MidOcean-Backed Pizza Maker’s Debt Ratings Sliced

A troubled restaurant market has led to unsavory expectations for Sbarro Inc., a fast-serve Italian food vender backed by MidOcean Partners.

Like many of its brethren in the industry, Sbarro has been battered by cautious consumer spending and increased commodity costs. Known for its pizza-by-the-slice sales strategy, the Melville, N.Y.-based company reported a net loss of $1.2 million for its fiscal third quarter ended Sept. 30, 2008, down from net income of $500,000 for the same period a year earlier. Revenue over that same period rose less than 1 percent to $91.9 million. EBITDA fell to $11.6 million for the quarter from $14.6 million in equivalent 2007 period.

Sbarro’s performance, combined with the difficult macro-economic environment, led Moody’s Investors Service to cut the company’s corporate family and probability of default ratings on Jan. 12 to ‘Caa2’ from ‘Caa1’—indicating the ratings agency’s belief that the company may be on the path to default. Standard & Poor’s had lowered the company’s rating in December to ‘CCC’ from ‘CCC+’ in part because it expects the company to breach leverage covenants on its senior secured facilities when they enter a more restrictive phase in 2009.

Sbarro wouldn’t be the first sponsor-backed restaurant to fall on hard times since the current recession began. Black Angus Steakhouse, a restaurant chain owned by Versa Capital Management, filed for Chapter 11 bankruptcy protection in January after sales fell about 26 percent over the last two years. Meanwhile, Buffets Holdings, a chain of buffet-style restaurants owned by CI Capital Partners and Sentinel Capital Partners, filed for Chapter 11 protection early in 2008 after the company proved unable to find new lenders to provide debt with more favorable terms.

MidOcean Partners acquired Sbarro in January 2007 for approximately $450 million. The deal included at least $208 million in debt financing led by Credit Suisse Securities and Bank of America Securities. Leverage took the form of a $25 million revolving credit line, $150 million in senior unsecured debt, and a $183 million term loan B that matures in January 2014, according to Reuters Loan Pricing Corp. and Moody’s. Sbarro is a portfolio company in MidOcean Partners III LP, which closed in late 2007 with more than $1.25 billion in commitments.

In addition to tepid consumer spending, Sbarro is also being hit with spiking commodity prices for two key pizza ingredients. The cost of cheese in the first nine months of 2008 increased nearly 20 percent to an average of about $2.18 per pound compared to an average of about $1.82 per pound the year before. Flour, meanwhile, more than doubled in price to $0.43 per pound as of Sept. 30, compared to $0.20 at the same time in 2007.

Last month Sbarro announced that CFO and Vice President Anthony Bugles was leaving the company “upon mutual agreement to pursue other interests.” The specifics of the situation were not disclosed in a regulatory filing announcing the move. Effective Feb. 12, Bugles will be replaced by Daniel Montgomery, who most recently served as a managing director at SkyWorks Capital LLC, an aviation advisory and investment banking firm.

The company will continue to be run by President and CEO Peter Beaudrault, who has been at Sbarro’s helm since 2005 and has prior restaurant experience as CEO of Hard Rock Café International. Sbarro has approximately 1,000 locations and 11,000 employees.