Analysts are expecting a good year for Mergers & Acquisitions within the restaurant industry, fueled by momentum from a strong 2010, optimism from a recovering economy and an improved debt market.
Bob Bielinski, head of the Restaurant Industry Practice within Corporate Finance at CIT Group Inc., which provides financing to small and middle market companies, discussed the M&A outlook this week in a podcast titled "Private Equity and the U.S. Restaurant Industry."
Although 2011 has started off slow, Bielinski said there is "a lot of money sitting on the sidelines" and that the activity will pick up as it did in 2010, when private equity firms dominated front page news with stories such as CKE Restaurant and Burger King going private.
In July, CKE Restaurants Inc., parent company of Carl's Jr. and Hardee's, completed its acquisition by Columbia Lake Acquisitions Holdings Inc., an affiliate of Apollo Management VII LP.
In September, Burger King Holdings Inc. was acquired by global investment firm 3G Capital for $4 billion.
The timing is ripe for a private equity courtship of compatible restaurant concepts, and these firms are either looking for growth potential or mismanagement.
"There are two themes for private equity firms (looking for opportunities). There's operational improvement deals in which private equity investors look at a business they think they can manage better," Bielinski said.
Firms with too much debt, for example, need restructuring, which is easier to do for a private company outside of the spotlight of quarterly reporting and investor pressure.
The other theme, and what will draw the most interest from the private equity community, is the strength of a brand.
"Chains like Papa Murphy's and Wingstop were well received by the market, and sellers were pleased with the prices. Strong businesses are going to attract a lot of attention from these firms," he said. "They get excited about potential growth brands."
Lessons from a recession
There are still some after-effects of the recession causing trigger shyness, however. The economic downturn taught private equity investors in particular to be careful with leverage, Bielinski said. In the midst of it all, restaurants were being offered more debt than they probably should have taken.
"When you run a business that is fundamentally a fixed-cost business and sales drop, then profits are going to drop faster. So a business that is highly leveraged can become over-leveraged awfully fast and that's trouble because then you start making decisions that aren't good for the business – like cutting expenses – that the consumer can actually see," Bielinski said.
Another essential lesson learned during the economic decline was that franchising doesn't necessarily mean automatic growth. Private equity firms tend to be attracted to franchisors because they fund growth, but when there is a credit crunch and lack of capital, such development isn't happening.
Many of these roadblocks have since been cleared and, together with a strong debt market, provide a reason to be optimistic about M&A activity for the rest of this year.
"I expect 2011 to be a good year for M&A. Strong businesses are going to attract a lot of attention," Bielinski said. "Now, private equity firms are taking advantage of strong debt markets. People are refinancing debt, they're doing recapitalizations where they take a little money off the table, and they're repricing debt – saying to their lenders 'we think we deserve a lower rate,' and they're being successful at it."
The entire "Private Equity and the U.S. Restaurant Industry" podcast, part of CIT's "5 Minute Capital" series, is available online.