Restaurant Deals Continue To Attract Capital

“Fifteen years ago, you could count the number of institutional investors in restaurant deals on one hand,” said Bob Bielinski, head of the restaurant industry practice at mid-market lending firm CIT. “But now it’s a broad swath of private equity firms that invest in restaurants.”

Brand name restaurant chains now controlled by private equity include the likes of California Pizza Kitchen, Arby’s, Boston Market, and Applebee’s Neighborhood Grill & Bar.

So what’s whetting their appetite? First, the restaurant business is a large, stable industry that tends to generate a lot of free cash flow. After all, almost every wage earner in the country eats out and spends a meaningful percentage of his or her income on restaurants. The industry is also incredibly fragmented, which translates into boundless opportunity for private equity firms to snap up opportunities.

Some sponsors look for promising concepts that they can rapidly expand domestically and internationally. Others target troubled or underperforming brands that they can turnaround by introducing operational efficiencies and improving profitability.

The upshot is that private equity firms are now some of the most active players in the restaurant space. Buyout firms participated in 27 percent of all transactions recorded last year in which either the buyer or seller had headquarters in the United States, according to The J.H. Chapman Group, an investment banking firm specializing in mergers and acquisitions in the food and restaurant industries.

And, when it comes time to exit these holding, it is often other private equity firms they are selling to. For instance, Ares Capital Corporation sold southern restaurant chain Huddle House, the nation’s fifth largest full-service restaurant franchisor, to private equity firm Sentinel Capital Partners last year. Soon after, Sentinel Capital Partners sold Southern California Pizza Company, the largest Pizza Hut franchisee in southern California with 224 locations, to Sterling Investment Partners.

“There are not many strategic buyers in the restaurant industry and it’s harder to take companies public now,” said one private equity professional familiar with restaurant transactions. “That means all the action is in private equity.”

CIT’s Bielinski agrees that private equity provides the most reliable market for restaurant deals. “Years ago, one private equity firm would never look to buy from another private equity firm because they figured that first firm had made all the changes and improvements they could make,” he said. “But now in the restaurant space you have some firms focused on taking the business from 25 stores to 100 stores, other firms taking it from 100 to 500 stores, and yet others taking it from 500 to 1000 stores. Private equity firms are specializing in different parts of the growth cycle.”

Overall, there were 96 chain restaurant merger and acquisitions in 2012, slightly less than the 100 reported in 2011 and 8 percent more than the 89 recorded in 2010, and up about 45 percent from 2009, according to J.H. Chapman. The public markets also bounced back a bit last year with chains like Bloomin’ Brands, Chuy’s Tex Mex, and Del Frisco’s successfully making it through the IPO window.

Some of the biggest private equity deals of 2012 included Angelo, Gordon acquiring Benihana for $296 Million, Centerbridge Partners gobbling up P.F. Chang’s China Bistro in a take private valued at $1.1 billion, and TSG Consumer Partners selling YardHouse to Darden Restaurants for $585 million.

Despite the uptick in M&A activity the past few years, industry watchers expect the market to cool off slightly in 2013. On the one hand, it’s a great time to sell because the debt markets are very strong and lenders like GE Capital have rushed backed into the sector. On the other hand, there’s a dearth of really good opportunities on the horizon.

Among PE restaurant deals that are four years or older, and thus ripe for exit, many of the best holdings have already been sold off, notes Bielinski. “There are very few strong businesses still in the PE portfolio,” he says. “Some firms have tried to divest, but couldn’t get the price they were looking for.”

Bielinski points to one notable exception: Jimmy John’s Gourmet Sandwich Shops which was backed by Western Presidio in 2007. “That’s a very strong performing business with a great franchise model,” he said. “The reality is that private equity guys eventually sell, so you have to wonder when they will do something with that one.” Sun Capital Partners is another major holder of restaurant businesses, including Friendly’s, Boston Markets, and Smokey Bones.

The restaurant industry faces other serious headwinds that could impact M&A activity this year.

“I think it’s a tough time with payroll taxes increasing, the uncertainty in Washington over budget cuts, and gas prices going up,” said the private equity professional. “All these things tend to have an impact on restaurant sales, so predicting what traffic will be like is tricky. Plus you have rising commodity costs and Obamacare, and other uncertainties that impact cost structure, so you have to be very cautious in this industry right now.”

Indeed, Darden Restaurants, the owner of Olive Garden and Red Lobster, recently cut its outlook saying that higher Social Security payroll taxes and rising gas prices have impacted sales because consumers have less disposable income to spend.

The one bright spot, however, are franchise operations. Private equity firms are starting to aggressively target successful franchisees that have built up mini-empires within a global brand like Pizza Hut or McDonald’s.

For instance, Altamont Capital Partners recently acquired Tacala, LLC, the nation’s largest franchisee of Taco Bell with 162 stores, and related company Boom Foods, a leading Sonic franchisee with 66 locations.

“Many large franchisees have been in the business now for 20 or 30 years and are looking to get out,” said Craig T. Weichmann, a former investment banker who specialized in restaurant deals and a partner at Meyer Metz Capital Partners. “They survived the economic downturn, they made their mark, and now they’re getting too old for this stuff. People are knocking on their door who would love to buy their stores, and now is as good a time as any to sell.”