High valuations push buyers to smaller restaurantsHigh valuations push buyers to smaller restaurants

With restaurant companies attracting higher valuations, private-equity groups and other buyers are looking at smaller concepts in earlier stages to find attractive targets, according to a MUFSO panel on the mergers-and-acquisitions market.

“I get the feeling that investors have had to reach deeper and earlier just to find good deals,” said Mike Mravle, CFO of Wingstop, the Richardson, Texas-based chicken wing chain. “We saw that several private-equity groups have invested in concepts with not much more than five or six units.”

Brian DeLeo, vice president in the corporate finance division at Deutsche Bank Securities, said life has grown more challenging for traditional concepts and traditional private-equity firms.

“The competitive landscape is fierce,” DeLeo said. “A lot of larger and more traditional firms are looking at earlier and earlier investments. It’s harder for traditional restaurant-focused private equity.”

The restaurant mergers-and-acquisitions market has been healthy in recent years, due to a combination of companies interested in buying concepts and the availability of lending into the restaurant space. DeLeo said his office gets phone calls or has meetings “if not daily, weekly.”

That market has slowed somewhat in recent weeks, however, which is likely due to a traditional seasonal slowdown at the end of summer.

Not every company is attracting a lot of attention from buyers. John Romney, a Dallas-based managing director at the private-equity group Levine Leichtman Capital Partners, said his firm recently backed out of a deal for a 200-unit chain with “good management” but a “tough history.”

But it also bid more aggressively for a growth concept in the Southwest, for a minority position at a valuation of 12 times cash flow.

Barron Fletcher, managing partner at the Dallas-based private-equity firm Riata Capital Group, said new concepts with new types of menus are getting a lot of private-equity interest and high valuations.

But, he said, “We’ve cycled through the better-burger phase.”

More companies have had initial public offerings in recent years, including four this year, a trend that is not expected to end soon, DeLeo said. And companies are going public at earlier stages in their cycles than they have in the past.

DeLeo noted that Zoe’s Kitchen Inc. went public last year with just about $10 million in cash flow.

“We get questioned a lot” about IPOs, DeLeo said. “But most management teams are fairly rational about it.”

Companies that decide to sell to a private-equity group need to choose carefully. They need to make sure they spend a lot of time with the investors to be sure that the goals of investors are in harmony with the management team.

“Make sure you’re in alignment with the other investors,” Mravle said. “You don’t want to head into that relationship with a different view.”

Companies need to know the investors’ philosophies, their histories and what kind of debt they’re going to put on the company, he said.

Romney said: “You are going to work together. If you don’t see eye to eye,” you’re going to have problems.  

Sellers must also have “realistic expectations” when it comes to valuation, DeLeo said. That could be tough in the current environment, with stories of high multiples told far and wide. Not everyone will get a “Shake Shack” multiple, he said.

“If you’re looking at a Shake Shack multiple … you might come to the finish line and be surprised,” DeLeo said.

Panelists said companies looking for investors should hire advisors with a strong track record to help guide the process.

“You’re not selling a house,” Fletcher said. “By having an advisor in the middle, you end up having an owner who is educated, and the chance of closing an investment is better.”

In addition, it’s a good idea for companies to plan effectively. Make sure the need for capital isn’t a desperate one.

“The best time to consume capital of any kind is when you don’t need it,” Fletcher said. “You don’t want to go into a situation where you’re undercapitalized and need it.”

Romney said management teams must understand that most private-equity firms will want an exit down the line. Traditionally, that exit is in about five years.

“There’s an exit,” he said. “Private-equity groups have to return capital to our investors. There’s going to be an exit at some point.”

Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze

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