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Restaurant Bankruptcies Makes PE Queasy

Two restaurant companies owned by Sun Capital Partners Inc. recently filed for bankruptcy, dealing a double blow to the Boca Raton-based turnaround shop’s restaurant portfolio and highlighting the risks for sponsors have made big bets that consumers will be more willing to eat out as the economy recovers.

Friendly’s Ice Cream Corp. and Real Mex Restaurants Inc. filed for bankruptcy within days of each other, citing a sluggish economy, high rent costs, slow consumer spending and high costs for essential commodities, such as the cream used in Friendly’s ice cream.

The news underlines concerns about the overall health of the U.S. economy after a year and a half in which sponsors invested heavily in cyclical industries like retail and restaurants, confident that the economy was turning around after its freefall in 2008.

Friendly’s, the ice cream parlor and restaurant chain, plans to close 63 of its restaurants while keeping 424 open. Sun Capital has petitioned to become the stalking horse bidder for the company, a sign it still has hopes to turn the company around. “We’re not done with Friendly’s,” Scott Edwards, a principal at Sun Capital said. “We continue to see potential with the company.”

Mexican restaurant operator Real Mex, which operates or franchises more than 200 restaurants in California and elsewhere, said it would sell its El Torito, Chevys Fresh Mex and Acapulco Mexican Restaurant chains, sister news service Reuters reported. Sun Capital has not signaled whether, as with Friendly’s, it will try to retain control of the Cypress, Calif.-based company. A source said Sun Capital would “keep its options open.”

Restaurants have been one of the more popular sectors for private equity investors over the last year or so, highlighted by Apollo Global Management’s $1 billion take-private of CKE Restaurants after a bidding war in July 2010.

Buyout shops bought at least 24 restaurant companies last year; those with disclosed deal values added up to $5.66 billion, according to Thomson Reuters, publisher of Buyouts. In terms of disclosed deal value, that was more than any other year in recent memory, including 2007, when sponsors backed 28 restaurant companies with a disclosed deal value of $4.86 billion.

The deals continued into 2011. In May, Golden Gate Capital Corp.—which, like Sun Capital, invests in troubled companies—took California Pizza Kitchen Inc. private for $470 million. And in June, Roark Capital Group bought Il Fornaio and Corner Bakery Café from Bruckmann Rosser Sherrill & Co., which reportedly generated a 5.7x return on its capital with the deal.

Some auctions seem to be on hold or taking longer than expected: Blog affiliate peHUB noted that Highland Capital Partners planned to sell its rib chain Tony Roma’s by the end of June, which hasn’t happened. It also reported that Castle Harlan Inc. and Lauren Crown Capital have been trying to exit upscale steakhouse Morton’s since March.

Sun Capital has at least 10 restaurant companies in its portfolio, according to its web site (see table. Real Mex does not appear on the web site). “In light of all these challenges, we are working with all of our companies in the restaurant sector to try to help drive performance, improve store traffic and maintain tight cost controls.”

Edwards said that despite the economic challenges, some of its restaurant companies are performing well. Casual rotisserie chicken restaurant chain Boston Market Corp., for example, just finished 12 months in which its comparable store revenues increased, though Edwards declined to say by how much. And Smokey Bones Bar & Fire Grill, which was losing money when Sun Capital bought it in 2007, is now profitable and generated double-digit EBITDA growth in the last year, Edwards said.