The restaurant industry has been hit hard by Covid-19. Restaurants for a while were restricted to take-out and deliveries only, prompting several chains to go bankrupt. However, with restrictions gradually being lifted, and consumers getting comfortable eating out again, there are attractive M&A opportunities for investors. Duff & Phelps, a Kroll business, global head of consumer corporate finance Josh Benn spoke to Mergers & Acquisitions about his outlook for the sector.

How did restaurants cope with Covid in 2020?

Operators spent the better part of 2020 shifting to off-premise capabilities, such as efficient drive-thru operations, curbside pickup and third-party delivery. Restaurants worked towards improving online ordering capabilities and building engagement with loyal consumers. Some have developed innovative solutions including leveraging existing kitchen,s as well as third party-operated ghost kitchens to continue generating sales, but it is unclear as to the ultimate sustainability of these initiatives.

How are restaurants changing in 2021?

As we slowly exit the pandemic era, the restaurant industry should emerge more streamlined, with strong concepts gaining market share and continuing to build on optimized store bases, innovative customer loyalty and labor management systems. Changes in consumer behavior following the pandemic will further accelerate the growing importance of technology in restaurant operations and reward those concepts that have been able to successfully implement sales driving and cost management technology solutions. Operators will likely use the first half of 2021 to continue optimizing their existing operations, strategically rationalizing underperforming locations and accelerating their opportunities to capitalize on the currently advantageous real estate environment.

Josh Benn

How are consumers reacting to these changes and challenges?

The pandemic has brought on a shift in consumer attitudes regarding online ordering, health and wellness, and food in general. During the past year, consumers have frequented quick service and fast casual concepts with solid digital ordering and delivery capabilities and attractive value propositions while also allowing themselves certain indulgences and/or comfort food. Now with the light at the end of the tunnel, consumers are increasingly focused on health and wellness and eager to get out to dinner, entertainment and sporting events. Once consumers more broadly are comfortable dining inside and we reach warmer weather in the northern half of the country, I would expect a strong resurgence in demand for on-trend bar forward polished casual and fine dining offerings.

How are investors reacting to these changes and challenges?

Certain concepts lost favor with investors in 2020, particularly in full-service, dependent on dine-in traffic that could not react quickly to the Covid-19 environment and develop their off premise capabilities. Concepts with daypart diversification, established off-premise capabilities and strong brand affinity performed well and will attract financial investor and strategic buyer interest and command healthy valuations. Increasingly the pool of forward looking investors and strategic platforms that have strong balance sheets are wading into the acquisition/financing market for full service dining opportunities that are well positioned for a solid resurgence post pandemic.

What type of investors is the sector attracting?

Private equity and family office investors remain interested in strong performing operators among both franchisors and franchisees across the restaurant sub categories. In addition as noted above, there is an increasing number of financial investors that are re-invigorating their focus on full service operators in order to get ahead of the cycle of strong demand and overdue equilibrium between supply and demand in the market. With strategic players becoming generally more comfortable with the health of their existing portfolios, they are becoming increasingly focused on complementary acquisition activity as well. Lastly, SPACs have continued to proliferate, delivering additional liquidity into the market, including many focused on the consumer and restaurant sectors. These vehicles are generally chasing larger transaction opportunities and therefore are causing operators with less than $50 million of Ebitda to seek combination scenarios that will make them appealing to the SPAC marketplace and allowing them to take advantage of the current private/public market multiple arbitrage opportunity that seems to exist in many sectors.

What is your outlook for M&A?

While uncertainty undoubtedly remains heading into Q2 2021, the acceleration in M&A activity that began in Q4 2020 will continue to remain robust through the balance of 2021 as additional stimulus and liquidity are pumped into the general economy and the capital markets. This heightened liquidity dynamic, coupled with operators’ realization that scale is increasingly important given cost dynamics in many sectors, will likely continue to drive consolidation throughout various industries including the restaurant sector. The M&A outlook for 2022 is less clear as concerns around inflation, rising interest rates and taxes become more likely.