Restaurant industry merger-and-acquisition activity continued to level off in 2012, but was still dominated by private equity interest in the space and franchise deals, according to a census by J.H. Chapman Group LLC.
The Chicago-based investment banking firm’s annual “Chain Restaurant Merger & Acquisition Census” captured 96 deal announcements in 2012, slightly fewer than the 100 reported in 2011. The 2012 tally was an increase of 8 percent over the 89 deals recorded in 2010.
Chapman principal David L. Epstein, who compiles and analyzes the census, said that M&A activity was led this year by equity funds and franchise transactions.
“In 2012 there were eight announced chain initial public offering announcements and six public chains going private. At the same time, chain franchisees announced acquisitions of franchised units in 36 percent of all non-public transactions," he said. "Equity fund purchases again contributed significantly to this year's activity.”
Valuations were higher in 2012 than they were in the past couple of years "…mainly because of some large strategic acquisitions that were made with high multiples,” Epstein said, citing Darden Restaurants Inc.’s $585 million purchase of Yard House USA Inc .
“That was a fairly heavily priced transaction," he noted. "It was really positive for the equity fund that sold it, and I think Darden has great growth plans for it.” Darden paid about 12 times earnings before interest, taxes, depreciation and amortization, or EBITDA, for the 39-unit, Irvine, Calif.-based Yard House chain, Epstein said.
Another high-value purchase was Caribou Coffee’s $340 million going-private deal  with Ludwigshafen, Germany-based holding company Joh. A. Benckiser Group, which was 11 times EBITDA. Minneapolis-based Caribou operates 408 coffeehouses and franchises another 202 locations.
Equity funds, strategic buyers, franchise action still dominate
In 2012, equity funds continued to buy restaurant chain brands, accounting for 27 percent of all announced transactions, the census found. Since 2007, equity funds have contributed 31 percent of all non-public chain restaurant transactions.
Equity funds investing in new concepts in 2012 included: Bruckman, Rosser Sherill’s investment in 17-unit Not Your Average Joe’s; Fidelity National fund’s acquisition in upscale casual J. Alexander’s; Thomas H. Lee Partners acquisition of Fogo de Chao; and Sentinel Capital’s acquisition of 393-unit Huddle House.
Franchise transactions represented 32 percent of all announced transactions in 2012, a decline from the 46 percent of all transactions tracked in 2011. Acquisitions within the buyer's own brand represented 90 percent of all franchised-unit acquisitions, the census found.
“It is now more common for franchisee organizations to consider synergistic acquisitions as a key component to their growth strategy,” Epstein noted.
Operators looking for new growth opportunities contributed 24 percent of this year’s activity, the 2012 census found. "Operating multiple restaurant brands seemed to make good strategic sense in 2011, although buyers didn't venture far from their core operating style," Epstein said.
Brands in this category, he added, included Luby’s Inc.’s acquisition of 23-unit Cheeseburger In Paradise and Ruby Tuesday’s acquisition of Lime Fresh Mexican Grill.
On the flip side, the number of sales of troubled restaurant chains declined in 2012, which helped keep valuations higher, Epstein said. “It was not as big a year for those types of transactions,” he explained. “Unless the lender has really lost faith in management or the concept, a lot of them have worked out payment programs and have reduced interest rates in order to make it more palatable for the borrower. Also, we’re not seeing the type of leverage we saw back in the ‘90s, thus there is more stability in these restaurant chains.”
Since 2007, acquisitions of chains in financial trouble, including bankruptcy sales, averaged 16 transactions per year. The census found that 12 troubled company transactions were captured in 2012.
Finally, plans for initial public offering announced in 2012 included Dave & Busters, Bloomin' Brands, Chuy’s Tex-Mex, CKE Restaurants and Del Frisco Restaurant Group. Going-private transactions included Teavana by Starbucks; J. Alexander’s by Fidelity National; Benihana by Angelo, Gordon & Co.; and P.F. Chang’s China Bistro by Centerbridge Partners.
An uncertain road ahead
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So far into 2013, Epstein said restaurant M&A activity has been muted. “We’re seeing a lot of conversation,” he said, “but we’re not seeing a lot of transactions. But it’s still early in the year.”
The year has started with a number of uncertainties, including many chains reporting negative same-store sales in January and February.
“I’m a little more pessimistic about 2013, just because of some of the things that are happening,” Epstein said. “First of all, the first quarter might have been one of the worst quarters for full-service dining in a long time. Because of that, sellers will think twice about whether this is the right time to sell their business, and buyers are going to value those businesses fairly conservatively.”
Epstein added that the uncertainty over federal policies clouds the outlook for M&A activity into 2013.
“I’m concerned about what’s going to happen to restaurant chains with the Affordable Healthcare Act,” he said. “Buyers are now asking the questions of sellers: ‘What provisions have you made to accommodate and comply with the act?’ While I think it was a topic of discussion last year, I don’t think it was as insisted upon.
“Restaurant chains that are considering selling need to have developed a plan on how they will deal with this issue,” Epstein continued. “It affects the experience for the consumer, it affects the turnover of employees and it affects costs. All those things play into uncertainty and a possible lower value. It’s going to affect M&A.”
On a positive note, Epstein said low interest rates, the ready availability of equity and debt and the stock market’s relative health will contribute to M&A activity this year.
J.H. Chapman Group has produced the “Chain Restaurant Merger and Acquisition Census” since 1989.
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