So let’s start with the acquisition and investment elephant in the room. Why haven’t there been more of either thus far in 2022?
I think there are several contributing factors. Valuation expectations remain high, driven by some of the transactions over the last 18 months—deals at these levels need companies to deliver robust growth. However, there is a lot of uncertainty surrounding ability to deliver on growth projections given supply chain challenges, competition for real estate (especially drive-thru), and inflation across the board. Additionally, a lot of third-party providers needed to complete a transaction (accountants, consultants, financing sources) were so busy at the end of the 2021 that many of the potential transactions ended up delayed into 2022.
One prediction I heard heading into the year was despite strong sales, many (if not most) restaurant companies actually saw margins erode because of higher food, fuel, labor, etc., costs. Couple that with difficulty hiring people, and you potentially have a conservative industry not looking to take on new assets. Essentially, cash flow—and the price acquirers are willing to pay for liquidity—were the primary drivers attracting buyers. So given the margin issues, it’s leading to a pullback. Have you seen that?
I think there is overall optimism that margins will improve toward the end of 2022 as many of the supply chain issues are resolved. We have seen a retreat to quality recently as investors chase concepts with better unit economics and wiggle room to deal with any margin compression. If a concept was marginal in terms of economics before, it’s certainly not in better shape now. However, stronger brands tend to attract better capitalized franchisees or investors, and for many of them, they see this as time to continue their growth, and potentially to access some great real estate opportunities. For example, two of our portfolio brands, Slim Chickens, and Walk-On’s Sports Bistreaux, both expect to open a record number of locations this year.
Do you expect things to change? There appear to be plenty of firms and brands, and banks, with flushed balanced sheets coming out of the crisis. Are they simply biding their time?
I think so. Firms, brands, and banks are all looking to deploy cash. Additionally, there is more committed capital in the restaurant market than ever before—there are more PE firms and non-bank lenders who will remain investors in restaurants despite the point in the economic cycle. We’ll continue to see those firms put capital to work this year.
How do you see this unfolding? Is more consolidation on the table for companies looking to diversity, like RBI buying Firehouse?
There are still some great brands and as you point out, there’s money out there to fund acquisitions. I expect that some of the big umbrella brands like RBI and Inspire Brands will continue to add to their brand portfolio. They’ve made investments in building out common platforms, so it only makes sense to continue adding to their portfolios to leverage these investments. This bundling of concepts and then subsequent unbundling of concepts seems to have been a trend in restaurants over the last 40 years (and longer)—we are at a point where the capital is available to support bundling.
Have digital capabilities, like ghost kitchens and virtual brands, made acquiring different concepts more attractive to larger groups?
The restaurant industry is incredibly competitive. While I’m sure there will be some success stories amongst the ghost kitchens and virtual brands, I think they will be the exceptions. For a larger group looking to acquire, they’re looking for brands that can scale quickly, delivering a consistent, differentiated brand experience. With ghost kitchen and virtual brands, you lose some of the ability to control all aspects of the experience; similarly, you’re not quite as close to your guests, and their feedback.
What about investments versus acquisitions? What will drive the first over the second, for some brands hoping to grow?
At least in our experience, investment versus acquisition is more specific to the situation of a particular company. At 10 Point Capital, we’re typically the first non-friends-and-family money into a high growth brand. Generally, the founders are looking for some liquidity or capital to grow. However, they also firmly believe in the prospects for their brand and want to be an integral part of the growth, and to financially benefit in the future. In other instances, the business is at an inflexion point where either the founder or the management team capabilities aren’t as well suited to driving the brand to the next level. In these cases, acquisition can be a better route to pursue. We also see acquisitions where the founders are ready to retire or there is already private equity investment and a need for an exit event.
How do you size up the growth potential for the industry, especially quick service, at this point in the recovery? It sure seems like a lot of brands are throwing massive targets out there, or expanding previous plans, such as Chipotle and Wingstop, which each added 1,000 units to their recent guidance. What kind of concepts are poised to expand?
On the whole, the restaurant sector is generally correlated to GDP. However, as we all know, the actual performance of specific brands and segments can be chaotic. There are usually winners and losers in segments that vary wildly despite the segment growth. Quick service, and brands with drive-thrus more generally, are certainly well poised for growth. COVID has shown that people want to keep getting food away from home, and that they love convenience; even as the world has opened up again, convenience has continued to be highly valued. A brand like Slim Chickens, a better-chicken quick-serve concept, has seen tremendous demand over the last two years from guests and investors alike—many of these units are still under development.
In particular, where do you think fast casual fits in?
Fast casual remains an attractive segment. However, both fast casual and casual are looking to quick-service restaurants for what they can learn to drive growth. Curbside, digital ordering capabilities, take-home meals, working with third-party delivery companies will all be important pieces of the toolkit, and where there’s an ability to add a drive-thru, many will look to do so