2011 Restaurants, Private Equity and Franchising Overview

November 4th, 2011

Pacific Management Consulting has updated its 2010 private equity and restaurants report to identify what is going on in the U.S. restaurant space by private equity (PE) firm. The result? A lot of activity, investments, and some high profile failures. There have just been a modest number of apparent successes to date.


PE’s often target distressed investments, and this shows up in the results. Failure is not unexpected. Every PE firm is different and has a different strategy.

The PE effect on different stakeholders is important to consider. The stakeholders have some common interests and some contradictory: (1) the PE sponsor investor (2) the company operator itself (3) franchisees (4) other stakeholders (employees, creditors, consumers).  

Franchisor franchisee reporting is very poor and makes the effect on franchisees difficult to read. Data in general for this topic is very limited.

There have been some apparent ”successes” but with the surge of 2011 PE Chapter 11 filings (AKA failure for investors, employees and creditors) “failure” right now outnumber the successes. Most of the class of 2005 acquisitions have failed. 

All the recent 2010-2011 acquisitions and many of the 2005-2009 acquisitions are unreadable, or still in the works. 

PE and Restaurants: the model and background

The “PE model” was that best practices and synergistic management practices could be introduced, and that companies could build/grow without supercharged Wall Street/investment community pressure. That premise is still to be determined.

The restaurant space had two big waves of PE acquisitions in 2005-2006 and 2010-2011. Since 2005, we’ve seen almost $21 billion in transactions, and we count seventy plus major chain restaurant brands PE owned. This count exceeds the 53 publicly held/traded USchain restaurants as of October, 2011.

Proxies for Bankruptcy and Distress:

 Of the 56 PE transactions since January 1, 2005, nine concepts have filed Chapter 11 and two have announced technical default, one has had a sure investor’s loss. By transaction timing, many of the 2005 transactions have failed.

 Chapter 11s: Charlie Brown’s, Unos, Barnhill Buffet, Perkins/Marie Calendars’, Claim Jumper, Real Mex, Sbarro’s, Friendly’s and Bugaboo Creek. There was an average EV/EBITDA multiple of 7.4 X at acquisition. Five were in 2005. Two were in 2006. And two were 2007 era transactions.

 Announced Covenant Breech: Quizno’s and El Pollo Loco. The average EV/EBITDA multiple was 10.8X at acquisition.

 Three PE investments sold via management buy out (MBO), that we estimate had to be at a large loss for the PE sponsor: Pacific Equity, Sizzler (9.3X) and Pat N Oscars, and Cheeseburger in Paradise(Outback/Bain parent). Pat N Oscar’s, part of the Sizzler acquisition, was sold by MBO and filed for Chapter 7- liquidation in 2011.

High acquisition price multiple alone does not explain the Chapter 11s or announced default group. Of this group, only Quiznos was a national scope, most were older, regional chains. The average time cycle to Chapter 11 was about 5 years from acquisition. We’d speculate that lack of menu renewal, lack of effective marketing budget size, lack of capital spending and older site locations were factors.

Defining Success:

Since the earnings of most privately held companies are not made public, one must gather data wherever possible: debt disclosure, press reports, surveys, bankruptcy filings, resale transactions and the like. Generally, though, growth in chain system sales and the number of units can be a proxy for success, as can resale to other PE firms. Chapter 11 and 7 bankruptcy filings and distressed, near default conditions are badges of failure.

For chain restaurants that franchise, little specific data of franchised units are available. This is one of the great financial reporting weaknesses in the restaurant space. Franchises power the capital and unit development of most franchisors, and represent the effective source of the bulk of the brand valuation.

2010-2011 Transactions: Not enough time yet:

There have been 20 major restaurant PE transactions in 2010 and through 2011. Two large 2010 acquisitions, Burger King (BKC) and CKR Restaurants (CKR) are still reporting quarterly but they have shown little trend movement since their acquisitions. Roark Capital acquired Arby’s in 2011. It now owns 11 restaurant brands. Only estimated sales data and unit count data is available, so economics is not discernible yet. Many transactions have just occurred and no trend is possible.  

Proxies for Success:

National and international brands seem to have done better. Dominos (DPZ) went public in 2004, levered up and levered down, and transitioned through the pizza recession of 2008-2010. DPZ is growing internationally but their US franchisees are struggling or in no growth mode. Dunkin Brands (DNKN) had a successful 2011 IPO and is about to begin issuing a quarterly guidance. The U.S. Dunkin Donuts franchisee store counts are up.

Bojangles, Logan’s, Papa Murphy’s and Church’s have been resold to other PE firms, with positive press reports of system sales and EBITDA growth.  Dave and Buster’s, Logan’s and Chuy’s are in pre-IPO mode.

While still listed as to-be-determined (TBD), Yard House, Noodles, Moe’s and Corner Bakery are apparently building AUV and unit counts, which are good signs.

 The To be Determined Group:

There are some very large chains in the TBD group. Outback Steakhouse Group is the largest brand that struggled through the recession. It lost AUV and a modest number of U.S. units.

Burger King (BKC) had a successful 2006 IPO but then ran into global headwinds, especially in the US. This resulted in its forced 2010 sale to 3G Capital. Burger King U.S. franchises have suffered sales/profit declines and are best described as in a rebuilding mode. And franchisor Arby’s has just been acquired by its franchisees. The brand bears watching, as do the three Golden Gate Capital brands; namely, Macaroni Grill, On the Border and California Pizza Kitchen.

