Private equity pros: No Bain, no gain?Private equity pros: No Bain, no gain?

Steve

Call it a Romney Effect, of sorts.


The Republican nominee’s career connection to Bain Capital has put the topic of private equity front and center in the 2012 presidential race, with Mitt Romney pointing to his experience as a wealth builder and President Barack Obama questioning his track record and portraying him as a job destroyer in ads.


Of course, private equity has long played a big role in the restaurant industry, infusing companies with capital and divesting them when the time was right. And now is no different. With the public equity market heating up for restaurant financings, private equity firms are lining up to take advantage.


Ignite Restaurant Group first stirred interest with a very successful initial public offering in mid-May. The initial offering price was $14 a share, and the stock was trading for approximately $17 a share in early June. Unlike the headline-grabbing Facebook IPO, Ignite had not traded below its offering price as of press time.


Bloomin’ Brands, owner of Outback Steakhouse, Carrabba’s Italian Grill and several other casual-dining brands, filed for an offering in early April and may attempt to price its offering this summer. Other restaurant companies that have filed for an IPO include Chuy’s, which filed late last summer, Del Frisco’s Restaurant Group, which filed early this year, and CKE Restaurants, which filed in May. Any of these could consider testing the market soon.


In addition, Cheddar’s and several other restaurant companies are rumored to be close to filing to go public. Private equity firms own all of these companies.


So why are all of these companies attempting to tap the public market now? First, the stock market, until recently, has been strong, with good demand for new stock issues. In addition, the private equity owners of these companies are looking for liquidity in order to provide a return to their limited partners. Most have been owned for three to five years, the typical holding period for most private equity-backed companies.


For instance, Bain Capital and Catterton Partners bought Outback in June 2007, and Lone Star Funds bought Del Frisco’s in late 2006. Pressure is building to provide a return on these investments. Ultimately, the overall strength of the market will determine whether these companies will be able to go public and whether additional restaurant companies will tap the public market.


But given the political discussion surrounding private equity, and Bain Capital in particular, let’s look at what such ownership has meant for restaurants.


Bain bought what is now Bloomin’ Brands in mid-2007. An analysis of the Outback parent’s performance before and after it went private could provide a window into Bain’s stewardship. We’ll look specifically at two areas: operating return on total capital and employment, the former because it indicates the health of the business and the latter because of the recent political rhetoric.


The absolute return on total capital is not comparable before and after the going-private transaction for various accounting reasons and strategic financing decisions. Consequently, the direction of return on total capital is more indicative of the health of the company than the absolute return.


Here’s what I found: From 2003 to 2006, Outback’s last full year of operation as a public company, the operating return on total capital declined by more than 50 percent, from 27.0 percent to 12.7 percent.


The primary reason for that decline appears to have been deleveraging of fixed and semi-fixed labor and other restaurant operating costs as a result of weak same-store sales. Outback’s same-store sales were down 0.8 percent and 1.5 percent in 2005 and 2006, respectively.


Outback’s first full year as a private company, 2008, was very difficult. Same-store sales declined about 6 percent, and the operating return on capital fell to 2.4 percent. Management changes were made, the economy stabilized, and operating results started to improve. In 2011 the operating return on capital had increased nearly fourfold, from the 2008 bottom to 9.1 percent, and same-store sales reversed the decline, rising 2.7 percent and 4.9 percent in 2010 and 2011, respectively.


It’s impossible to know whether results would have been better or worse had the company remained public. What is clear is that the company today is on relatively solid footing after a very difficult period late in its public and early in its private history.


I have no opinion on how important the change in management was to the company’s improving fortunes, although it is probably not a coincidence that operating results began to improve shortly after the change. What is probable is that there would not have been new management if the company had remained public. My conclusion is that private equity facilitated a positive turn in fortune.


So how much of that improvement came at the expense of employment?


The company’s total employment declined from 116,000 at the end of 2006 to 86,000 at the end of 2011. The number of company-operated restaurants remained essentially flat, suggesting that lower employment could have contributed to improved results. Total labor costs actually rose marginally from 2006 to 2011, implying significantly greater expense per employee. A logical conclusion is the decline in employment likely resulted from hiring more full-time employees, who make more money than part-time employees.


Private equity has been an important source of capital for the restaurant industry. While there have certainly been failures, there have also been many successful investments.


Given the surge of recent IPO filings and the possibility of more to come, investors and the general public will get an even better view of the impact private equity companies have had on both the restaurant industry and the companies in which they have invested.


Steve Rockwell has 30 years of experience in the restaurant industry, including as a restaurant analyst, finance executive, investor and consultant. He is a partner in Results Thru Strategy, a consulting firm based in Charlotte, N.C., and can be reached at [email protected].