Why the Barteca acquisition caused Del Frisco’s downfall

Rather than give the company long-term growth, it led investors to force a sale and the company’s ultimate breakup, says RB’s The Bottom Line.
Photograph courtesy of Barcelona Wine Bar

In May of 2018, Del Frisco’s Restaurant Group announced a somewhat surprising agreement to buy Barteca Restaurant Group, then the owner of Barcelona Wine Bar and Bartaco, for $325 million.

The acquisition was designed to give Del Frisco’s growth. The Barteca concepts were, and still are, highly regarded. In theory, they paired nicely with the parent company’s flagship Del Frisco’s Double Eagle Steakhouse, while giving the company some time to repair its polished-casual chain Del Frisco’s Grille.

That didn’t happen. Instead, Del Frisco’s would soon find itself with plunging stock and angry investors and a sale process that would take the company private less than 18 months later at a price considerably lower than it was when the deal was made.

That tumultuous era ended Wednesday when private-equity firm L Catterton announced that it had completed its purchase of Del Frisco’s, taking the company private. And, as if to prove that the Barteca deal should never have happened, the new owner announced a deal to sell the steakhouse chains to Landry’s, keeping the growth concepts Barcelona and Bartaco for itself.

To understand the issue, go back to 2016. That year, Del Frisco’s had no long-term debt and was generally profitable, with an operating income of $25 million. Its stock price, however, had declined 40% over the previous two years from its peak amid same-store sales challenges.

Toward the end of the year, Mark Mednansky retired as Del Frisco’s CEO. He was replaced by Norman Abdallah, a longtime industry executive who had worked with Dinosaur Bar-B-Que, Romano’s Macaroni Grill and other concepts.

By the end of 2017, it had become clear that Del Frisco’s Sullivan’s Steakhouse chain had become a problem, and Del Frisco’s was looking for answers on what to do with it. The company reported an operating loss of $12 million, thanks mostly to a $22 million, Sullivan’s-related impairment charge.

Sullivan’s, like Del Frisco’s Grille, was meant to be a growth concept, but its sales problems kept the company from adding units. The company ultimately sold Sullivan’s to Macaroni Grill for $32 million.

Wanting that growth, and deliberately paring back plans for the Grille concept, Del Frisco’s went shopping and used its capacity to take on more debt as ammunition.

Del Frisco’s ultimately turned to Barteca, essentially offering a price so high that the sellers had no choice but to accept.

Paying high prices is not uncommon in strategic deals like this one. Darden Restaurants and Restaurant Brands International have both paid super-high prices to get companies they want. The difference here is that the target chains in those case were considerably smaller and therefore more easily digested.

In this case, as activist investor Engaged Capital later pointed out, the $325 million was nearly the same as Del Frisco’s enterprise value at the time. And the company borrowed the entire amount to fund the deal.

Debt is a necessary evil in the restaurant business. But in two years, Del Frisco’s went from almost no long-term debt to $320 million. In 2018, it had an operating loss of $22.5 million, plus another $32 million in interest costs.

Debt is risky. But in this case, it also restricted Del Frisco’s ability to spend money to build new Barcelonas and Bartacos. In March, Del Frisco’s acknowledged that it was slowing its growth.

Del Frisco’s “high leverage resulting from the Barteca acquisition has instead forced management to reduce the amount of capital investment planned for Barcelona and Bartaco in 2019 from Barteca’s plans as a stand-alone concept, effectively lowering its growth outlook and therefore value,” Engaged Capital said in a letter to Del Frisco’s board late last year.

That letter was sent less than seven months after the Barteca deal was announced.

Investors weren’t just clamoring for something to change. Federal securities documents suggest that the company had enough liquidity and financing needs that it needed to sell at least one of the concepts to pay down debt so it could continue as a stand-alone company.

Few buyers wanted all four concepts. Several companies made bids, but for the most part, financial buyers like private-equity groups were eyeing the growth chains. Strategic buyers were interested in the steak chains.

L Catterton won the bidding in part because it was willing to buy the whole company, saving Del Frisco’s from the potential costs and headaches of breaking it apart on its own. L Catterton was willing to find a buyer for the steak chains so it could keep the growth concepts for itself.

So, to summarize: Del Frisco’s acquisition of Barteca led to its own breakup.

In the end, Barcelona will get to stand on its own. Bartaco will be managed along with Uncle Julio’s. And once the deal is done, Del Frisco’s will be part of the Landry’s collection—a prize Landry’s CEO Tilman Fertitta has wanted for years.

Del Frisco’s Barteca mistake isn’t without its victims, either. Employees lost their jobs with the acquisitions, after all, and investors also lost out as the stock price fell.

Buying Barteca might have been a good idea. But buying Barteca at a high price and with a ton of debt was not.

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