Dining Habits Bode Well for Eatery Growth and Deals: The restaurant sector, buoyed by an increase in dining out, has been serving up an abundance of industry buyouts

The restaurant industry, including upscale dining establishments, has been attracting more attention from prospective buyers, particularly private equity firms, in recent months. Strategic buyers looking to expand their portfolios may be priced out of deals because equity investors tend to be willing to pay more. Restaurant M&A pro Robert Hill, a Principal at J.H. Chapman Group, a food-focused investment bank, says that high-end restaurant deals – a tiny percentage of all restaurant buys – tend to be one-offs. They are based more on the bidder’s emotional attachment to the property than on the hard-core financial analysis that drives deals elsewhere in the sector. It’s hard to categorize luxury restaurant deals because they tend to be unique transactions for a single restaurant or small group of eateries. In two recent upscale restaurant deals, steakhouse chain operator Smith & Wollensky Restaurant Group agreed to be acquired by Patina Restaurant Group about $80 million. And in a deal that was rumored for months, PE firm Starwood Capital Group acquired 16 high-end restaurants, including New York City’s Blue Water Grill, Atlantic Grill, Dos Caminos, and Ruby Foo’s, from Manhattan restaurant mogul Stephen Hanson for about $150 million. According to restaurant-deal specialist, Lynne Jacoby, the Food & Beverage Practice Leader at PricewaterhouseCoopers, the upscale dining niche is the first impacted by an economic downswing. Hill agrees that the upper echelon of restaurants will be the most sensitive to cutbacks in corporate spending on travel and entertainment. But Jacoby adds that the United States recently has crossed an economic and lifestyle threshold that bodes well for the restaurant industry as a whole. The turning point, he points out, has been the change in Americans’ dining habits to eating more meals outside of the home. One interpretation Hill puts on this metric is that the growth of all kinds of restaurants, and by extension, restaurant deals, will only increase, both in the rarefied world of luxury dining and the sectors below it. One of those sectors, fast casual, is the fastest growing segment in the North American restaurant business. Recent deals such as the $3.2 billion going-private buyout of OSI Restaurant Partners, the operator of the Outback Steakhouse, Carrabba’s Italian Grill, and Bonefish Grill, by an investor group composed of Bain Capital Partners, Catterton Partners, and company founders reflect the attractiveness of the dining sector. Other significant transactions include the $255 million buyout of Dave & Buster’s by an investment group led by Investcorp and company founders and Sun Capital Partners’ acquisition of Fazoli’s Restaurants, one of the largest quick-service Italian restaurant chains in the U.S. The nation’s largest mid-priced sit-down restaurant chain, Applebee’s, said earlier this year that it would explore strategic alternatives at the urging of Richard Breeden, Chairman and CEO of Breeden Capital Management and Managing Partner and CIO of Breeden Partners, which collectively own 5.2% of Applebee’s. Franchise operations are attracting private equity bidders because by cutting overhead they can increase profitability. Lenders warm up to the sector Jacoby says that banks and other lenders have become more comfortable with the restaurant industry and, as a result, PE firms can offer more attractive purchase packages than strategic buyers. In fact, the high prices being paid by PE funds have deterred strategic buyers from winning auctions. The restaurant industry as a whole is attractive to PE buyers because restaurants generate a lot of cash, don’t need to keep large inventories on hand, and are usually able to resist undercutting by competitors. Also, restaurant targets tend to have high enterprise valuation multiples, and a number of chains are choosing to focus on core brands – creating a number of assets sales According to Hill, another factor that has lured PE firms to the space is the opportunity buyers have to create separate income streams from food operations and restaurant real estate. Real estate considerations, he adds, are much more important in structuring a restaurant deal than they were five or six years ago. Financial buyers have created a parallel market by using sale and leaseback structures that make restaurant deals appealing. Use of this technique has introduced different pricing and value considerations into these deals. “Private equity firm view restaurant real estate as a more reliable source of cash flow and capital appreciation,” Hill says. In effect, Hill adds, a dollar’s worth of rent versus a dollar’s worth of operating profit on the food sales can turn out to be worth twice as much to the owner. “We’ve found that all things being equal, if we’re representing owners of chains that want to sell, we can create maximum value for buyers by bifurcating the revenue streams,” Hill says. And if the restaurant fails, the site can be used for other commercial purposes. Hill notes that strategic buyers might like to own the real estate but are not willing to structure a restaurant deal as a sale and leaseback. “They don’t look at the real estate as a separate asset class,” he notes. Hill describes a recent deal in which a small, regional chain with nine locations and a pan-Asian theme was being sold by auction. The process attracted six qualified buyers, five of which were private equity firms. The one strategic buyer dropped out. He says that three years ago, the strategic buyer would have been more aggressive. Distressed eateries suited for strategics One niche where strategic buyers may be able to take on financial competitors is troubled restaurants. “Financial buyers have shied away from deals that called for them to fix a sagging concept,” Hill states. “They will invest to grow a business but are not inclined to fix broken formulas.” Another trend, Hill points out, is that private equity funds are becoming more selective. They are participating in fewer auctions, and need to have an “angle” on the deal that gives them a reason to expect an impressive return. But even if some buyers are becoming more careful, Hill notes that the underlying social and economic forces that are buoying the industry won’t be short-lived. “The reason why values have risen is that people prefer to eat out, and that isn’t likely to change.” On a final note, Hill says that if debt availability changes, it may strengthen the hand of strategic bidders, but restaurants will still continue to be attractive targets for both types of buyers. (c) 2007 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com