There have been several recent examples of non-restaurant companies acquiring restaurant operators. The rationale behind at least a couple of these acquisitions is that these restaurants may generate targeted foot traffic to the acquirers’ core business.
The most recent example involved Urban Outfitters, a multi-billion dollar revenue lifestyle specialty retail company. It caused quite a stir across Wall Street when it announced the acquisition of most of a small Philadelphia restaurant company, Vetri Family restaurants, including three Pizzeria Vetri locations. That news, coupled with reportedly disappointing quarterly operating results, sent Urban Outfitter’s stock down approximately 20 percent the next day, although subsequently it has largely recovered. Luminaries such as Jim Cramer questioned the sanity of Urban Outfitters in making the deal.
I’m not weighing in solely on the merits of this transaction. Its success will ultimately be determined by the long-term execution of Vetri’s growth strategy and the restaurants’ impact on traffic and sales at Urban Outfitters retail stores. But I do think companies in the restaurant space could learn a lot from this example and the ones mentioned below. Other recent examples of non-restaurant companies investing in restaurants include Whole Foods’ investment in Mendocino Farms and Hain Celestial’s investment in Chop’t. A common attribute of these three companies — Vetri, Mendocino Farms and Chop’t — is that they are small, emerging brands (Chop’t is the largest with 32 locations), and have significant growth opportunities ahead of them.
Some may question why a small chain with substantial growth potential would accept an investment from and potentially lose control to a large, non-restaurant company. While I haven’t spoken with any of these companies directly to understand the true motivation, the logical reason is access to valuable capital, and, for Vetri Restaurants and Mendocino Farms, access to key locations. An additional benefit of a non-restaurant investment is that the restaurant brand is more likely to retain operating autonomy and be able to independently develop its corporate culture, always an important factor in the success of a restaurant brand. In my opinion, this may be the most important benefit of all.
These acquisitions or investments should serve as a blueprint for larger, mature, free-cash-flow generating restaurant companies that are struggling to grow their core concepts. Over five years ago, I wrote that these kinds of restaurant companies should follow the example of P.F. Chang’s financing of True Food Kitchen. I argued that they should use some of their free-cash flow to effectively serve as a venture capital/early-stage private-equity firm and make minority investments that fund the growth of promising, small restaurant companies. Since then, among the larger, more mature companies, I am only aware of Buffalo Wild Wings pursuing that type of strategy with its investments in PizzaRev and Rusty Taco.
Taking advantage of entrepreneurial spirit
The reluctance of restaurant companies to make acquisitions is understandable given the historically unsuccessful track record of many that have pursued the strategy. While managements should of course be wary of falling victim to the mistakes of others before them, dismissing an acquisition strategy because of previous failures doesn’t make sense. Forward-thinking executives should learn from those failures and devise a strategy that avoids repeating the same mistakes. When acquired companies’ cultures are homogenized with that of the acquiring company, key points of differentiation are often destroyed with negative consequences for employees and customers alike. Therefore, in successful acquisition strategies, investments should be structured in a way that enables the founder/entrepreneur to retain operating control of the business.
If restaurant companies do not adapt their investment strategy, their growth potential could be truncated by resourceful companies from outside the industry. Not only will young brands not be available for investment, but their expansion is likely to accelerate. By providing capital but not assuming full control, investing companies enable emerging brand management to also focus on creating great restaurants and corporate cultures rather than splitting time between operations and fundraising. Because restaurant companies have the added value of offering relevant services to an acquired company, including back-office systems, and imparting wisdom related to growth, real estate, marketing, purchasing, human resources and other administrative functions, they should have a competitive advantage over non-industry investors.
Many mature restaurant companies also generate substantial cash flow and are not able to reinvest all of it back into the business. Several use that free-cash flow to pay dividends and buy back stock to provide a return to shareholders. While that is a good strategy, why not supplement it with strategic investments in promising emerging brands? A successful $5 million to $10 million growth capital investment could create a multiple of that in value for shareholders. Actively building a portfolio of investments, such as Buffalo Wild Wings is orchestrating today, reduces the financial risk of failure while increasing the chances of a very meaningful success.
Entrepreneurial activity in the industry is as high as I have ever seen it. Today, companies with excess free-cash flow have an opportunity to selectively provide growth capital and take advantage of that spirit. If they don’t, someone else will, and an opportunity to create incremental shareholder value will be lost.
This information should not be regarded as a solicitation or recommendation of any particular security or to engage in a particular trading strategy. This was prepared for informational purposes only and is not believed to be sufficient on which to base an investment decision.