 2005-2011 Transaction Summary:
<ul>
<li>
Chapter 11 filing: 9</li>
<li>
Distressed/covenant breech/ investor loss: 2</li>
<li>
To be determined: 36</li>
<li>
Pre-IPO status: 3</li>
<li>
Resale to other PEs: 2</li>
<li>
Positive trend: 3</li>
<li>
Completed IPO: 1</li>
<li>
Grand total: 56</li>
</ul>
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Write us and we'll send you the entire display: <a href="mailto:jgordon@pacificmaangementconsultinggroup.com">jgordon@pacificmaa…;

John A. Gordon, <a href="http://www.pacificmanagermentconsultinggroup.com" target="_blank">Pacific Management Consulting Group</a>, chain restaurant analysis and advisory

John Gordon

John A. Gordon is Principal and founder of Pacific Management Consulting Group, which provides chain restaurant sales, profitability, earnings and economics research and special analytical projects to those in, or who need to know about the restaurant sector. Among others, we support franchisees and those supporting franchisees.

Gordon has a long background in chain restaurant operations and financial management roles, such as cost analyst, financial analyst, manager of planning and analysis and CFO, and has been consulting since 2000.

He is passionate in providing independent, creative, detailed and useful perspective, with no conflicts of interest. Email him or call (619) 379-5561.

Comments

Edward Ryan

November 6, 2011 - 21:13pm

Kosman On Bain's DNKN, DPZ, & BKC

Josh Kosman recently published a piece in the NY Post on DNKN's recent secondary offering announcement. He briefly discusses the investment performance of Dunkin' Donuts (DNKN), Dominos (DPZ), and Burger King (formerly traded as BKC). All three franchises were acquired by Bain Capital.

Dunkin' Donuts (DNKN)

That the shares didn’t crater more is perhaps a tribute to its strong third quarter, which saw same-store sales gain 6 percent and profits soar 32 percent compared to the year-earlier period.

D.A. Davidson analyst Bart Glenn said the sales gain was partly attributable to rising coffee prices and the growth of the K-Cup business.

However, a presentation given in August at a Dunkin’ Donuts Independent Franchise Owners’ conference suggests those robust results may soon fade.

Dominos (DPZ)

Domino’s same-store sales started falling in 2006, 17 months after the initial public offering, and were down in 11 of the next 12 quarters. Same-store sales in those 11 quarters were worse than the pizza restaurant industry average. Shares fell to $3.86 in late 2008.

Burger KIng

At Burger King, the bottom fell out less than three years after the IPO. For nine straight quarters, starting in 2009, there were negative same-store sales, and revenue trailed the fast-food industry average, according to Technomic data.

November 14, 2011 - 09:38am

Mystery

Josh has unearthed a bit of mystery. How can the stock price remain high, when people know when the same stores sales start to drop, they are going to drop for a long time? Love to see a graph of the same sales change data plotted against change in stock price.

November 14, 2011 - 11:24am

Not A Mystery At All

Dunkin' sales were up and it is opportunistic for the PE owners to bail out because they like to get out when valuations are high.

K-Cups and the Keurig brewers are high ticket items being sold only in franchised shops. Push enough marketing dollars behind a couple of promotions and most systems will see an increase in sales. Not to mention most coffee shops are benefiting on year-over-year comps due to menu price increases driven by higher coffee bean prices.

When the PE owners bail out, it signals the recent healthy comps are not sustainable and it's time to get out. Can't do much stock and sales comp plotting with DNKN since they have less than 4 months history as a publicly traded company. I believe Kosman identified those trends in DPZ and BKC.

November 14, 2011 - 13:17pm

Wrong Answer

Jone Mcl writes: "Dunkin' sales were up and it is opportunistic for the PE owners to bail out because they like to get out when valuations are high."

Uh, then the stock would tank when the PE owners got back their capital and now a free option. That is the mystery.

November 14, 2011 - 18:55pm

Michael: Where Have You Been?

DNKN tanked nearly 7% when they made the secondary offering announcement on Nov. 1st. The new shares coming to market does not dilute the total number of shares outstanding. It'll increase the float available to trade. Today, Dunkin' announced it's IPO lock-up waiver:

"Dunkin' Brands Group, Inc., the parent company of Dunkin' Donuts and Baskin-Robbins, announced today that J.P. Morgan Securities LLC, Barclays Capital Inc. and Morgan Stanley & Co. LLC, the lead book-running managers in the Company's recent initial public offering of 22,587,500 shares of its common stock, are waiving a lock-up restriction with respect to up to 732,758 shares of the Company's common stock held by certain officers and directors of the Company."

Not only are the PE owners bailing out, so are the corporate officers and directors. Seems like they're getting out while the getting is good.

November 14, 2011 - 19:38pm

Earnings Premium

Guest notes: "DNKN tanked nearly 7% when they made the secondary offering announcement on Nov. 1st. "

Yes, but it is still trading at unstainable premium -15x ebitda if I recall.

November 14, 2011 - 20:53pm

Re: Earnings Premium

Let the new shares come to market. In 6 months from now, the stock will be trading in the range between $15-$17. This is exactly what happened to BKC.