Even as deep-pocketed private-equity players continue to grab headlines with billion-dollar restaurant acquisitions, operators and blank-check companies are increasing their purchasing activity in smaller deals, resulting in a more vibrant merger-and-acquisition market.
With increased access to capital because of favorable debt financing and the recent stabilization of sky-high purchase prices, operators are finding diverse ways to participate in the M&A space, investment bankers say. And because the amount of capital that private-equity firms have to deploy for investment is still robust, those firms are seeking out larger investment opportunities that in turn leave ripe, low-hanging fruit for strategic purchasers.
Investment bankers use the term “strategic buyer,” or a buyer interested in an acquisition because of how it would fit into its business plan, to differentiate from a “financial buyer,” or one interested in the return garnered through buying another business.
“Many equity sponsors are so focused on larger transactions today that a $15 million to $20 million infusion isn’t an option,” said David Epstein, a principal at investment bank J.H. Chapman Group LLC. “So the strategics are playing at the lower levels, where there is more inventory with fewer buyers.”
A prime example is the battle between Houston-based Landry’s Restaurants Inc. and New York-based Patina Restaurant Group LLC as they vie to acquire New York-based Smith & Wollensky Restaurant Group Inc., parent company of 14 upscale restaurants. The latest offer made by Landry’s totaled $84 million. Darden Restaurants Inc. of Orlando, Fla., also has noted its ongoing search for an approximately 25-unit, regional growth concept.
Although hyperactive private-equity buyers bullish on the restaurant sector have dominated many restaurant deals during the past two years—think of the billion-dollar transactions concerning Dunkin’ Brands Inc. and OSI Restaurant Partners Inc. or the potential buyout of Applebee’s International Inc.—most deals occur under the $150 million mark among franchisors, franchisees and other buyers eager to purchase concepts to facilitate corporate growth.
“All of the large private-equity-sponsored, public-company buy-outs are basically financial engineering,” Epstein said. “But most of the M&A activity is really strategic in nature—deals that make good business sense for diversification, expansion to other markets or the taking out of a weak franchisee, for example.”
According to Rosemont, Ill.-based J.H. Chapman, strategic buyers completed 60 percent of the 99 nonpublic-market transactions in the restaurant industry in 2006. In 2005, that number was just 20 percent of all nonpublic-market transactions.
More specifically, in 2005 there were 29 transactions involving equity funds and 15 involving operators, according to J.H. Chapman’s research. In 2006, that gap narrowed, as there were 27 transactions involving equity funds and an equal 27 transactions driven by operators. This year, if the lending environment remains positive, the industry should see the same level of activity as it did in 2006, Epstein projected.
Ron Berger, chairman and chief executive of Figaro’s Pizza, a 114-unit pizza delivery and take-and-bake restaurant chain, kicked off 2007 with an acquisition. In mid-March, Figaro’s, based in Salem, Ore., acquired the 10-unit Sargo’s Subs, an Italian-theme sandwich chain. While terms of the deal were not disclosed, Berger said the transaction was financed solely through cash from operations.
Berger said he had been looking since 2001 to make acquisitions, both within the pizza segment and among brands that would complement its flagship Figaro’s chain, and only now was able to find the right deal.
“It was the right strategic opportunity,” he said. “We’re in the pizza business, so about 70 percent or 80 percent of our sales are after 4 p.m. In the sandwich business, almost 80 percent of their sales occur before 4 p.m.”
Both brands would be the focus of expansion, Berger said, as his company will offer Sargo’s franchises to both prospective and existing Figaro’s franchisees. In addition, Figaro’s franchisees would be offered the opportunity to sell a selection of Sargo’s sandwiches in their Figaro’s units.
Berger said he was looking for additional acquisitions, mostly among concepts in the 50-unit range.
Also operating in the under-$100 million market is Christopher R. Thomas, president and chief executive of Restaurant Acquisition Partners Inc., a publicly traded blank-check buyout firm.
Thomas said he and his partners—all restaurant industry veterans from various chains like Planet Hollywood, Sizzler, Chart House, Long John Silver’s and Wendy’s—purposely undertook a small equity-gathering public offering in the $20 million range so that future acquisitions also would be small.
“We were getting encouragement to do a $75 million to $100 million IPO, but we are required to make an acquisition of at least 80 percent of the offering,” Thomas said. “If we have to make that large an acquisition, well, because of the heated competition from all the large, flush-with-cash equity firms, we decided that was way too competitive.”
The company is seeking to purchase concepts with earnings prior to interest, taxes, depreciation and amortization of between $4 million and $10 million, which would put the transaction value under $100 million, a space that “isn’t being addressed by private equity,” Thomas said.
Investment bankers Dean Zuccarello and Carty Davis, principals at the Southern Pines, N.C.-based Cypress Group, said there is indeed an “emergence of a subset of strategic buyers” that aren’t traditional strategic operators—but are not private-equity buyers, either—looking to add concepts to an existing operating platform.
“The big strategic restaurant companies are still focused on their core businesses,” Zuccarello said. “But some of the other groups, they feel they have their houses in order and they need a growth vehicle.… You’ll see more of that.”