remodels and new unit development.

As these companies struggle to survive, their sponsors may be called on to use their cash to keep them from going under altogether. (Not all of them are doing so, as today’s report on Cracker Barrel pulling its support for Punch Bowl Social indicates. While that’s a strategic sponsor, many private-equity firms will undoubtedly make similar moves with their companies.)

“Since most sponsors have limited resources to share with their owned companies … they will need to decide where to best allocate time and resources,” according to a report on private equity and the coronavirus by consulting firm McKinsey.

At the same time, however, valuations have plunged for the industry.

As the industry grew in recent years, private-equity firms were priced out of a lot of deals. Companies such as Outback Steakhouse owner Bloomin’ Brands and Jack in the Box found a merger and acquisition market that was unwilling to pay the valuations they sought.

Investment firms have limits on what they spend for many chains. While investors were apparently willing to pay obscene multiples for chains such as Sweetgreen and Cooper’s Hawk, in most cases they have limits. That’s because private-equity firms want to make a return on their investment when they exit in a few years.

And many companies were effectively priced out of that range.

Almost overnight, that dynamic has changed. Wall Street largely reset industry valuations. With multiples at a much lower level, firms such as Apollo can theoretically step in and buy up companies at a bargain price.

What’s more, much of the competition will be gone. Because so many other investment firms and strategic buyers will be occupied shoring up their investments, the private-equity firms that have cash to spend will be able to pay remarkably low prices to get the deals they want.

To be sure, lending in the restaurant space could well be thin as lenders pull back, and that could limit the possibility of buyouts. But even that could put those cash rich financiers in the driver’s seat.

“The current financial-market displacement and equity valuations have undoubtedly created potential investments for sponsors with dry powder,” McKinsey wrote, noting that “many sponsors are preparing for a broader range of investments.”

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