Sponsor-backed Retail and Consumer Companies Struggle

The pizza chain Sbarro Inc. filed for bankruptcy protection on April 4, capping a week that saw ratings agencies downgrade another sponsor-backed restaurant company as well as a sponsor-backed company that sells arts and crafts.

The developments suggest that although the economy is improving, many sponsor-backed companies that rely on consumer spending continue to struggle from the effects of the Great Recession and excessive debt employed by sponsors during the mid-decade buyout boom.

Melville, N.Y.-based Sbarro announced it had reached an agreement with lenders that will eliminate about $200 million of debt and improve its financial stability going forward, sister news service Reuters reported. Its lenders include MidOcean Partners, the New York-based mid-market buyout firm that bought the company for approximately $450 million.

Sbarro’s struggles surfaced soon after MidOcean bought the company, as the credit markets chilled and the Great Recession took hold. Consumers became more cautious, while prices for flour and cheese—two critical ingredients for pizza—spiked, making it more expensive for Sbarro to do business.

Sbarro’s restaurants, frequently found in malls and airports, will continue to operate without interruption, the company said.

A week earlier, Standard & Poor’s downgraded quick-service restaurant chain El Pollo Loco Inc.’s corporate credit rating to ‘CC’ from ‘CCC,’ with a negative outlook, because of doubts the purveyor of flame-grilled chicken will be able to meet large debt payments coming due. The company’s backers include Trimaran Capital Partners and Freeman Spogli & Co.

As of Dec. 29, the company had $269 million of debt. In May, it faces a mandatory principal payment of $10.6 million on its 2014 notes, of which there are $29.8 million outstanding; and in June it has $14 million of interest payments due.

Like Sbarro, the Costa Mesa, Calif.-based company suffered amid the recession. Its losses were magnified, however, by its concentration in the Southwest, which the housing downturn hit particularly hard, and regional unemployment exceeding the national average, Jerry Hirschberg, a senior director at Standard & Poor’s, told Buyouts.

“Most places in California have felt the sting of the poor economy and with it having a high amount of debt, it has not had the revenues to produce the earnings necessary to help pay everything off,” he said.

Standard & Poor’s also recently downgraded the corporate credit rating of Provo Craft & Novelty Inc., a maker of cutting machines and other craft and hobby products whose backers include BAML Capital Partners and Sorenson Capital.

The ratings agency cut its corporate credit rating on the South Jordan, Utah-based company to ‘CCC+’ from ‘B’ out of concern it might soon breach the total leverage or senior leverage ration covenants. The company had about $140 million of total senior debt outstanding as of Dec. 31.

Provo Craft’s performance deteriorated in the third quarter of fiscal 2010, primarily because it borrowed substantially from a $40 million revolving credit facility to help launch a new electric cutting machine that analysts expect will actually cannibalize sales for existing products that perform similar tasks.

The ratings agency also lowered the ratings on the company’s remaining $170 million senior secured credit facility to ‘B-‘ from ‘B+’.