Private equity dominates 2013 restaurant M&A activity

Restaurant industry merger-and-acquisition activity in 2013 continued to plateau, as it did in the prior year, and was still dominated by private-equity interest and franchise deals, according to a census from J.H. Chapman Group LLC.

And so far in 2014, the market for initial public offerings has cooled off and many deals are coming with private-equity investments in emerging chains, said David L. Epstein, principal with the Chapman Group, in a phone interview.

The Chicago-based investment banking firm’s annual “Chain Restaurant Merger and Acquisition Census” captured 97 transactions in 2013, one more than recorded in 2012 and three fewer than the 100 reported in 2011.

Nearly five months into this year, Epstein said, “My feeling about the number of transactions we’ll see in 2014 is that it will be less, unless we see some of the major chains refranchising.” In 2013, both Applebee’s Neighborhood Grill & Bar and Wendy’s undertook major refranchising efforts, he noted.

“We’re not seeing in 2014 the robust number of transactions that were being done in 2013,” Epstein said. “I’m a little surprised. I thought the huge success Wendy’s and Applebee’s had had in selling their corporate units to franchisees that a lot of other restaurants would see that and embark upon the same thing, but we haven’t seen that.”

Epstein noted financing for refranchising deals is often easier than for other acquisitions. “Lenders will agree with me that the best type of loan they like to make is to a franchisee of a concept who wants to buy more units in that concept,” he said. “They know how good or bad they are in operating those types of units. It’s typically a fairly good loan to make.”

Equity funds continued to be attracted to the industry, the Chapman census found, with those deals accounting for 35 percent of all transactions in 2013, rising from 27 percent in 2012.

“Many of the equity funds are looking for small, emerging chains,” said Epstein, adding that they’re also looking for great management, good unit economics and an ability grow but with a need for financial backing. “They’ve found great success in taking [these chains] to the next level,” he noted.

Already this year, a number of equity funds have found deals in smaller chains. In January, Lee Equity Partners made a significant investment in the six-unit Project Pie concept, which is based in Carlsbad, Calif. In February, KarpReilly LLC bought a controlling interest in the 12-unit Patxi’s Pizza of San Francisco. In March, Sentinel Capital, which earlier in the year bought the Checkers Drive-In Restaurants Inc., acquired the 67-unit Newk’s Eatery, based in Jackson, Miss. And in April, Laurel Crown Partners LLC and Huntington Capital made a $15 million investment in Chicago-based Native Foods Café, which has 16 units.

These smaller deals, Epstein said, don’t “involve the quantity of dollars that equity funds like to employ, but they have significant growth. These smaller chains can use the knowledge that these equity funds have in growing a business.”

Equity funds have done extremely well in the restaurant industry, Epstein added, because of the favorable earnings before interest, taxes, depreciation and amortization.

“They know that they have to build units,” he said. “They know unit growth means EBITDA growth. There’s leverage in building new units with the same management team and infrastructure. So every new unit that is built contributes significantly to the EBITDA of the company. That’s what they need, the growth in EBITDA. They also need leverage when they buy. This industry has been a magnet for leverage. Lenders have wanted to lend to this industry.”

Public deals face stiff headwinds

(Continued from page 1)

The Chapman census for 2013 found public market announcements grew significantly, including four initial public offerings and 10 secondary announcements.

But those public-market deals faced stiffer headwinds toward the end of 2013 and into this year, Epstein said.

“We thought the stock market would be really hot coming into 2014 and that we’d see a number of IPOs,” he said, “but the IPO market this year showed good values, and the marketplace was a little fickle when it came to the pricing of those IPOs. That’s not just restaurant chains, but overall. They have been at the lower range that bankers have proposed.”

He said about 75 percent of all IPOs from last year are trading at or below their initial IPO price. “I think that has discouraged a number of the IPOs that were headed toward the marketplace in 2014,” he added.

By region, the South continued to record the most activity, although the North Central region saw substantial growth. “Among franchisee transactions, especially within the group of franchisor divestitures, many of the units sold are located in the South and West,” the census noted.

Reasons for the transactions varied. The 2013 census identified a larger number of minority-equity investments in chains that were interested in growing their number of units compared to the previous year. Many sellers also indicated that the primary reason for selling was that the chain no longer fit the company’s goals or objectives.

Reasons on the buy side included equity funds with other chain holdings and existing restaurant chains acquiring new concepts.

Almost 70 percent of all transactions recorded in 2013 involved quick-service chains. Divestitures in Burger King’s refranchising program accounted for 6 percent of non-public transactions, and a similar program at Wendy’s amounted to 13 percent of the non-public transactions.

The census also identified an increase in activity for Yum Brands! Inc., with Taco Bell and KFC programs accounting for 18 percent of the non-public transactions captured.

J.H. Chapman has conducted the chain restaurant census since 1989. In order to be counted, a meaningful change of ownership must have been announced. The census does not include routine trades of restaurant securities on a formal exchange, but does include initial public offerings, subsequent stock offerings, significant investments and traditional mergers and acquisitions.

The company said restaurant chains qualify for the census if either the acquirer or the target is headquartered in the United States and has at least four separate foodservice establishments of the same or different concept.

Contact Ron Ruggless at [email protected].
Follow him on Twitter: @RonRuggless