Steve Rockwell has more than 35 years of experience in the restaurant industry, including as a restaurant analyst, finance executive, investor, investment banker and consultant. He can be reached at [email protected] This article does not necessarily reflect the opinions of the editors or management of Nation’s Restaurant News.
As Jonathan Maze presciently wrote in February, 2017 is turning out to be the year of restaurant acquisitions.
Panera Bread Co., one of the most consistent and best-performing restaurant companies for the last 15-plus years, recently agreed to be acquired by JAB Holding Co. for $7.5 billion, or 19.5 times EBITDA, based on Nation’s Restaurant News calculations.
Cheddars ($780 million purchase price), Checkers ($525 million), and Popeyes Louisiana Kitchen ($1.8 billion) are three other large transactions that were announced earlier in the year.
All four companies were seemingly selling from positions of strength, as defined by good sales and margin performance and operating a differentiated brand. There are a number of other companies that have been sold or are up for a potential sale, including Bob Evans (which was sold in January), Ruby Tuesday, Bravo Brio and Ignite, although they are negotiating from positions of weakness. Demand to buy these companies, and therefore their valuations, is significantly less than for the stronger brands. The following comments relate largely to the better-performing companies.
Why are buyers willing to pay historically high multiples for restaurant companies now? The reasons include:
- A dearth of traditional retail investments due to the Amazon effect causing investors to increasingly look to the restaurant industry for consumer exposure;
- A large amount of equity capital available; and
- Low interest rates and a freeing up of credit since the end of the recession.
Also, equity values of potential strategic acquirers are high, resulting in that currency being very inexpensive, although all of the acquisitions mentioned were for cash, not stock.
It’s easy to understand why a seller would be interested in selling at a very high valuation. Consider Panera’s purchase price at 19.5 times EBITDA and more than 30 times next year’s earnings estimates. These multiples are very high for a company, albeit an excellent one, with a mid- to high teens growth rate.
Popeyes, by my calculations, was acquired for a stunningly high 20+ times EBITDA. Admittedly, its franchise model warrants a higher multiple than a company-operated one and the buyer, Restaurant Brands International, intends to eliminate significant overhead, effectively lowering the multiple. But I am hard pressed to remember an acquisition of a larger company at that kind of multiple.
Emerging brands have also raised capital recently, including Cava Grill, MOD Pizza and Velvet Taco. Because they are privately held, valuation information has not been disclosed. Based on the size of the investments relative to the size of the companies, however, the valuations were undoubtedly high relative to cash flow, sales and/or net income (if any).
Are these lofty valuations justified, and will investors be happy with their purchase in four or five years? Ultimately, the success of the larger strategic acquisitions such as Popeyes, Panera and Cheddars depends not only on execution, but on the successful assimilation of the acquired companies’ cultures and the synergies achieved from their combinations with their acquirers.
In my experience, there is a greater potential for the buyers of these larger companies to experience buyers’ remorse than to be pleasantly surprised. These acquisitions were priced to perfection, and any setback is likely to impair their future value and reduce the return on investment for the acquirers.
While investments in smaller companies have different challenges and risks, there is a greater chance for a high return on investment. For example, assume an investor buys a 30-unit fast-casual chain currently generating sales of $2.5 million each, with a 20-percent store-level margin, for $150 million (10x unit-level cash flow and two times sales), clearly a high valuation. Assume that over five years, the company adds 100 locations (20 per year), average sales decline to $2 million, with unit-level margins holding at 20 percent, and incurs S, G & A of 7 percent. Corporate EBITDA would be approximately $34 million. A 10 multiple would result in a value of $340 million and represent a compound return of 18 percent.
One can argue whether an 18-percent return is worth the risk inherent in developing an emerging brand. However, for JAB to get that same return on Panera, it would have to be worth more that $17 billion in five years. (As a private company with a very long-term investment horizon, JAB may not view its acquisitions like more traditional domestic investors.)
Execution needs to be flawless for both the larger and smaller high-priced acquisitions to achieve their expected returns. For the larger companies, valuations must remain at record levels to produce superior returns, whereas the growth of smaller companies could allow for some decline in valuations.
There is clearly a seller’s market for strong-performing restaurant companies right now. Owners should take advantage of it and at least explore a transaction.