Q&A with Anthony Valentino of Mergermarket, which tracks and analyzes M&A data.
Since the first of the year, there have been four big restaurant deals: JAB Holdings Inc.’s offer for Panera Bread Company, Bob Evans was purchased by private equity firm Golden Gate Capital, Restaurant Brands International bought Popeye’s Louisiana Kitchen, and Darden purchased Cheddar’s Scratch Kitchen. What’s driving the interest in the restaurant sector? Are these deals simply coincidence or is the restaurant industry about to endure? FE&S’ Editorial Director Joe Carbonara posed these questions and more to Anthony Valentino, deputy editor for Mergermarket, a company that tracks and analyzes data associated with global mergers and acquisitions.
FE&S: What’s driving the merger and acquisition activity in the restaurant sector?
AV: A number of factors are driving activity in the restaurant space. Financing continues to remain inexpensive, and that has helped boost deal activity broadly across sectors.
Another major factor is that the U.S. is overstored from a restaurant perspective and the industry has become even more intensely competitive. When you reach critical mass like that, consolidation is a natural result. This overstored environment has been a major contributor to the dwindling traffic and slower same-store sales figures, which has been thrashing the industry. We see this overstored nature in retail as well, though the retail subsector has massive headwinds in the form of competition from e-commerce that could lead to a combination of insolvencies and M&A as a natural consolidation result. Fortunately, the restaurant industry does not look to be displaced anytime soon by the Internet, so liquidation is likely to be less prominent.
Additionally, valuations in the restaurant space have slowly come down the past few years. In a way this has led to stabilization as valuations had become out of whack with the reality of the growth prospects for many restaurant businesses. The only area that has seen a true uptick has been QSR.
The restaurant sector has also seen flagging traffic and same-store sales figures the past few years and, particularly for many large strategic players in the space, M&A is viewed as an opportunity to combat slowing growth of legacy brands via the addition of higher-growth concepts that are usually found in the middle market. Acquisitions are also seen as a way to cost-cut and achieve greater economies of scale that can offset rising labor costs the industry faces.
Consolidation in this aspect is in large part related to the ever-changing profile of the consumer, which has resulted in fast-casual concepts becoming the darling of the space from an M&A perspective. Other areas of interest that have mirrored shifting consumer taste profiles include restaurant chains emphasizing farm-to-table cuisine. And while these healthy food fast-casual concepts have seen a lot of play, there is still room, especially as recent deals have shown, for quick-service restaurants and casual dining concepts to trade.
FE&S: Is that an unusual number of deals for a specific business segment in less than four months?
AV: The number of deals is not necessarily unusual for a particular subsector within the broader consumer space. In fact, we saw several other lower middle market deals as well since January 1, including Union Square Hospitality taking a position in Joe Coffee, Four Foods Group acquiring Bravo Food Service, Meritage Hospitality scooping up a group of Wendy’s locations and Freshii going public in Canada.
The real oddity in the spate of recent deal making in the restaurant space comes not from deal count, but the overall deal value involved in these transactions, and also that two of these transactions involved strategic acquirers.
Strategic M&A in the restaurant space has been infrequent, at best, during the past few years as many of the large restaurant groups have struggled with their existing concepts — for instance Darden with Red Lobster or DineEquity with Applebee’s. These large, publicly traded groups are some of the more logical strategic buyers. Because they are wrestling with internal inefficiencies and slumping traffic, though, there’s not much opportunity for acquisitions.
FE&S: Do those four deals represent the start of a M&A frenzy in the restaurant community? Or will things taper down in the coming months?
AV: You have to keep in mind that restaurant and retail consolidation, from a volume perspective, tends to be less pronounced and frequent within the consumer space than food and beverage company tie-ups or acquisitions within the consumer products space, especially among manufacturers where synergies are often very distinct. There are a number of reasons for this, but many times it can simply be cheaper to expand organically than pay a multiple for a different concept, especially if you have a franchised business.
While there is always a steady stream of restaurant M&A, many times it is private equity getting involved, and more recently venture capital firms have become interested in investing in fast-casual businesses appealing to Millennials and the health-conscious consumer, such as sweetgreen and honeygrow.
All of that said, I don’t think we will have an M&A frenzy on our hands after these deals, but I do expect deal volume will remain consistent. With the number of major deals that have been done, plus several strategic reviews that have recently occurred, any restaurant company board would be doing a disservice to their shareholders not to call up their M&A bankers and see what is potentially out there. Deals breed deals in this way — as we saw in the food & beverage space a few years ago with several major deals in a row — and this alone could contribute to a few transactions that may not have been previously on the table.
