Is there hunger for more restaurant acquisitions in 2018?

Recent transactions in the restaurant sector have continued to impress industry insiders. In all sectors, both volume and transaction were expected to gain pace in 2018, according to a report by Deloitte & Touche, The State of the Deal: M&A Trends. More than a third of companies with revenues in excess of $1B “intend to pick up the pace” on acquisitions in 2018. Private equity firms are also bullish. According to an article in Forbes, Triago Fund Advisory estimates that money raised by private equity funds for deals in 2017 totaled $621B, surpassing a previous record of $557B set in 2008. With so much money raised, it’s time for businesses to spend. And spend they will, as tax rates are much more favorable due to the current economic environment, creating better returns.

The total volume of U.S. M&A in 2017 was $2.9T, according to JPMorgan Chase’s Global M&A Outlook report-- the same amount as in 2016-- but, the volume of transactions is expected to increase in 2018.

Lower interest rates are indeed a reason for more deals among corporations and private equity firms, according to John A. Gordon, principal of Pacific Management Consulting Group. Multiples in the restaurant sector have been aggressive, and now is the time for more restaurant acquisitions to occur because selling companies can continue to rationalize higher valuations. According to Duff & Phelps in its June 2018 Quarterly Industry Report, enterprise value for restaurant brands is historically high for fast

Bartaco is part of the DFRG acquisition of Barteca Restaurant Group.

Photo by Bartaco.

casuals in the last twelve months at 19.6 times enterprise value while quick-service brands were historically high in 2017 at 16.4 times.

Two of the more notable acquisitions by private equity firms this year were Roark Capital’s acquisition of Sonic Corp. for $2.3B through its Inspire Brands subsidiary, and High Bluff Capital’s acquisition of Taco Del Mar and Quiznos’ parent, QCE LLC, for undisclosed amounts. Roark Capital, through Focus Brands, also finalized its acquisition of Jamba Juice for $200M in September and Buffalo Wild Wings (BWW) for $2.9B in February, the same time it created BWW’s parent, Inspire Brands (also parent of Arby’s Restaurant Group), led by Arby’s former head, Paul Brown.

German investment firm JAB Holding Company, through Krispy Kreme, strengthened its bakery foothold with the acquisition of Insomnia Cookies, and most certainly planned for Insomnia’s expansion abroad through Krispy Kreme’s current infrastructure. 2018 has otherwise been a quieter year for JAB, which acquired Panera Bread and Au Bon Pain last year, in addition to the Bruegger’s Bagel chain through JAB’s ownership of Caribou Coffee. JAB is massively consolidating the U.S. coffee production and bakery & coffee chain subsectors through acquisitions that could last for decades to come.

Building a case for acquisitions

Restaurant companies that acquire other restaurant companies have similar incentives as investment firms, including capturing undervalued assets to both generate a good internal rate of return and create efficiencies of scale. This is likely what is occurring with Inspire Brands. By bringing Arby’s Restaurant Group, Buffalo Wild Wings, Rusty Taco, and now Sonic Corp. under its portfolio, Inspire brands now has greater purchasing power.

For those looking to be best-in-class employers, size does matter. Large companies have more access to a larger set of options for employer health coverage and can more easily offset higher labor costs. A lesser-known advantage to size is the consolidation of executive oversight. Pacific Management’s Gordon notes that the restaurant industry is losing bright and promising executives to other industries. By combining restaurant companies, however, we can still have the best and brightest in foodservice leading top brands.

Synergies aren’t just created by on the cost side of the profit & loss statement. Certain brands can truly complement each other. In the case of Del Frisco’s purchase of Barteca—completed in June, the polished casual dining operator saw an opportunity to create a stronger company by combining the two organizations, notes Gordon. At the time of the purchase, DFRG indicated the new company would also be less susceptible to seasonal swings in revenue. Cava’s recent acquisition of Zoe’s Kitchen caught many by surprise since it involved a much smaller brand—66 units—acquiring a nearly 250-unit competitor (albeit with major funding from Act III Holdings, the investment arm of Ron Shaich, former chairman and chief executive of Panera Bread). Zoe’s Kitchen had been struggling for some time though. By the

time it reported its results in its 2017 annual report, average annual sales per unit were down nearly $100K, and comparable sales were down two percent. For companies that are doing the selling, being acquired by a private company can have an advantage, taking existing company executives out of the limelight and extracting the most value for shareholders. An acquisition can help executives win praise and earn higher stock option valuations and bonuses, while at the same time relieving them of rationalizing disappointments in front of investors and analysts during quarterly conference calls.

One of the main reasons franchise concepts are acquired, as in the case of Restaurant Brands International’s acquisition of Burger King, Tim Hortons, and Popeyes Louisiana Kitchen, is the ability to franchise a well-established and easilyreplicable restaurant brand. There’s a lot of value in the potential to franchise a brand globally. Not all brands have gone through a strong international development phase yet. Popeyes is now entering Brazil and the Phillipines post- RBI acquisition. When second-quarter financial results were reported this year, Popeyes had added more than 200 restaurants and Burger King had increased its location count by more than 1,000 year-over-year (including possible franchised-unit takeovers).

Not all franchise concepts grow their units post-acquisition, however. A study conducted by Peter Schwarzer of LeOS Franchise Consulting, and reported by Franchising.com in June, suggests Roark Capital-controlled concepts are not necessarily growing in unit count after acquisition. What is happening instead is that average unit revenues grew faster after these brands are in Roark’s control. For these restaurant brands, compounded annual growth rates (CAGR), on average, grew 150 basis points to 3.4 percentage points in the three years post acquisition, even though unit growth itself did not. Value was certainly created, but not in the way most would think, Still, franchisees have been able to benefit in the short and long term.

2018 NOTABLE

ACQUISITIONS

• Elysium Management acquired Huddle House from Sentinel Capital in January.

• Butterfly Equity acquired fast-casual Modern Market in February.

• Barington/Hilco Acquisition Corp agreed to acquire Papa Gino’s and D’Angelo’s Sandwich Shops in February.

• TriSpan acquired Rosa’s Mexicano in March and revamped management team.

• In February, Inspire Brands, a Roark Capital whollyowned subsidiary, is created after Arby’s finalizes acquisition of Buffalo Wild Wings.

• Spice Private Equity acquired Bravo BrioRestaurant Group in March.

• Rhône Capital completed acquisition of Fogo de Chão in April.

• Earl Enterprises acquired Bertucci’s out of bankruptcy in June.

• High Bluff Capital acquired QZE (Quizno’s LLC) in June.

• Mlllstone Capital Advisors acquired Native FoodsCafe in June.

• Oprah invested in True Food Kitchen in July.

• High Bluff Capital acquired Taco Del Mar in July.

• Zoe’s Kitchen entered into merger agreement with CAVA in August.

• Roark Capital, through its Focus Brands subsidiary, finalized acquisition of Jamba Juice.

• In September, Roark Capital, through its InspireBrands subsidiary, agreed to acquire Sonic Corp.

• Elite Restaurant Group bids to take Noon Mediterranean out of bankruptcy in October (Restaurant Business Online)