A young generation of startup restaurant chains is disrupting the restaurant industry and taking share from larger chains — fueled by an unprecedented flow of investment cash into small concepts.
“This is a really disruptive restaurant environment, with startups happening across the United States,” said Roger Matthews, managing director at Bank of America Merrill Lynch, a big lender in the restaurant space.
“This group of startups are better funded than they’ve ever been in the past,” he said. “An explosion in funding from private equity groups and wealthy investors” is helping get these startups off the ground.
Matthews was speaking along with Cristin O’Hara, also a managing director at Bank of America, on a conference call Thursday to discuss the current state of the merger and acquisition environment in the restaurant industry.
They described an environment in which Millennials are driving major changes in the industry, in part by their changing eating habits and their tendency to spend more on dining out.
According to credit card data, Matthews said, Millennials spend a significantly higher percentage of their credit cards on restaurants than their cohorts — about double — though Baby Boomers spend more in absolute terms.
Part of that is math. Baby Boomers have a lot more money than Millennials. If the younger generation wants to eat out, therefore, it will have to spend a greater percentage of its money to do so.
But, Matthews said, they also just eat out more. “Millennials are spending more on restaurants than similar age cohorts,” he said. “That’s partly social trends. They get married later. They’re forming households later. They have a higher amount of disposable income to spend on themselves. They’re not buying a house. They’re not having children.”
Those Millennials are dining at different types of restaurants. “Millennials are looking for the best of a product: The best hamburger, the best taco, the best cupcake,” Matthews said.
Millennials also spread it out, going to many different restaurants rather than just a few. “They want to experience a variety of different concepts,” O”Hara said. “We’re seeing they rotate through a variety of flavors.”
So younger concepts are grabbing market share. Traffic at larger chains has been relatively weak for some time. Sales indexes like the monthly index from Black Box Intelligence have shown declines in traffic of more than 1 percent for well over a year — including a 1.1 percent traffic decline in August.
That index is focused on mostly chain restaurants. And when chain restaurants lose traffic, it creates a big opportunity. To wit: When McDonald’s Corp. sales decline by 1 percent, it creates $350 million in potential sales for other restaurants. “That’s like creating several Shake Shacks in one year just by losing that 1 percent,” Matthews said. “Larger concepts are seeing modest erosion in traffic, and startups are benefitting.”
Private equity groups see that. And they’re putting their money toward those disruptive concepts grabbing market share and luring Millennials.
Last year, the big private equity group KKR made a minority investment in the 14-unit Los Angeles chain Lemonade. While that investment was big for Lemonade, it was tiny for KKR.
Other deals have come. Roark Capital invested in the Middle Eastern concept Naf Naf Grill. Just this week, Cava Mezze Grill announced a new round of funding, $45 million. Catterton Partners in recent years has invested in a handful of startups.
And it’s not just private equity groups, either. In some cases, venture capitalists are pumping money into these new concepts. One of the investors in Cava Mezze Grill is Revolution Growth, a venture firm started by AOL co-founder Steve Case. Revolution Growth has been putting money into other restaurants, too, such as the fast-casual concept Sweetgreen.
In part due to the initial public offering market, private equity investors are motivated to invest in these emerging companies. Companies can go public at an earlier stage in their life cycles than they have been able to before. In past years, companies couldn’t go public until they’d reached annual cash flow of $40 million to $50 million. Now companies can go public with less than $15 million in cash flow.
“Some of the old rules of thumb have been put aside as investors wanted to participate in this growth,” Matthews said.
In 2010, for instance, Lee Equity Partners LLC was able to buy Papa Murphy’s — a chain many figured could have gone public — for $180 million. Lee took Papa Murphy’s public four years later. These days, Papa Murphy’s likely would likely have skipped the sale to Lee and went public earlier.
This trend has forced private equity groups and other investors, which have money to spend, to focus on smaller companies.
Private equity groups have increasingly invested in large franchisee groups, O’Hara said. “A lot of private equity is starting to understand that, even though you don’t control the brand, it’s still a path of making a good return,” she said.
In addition, retirements and an aging franchisee base is driving a lot of consolidation, as is refranchising efforts on the part of companies like TGI Friday’s and CKE Restaurants.
“There are a lot of experienced, multi-unit operators. They’re aging, and they may need to think about planning for that next stage,” O’Hara said. And, she said, multiples for many brands “are at all time highs,” enabling many of these operators to get out and get a good price. And numerous lenders are pumping money into these deals.
“On the franchisee front,” she said, “It’s a hot market.”
Contact Jonathan Maze at [email protected].
Follow him on Twitter at @jonathanmaze