This would be a stark contrast to the past 18 months where we say restaurant M&A activity had been very quiet after a prior 24- to 36-month period that saw a spate of deals and a bevy of IPOs. In fact, I do expect that we will see restaurant company IPOs return to the fold this year, with at least a couple of new listings, as the market turbulence has seemed to calm. Last year we had zero restaurant IPOs.
With acquisitions, many public and privately held concepts that are struggling to drive traffic would be interesting turnaround situations for private equity if these financial sponsors can get the valuations they would like. Many of these potential public targets have seen their valuations shredded during the past 24 months as they had trouble hitting lofty growth expectations, particularly those that have gone public within the past 3 to 4 years, with Noodles & Company, Potbelly, Papa Murphy’s serving as examples.
The other factor that has driven M&A in the space, and will continue to be a major impetus, are the higher-growth middle market concepts, particularly fast-casual, that are seeing traction among Millennials. These concepts will continue to attract heavy interest and contribute to overall restaurant M&A significantly as they represent the broader trend of consumer seeking high-quality ingredients in a setting where they can eat quickly and relatively inexpensively.
From a strategic standpoint, Restaurant Brands and Darden will be digesting major acquisitions, so that will likely take them out of the potential acquirer pool for a bit of time. Nevertheless, there are other strategic players who could jump into the M&A pool, with Domino’s and Starbucks being a couple that have been publicly floated as potential buyers. With other players, such as DineEquity or Brinker, struggling to right their own ship, it’s difficult to see those types of companies as buyers. Overall I believe you will see more private equity activity than strategic activity in the space in the coming year, however, which falls in line with historic norms in the restaurant space.
FE&S: What drives a company to sell?
AV: Specific to the restaurant industry we have seen companies under pressure from activists that have been compelled to sell or explore a sale through a strategic review even if that review did not result in a deal. An intensely competitive environment in the space is also a reason that concepts in the space would sell, especially if they have experienced flagging SSS [same-store sales] and traffic figures. These concepts may need a tie-up with a larger strategic player for long-term survival or need a PE firm to step in and conduct a true turnaround.
For privately held companies in the space, valuations have been a major driver of activity during the past few years, as they rose rapidly and many owners were compelled to explore their options due to a potential valuation that was ostensibly unprecedented in the industry. This caused a ripple effect of acquirers, particularly private equity, moving further down the size chain to seek acquisitions of businesses that had less than 20, 15 or even 10 locations.
We’ve also seen a lot of private equity-backed restaurant companies approach their owners’ investment fund exit horizons and that has contributed to a fair bit of the selling in the industry as well. I expect this will continue to remain a major trend in restaurant M&A moving forward, perhaps even an increasing one in the next one to three years, as the bevy of PE activity in the space from three to four years ago results in portfolio companies that have now been held for that period of time and their PE backers begin to evaluate exit options for those businesses.
FE&S: What makes a company attractive to a buyer?
AV: A lot of it can be very buyer and target specific, but in general in the restaurant space key factors that make a target attractive are geographic white space for expansion, strong cash-on-cash returns at the unit level, and a strong management team. Same-store sales figures are also important for buyers looking for growth concepts, though in turnaround situations targets are typically struggling with this.
With recent deals, Restaurant Brands sought Popeye’s largely for its geographic white space, i.e., the ability to expand the concept globally. Where RBI has a massive footprint, that’s less so with PLKI. Darden’s buy of Cheddar’s, meanwhile, puts its excess cash to good use. A driving factor for that deal included a good cost-cutting opportunity to boost earnings per share and the deal allows Darden to add a concept with a differentiated menu to its existing brand portfolio.
FE&S: How can we tell if a company might be in play or positioning the organization for a potential sale?
AV: Oftentimes it’s not easy to tell whether a company is a potential sale candidate, but you can look at the broader desirable asset characteristics of a business, think fast-casual or franchised concepts, as two areas that are particularly attractive to buyers, as logical candidates for interest from strategic players and PE.
In the public realm, ideas are floated constantly, and potential candidates are characteristically those struggling to meet their growth benchmarks several years in a row. If these companies’ valuations begin to become out of whack with the industry norms, it could be an appealing opportunity for PE to step in and complete a take-private transaction. Ultimately these financial sponsors can address the problems of the brand out of the public eye. They can take four to six years to turn the concept around and then position it for a sale or another public listing.
Activist pressure has also played a role in identifying potential targets in the restaurant industry during the past couple of years. One example was the sale of Bob Evans, which had been pressured by Sandell Asset Management to separate its food and restaurant businesses. Fiesta Restaurant Group is another restaurant company that has been in the crosshairs of an activist investor, and underwent a sale process, but did not find a buyer. You also have activist pressure at companies such as Buffalo Wild Wings and Chipotle, though for CMG and BWLD the focus has been on operational changes for the time being.