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Steak ‘n Shake lawsuit highlights the booming business of credit deals

Investors are increasingly using “loan-to-own” strategies to take control of restaurant chains, says RB’s The Bottom Line.
Photograph: Shutterstock

The Bottom Line

When does a lender not want its debt repaid?

When that lender isn’t actually making the loans.

This is an issue in the lawsuit filed recently by Steak ‘n Shake against Fortress Investment Group. In short, Steak ‘n Shake is accusing Fortress of getting confidential information by trying to buy the chain’s real estate when it was up for sale last year—then using that information to buy up the company’s debt on the secondary markets. It then threatened to throw Steak ‘n Shake into bankruptcy in a bid to take control of the chain.

The dispute highlights “loan-to-own” strategies investors have used with greater frequency over the past year. Several chains have been acquired in credit deals where the buyer acquired the debt in advance of a bankruptcy filing.

Here’s how it works. A lender worried that it might not get repaid can sometimes sell debt on the secondary market at a discount, hoping to recoup at least some of its investment rather than risk losing even more of it should the borrower end up in bankruptcy.

Investors with a bigger appetite for risk buy up this debt, often at a discount. For instance, a lender holding a $200 million loan to a company could sell it for $150 million to an investor, who then bets on recouping the full $200 million—thus making a $50 million profit. While we call companies like Fortress a “lender,” it is not actually a lender but an investor that buys up loans from the actual lender.

These investors can sometimes take ownership of the company whose debt they hold if there are no other avenues for repayment, such as a borrower refinancing the loan. Or, more often, if the company can’t find a buyer willing to pay a price equal to the amount of debt the investor holds.

The investor then just makes a credit bid out of bankruptcy, swaps the debt for equity, and then hopes improving performance—or more likely drastic cost cuts—will improve the value of the chain in a later sale. And often these investors just pay themselves dividends using the cash they generate.

By acquiring the debt at a discount before a company files for bankruptcy, an investor can get the inside track on an acquisition. Another buyer would have to bid more than the amount of debt on the company to effectively outbid the loan-to-own investor.

This has become an increasingly common strategy for investors to take control of restaurants since the start of the pandemic, largely because the value of certain types of restaurant chains have plunged and the number of investors willing to buy such companies has shrunk. As such, investors such as Fortress have used the “loan-to-own” strategy as a way to take ownership of restaurant companies.

Fortress Investment Group, which was sold to the Japanese-investment bank SoftBank Group in 2017, has taken a keen interest in restaurants over the past year.

The firm acquired the burger chain Krystal in May with a $27 million credit bid. At the same time, it acquired Craftworks restaurants, the owner of Logan’s Roadhouse, for $93 million.

They are hardly the only ones, of course. California Pizza Kitchen and Ruby Tuesday have been sold in credit bids.

Increasingly, the buyers are actual operators who see a chance at expanding their holdings at relatively low prices—while using the bankruptcy process to close money-losing restaurants. Aurify Brands bought two concepts this way, Le Pain Quotidien and Maison Kayser.

Indeed, while the tactic seems ruthless, in many respects it is just opportunistic. And such investors provide an important service, preventing companies from going dark completely and keeping locations open and jobs available.

At the same time, these companies can force tough negotiations and use their status as secured lender to force bankruptcy proceedings. In its lawsuit filing, Steak ‘n Shake said Fortress used a real-estate sale process to get confidential information which it used to buy up debt and then drove a hard bargain during repayment negotiations.

Fortress “never intended to buy the properties,” Steak ‘n Shake said in its complaint. “Fortress wanted to buy Steak ‘n Shake. In other words, when Fortress entered into the [confidentiality agreement] in July 2020, it was not to kick the tires on a potential real estate transaction, but to perform due diligence on the company itself.”

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