Private equity is financing some of the largest restaurant acquisitions in the U.S. even as the industry is on track to finish 2018 at its lowest deal count since 2010, according to an analysis by S&P Global Market Intelligence.
Investment firms also account for a larger share of all direct restaurant buyers in 2018 than all but two years of the previous decade, the data shows. Indirectly, firms are also backing other restaurant operators and companies financially as they buy restaurant properties.
As of Sept. 25, 133 restaurant deals have been announced year-to-date, while more than 200 restaurant deals were announced each year between 2013 and 2017, according to S&P Global Market Intelligence data.
Activity was slower in the preceding five years ending 2012, though the total number of M&A deals so far in 2018 remains lower than every year in the 11-year period except 2009, the data show.
The figures cover all transaction sizes in the sector, from individuals buying small, privately owned restaurants to the largest deals in the industry each year, including entire restaurant chains or franchisees selling a handful of locations.
In 51 of the analyzed deals year-to-date, the target company was purchased by another restaurant operator. The remainder were acquired by individuals or families, small investor groups, investment firms and other companies.
In a sectorwide view, analysts and industry watchers are seeing more publicly traded companies removed from markets as private buyers snatch them up.
"I think there is almost always interest, especially from the private equity world, in terms of acquisitions in the restaurant space," BTIG analyst Peter Saleh said in an interview.
Private equity driving large transactions
Roark Capital Management LLC Capital-backed Inspire Brands' $2.36 billion acquisition of Sonic Corp. is the largest transaction of 2018 so far, though private equity also accounts for some of the year's other big deals. Rhône Capital LLC bought Fogo de Chão Inc. for $598.1 million and took the Brazilian steakhouse chain private, while private equity-backed Cava Group Inc. paid $300 million for Mediterranean chain Zoë's Kitchen Inc.
Roark also owns Focus Brands Inc., which on Aug. 2 announced the $213.8 million acquisition of Jamba Inc., the company that owns, operates and franchises Jamba Juice stores. Jamba Inc. filed a notice to delist its stock with the SEC on Sept. 13, according to filings.
Private firms were also behind 2017's largest deals. JAB Holdings BV closed a $7.75 billion purchase of Panera Bread, while the Roark-backed Arby's Restaurant Group Inc., which later became Inspire Brands, signed a $2.89 billion purchase of Buffalo Wild Wings Inc. from Franklin Advisers. A private investor group also sold Popeyes for $1.83 billion to publicly traded Restaurant Brands International Inc., adding to a portfolio that includes Tim Hortons and Burger King.
Before that, JAB also took Krispy Kreme Doughnuts Inc. private in 2016 for $1.35 billion and in 2012 pulled Peet's Coffee & Tea Inc. from public trading after a $1.01 billion acquisition. Centerbridge Partners LP bought P.F. Chang's China Bistro for $1.11 billion the same year before delisting the chain.
In 2014, Darden Restaurants Inc. off-loaded Red Lobster Seafood Co. LLC to Golden Gate Capital in 2014 for $2.1 billion.
Why buyers take public brands private
The reasons for taking a restaurant business private vary from case to case, yet BTIG's Saleh noted some common themes.
"Some of these companies are taken private when they really stumble, the buyer feels like it's mismanaged, and there's a real opportunity to change out management and really create a lot of shareholder value. In other instances, they're buying up great names that they think that they can really grow," Saleh said.
Other benefits include consolidating back-office functions and being able to offer multiple brands to international franchisees, said Stephen Robb, managing director of the consumer and retail group for Mizuho Americas.
"It's a very case-by-case basis. There's definitely the distressed turnaround play of something that loses momentum or steam on the growth side, that runs into operational challenges, needs to get fixed. ... There are people that like that thesis. There are other people that won't touch a turnaround," who want to buy a growing business, Robb said.
Restaurant properties are generally moving to new private equity investors when current firms seek to exit their involvement, Moody's Vice President Bill Fahy said in an interview.
"The [private] equity investors, generally a lot of them, they have a hold period of five to seven years because they're in a fund, then they move out of them," Fahy said.
Restaurant IPOs have also slowed for investors looking to exit, Robb said.
"If you take the thesis on an economic basis that the consumer is happy, the economy is chugging along fine, unemployment is low, disposable income is high, consumer confidence is good, then restaurants should be enjoying the Goldilocks economy. If restaurants are enjoying the Goldilocks economy, isn't now the time to IPO them? But, that doesn't seem to be happening," Robb said.
Smaller chains are likely takeout targets
Private equity will remain a "driving force" behind M&A in the sector, Stifel analyst Chris O'Cull said in a Sept. 25 research note.
"We believe acquirers will continue to be selective targeting companies poised for accelerating growth and/or potential to improve returns with greater scale," including The Wendy's Co., Wingstop Inc., BJ's Restaurants Inc. and Chuy's Holdings Inc., O'Cull said in the note.
BJ's and Chuy's are also attractive takeout targets for Stephens analyst Will Slabaugh, who looked at the chains' "maintenance" free cash flow, or cash flow excluding growth capital expenditures. The metric is useful in gauging the potential for shareholder returns and general risk and reward, Slabaugh said in a Sept. 18 research note.
"It looks a bit cheaper once you look at this on a maintenance perspective versus a lot of the growth capital that's being pumped in," Slabaugh said in an interview.
BJ's has accelerated single store sales growth toward "the top of the casual dining industry," while also committing to cost management and trading at near all-time valuations, Slabaugh said. Chuy's, meanwhile, has the potential to grow its size by three or four times and the chain's differentiated menu should set it apart as it enters new markets.
Red Robin Gourmet Burgers Inc., Carrols Restaurant Group Inc. and Papa Murphy's Holdings Inc. are also attractive targets, given relatively high free cash flow excluding CapEx, Slabaugh said in the note.
Generally, private equity firms are also investing more in smaller chains with hopes of growing them into something larger, Slabaugh said, adding, "We've seen definitely a move toward that."
Robb, meanwhile, did not want to name specific companies but pointed to common traits among possible takeout targets.
"There's easy screens to do of anybody that trades badly, anybody that's had operational challenges, especially operational challenges over multiple years. ... If you continue to be in the press about operational difficulties and you can't get your operations working on a regular basis and you need to fix yourself, maybe being in private hands is a good way to do that," Robb said.
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