In the foodservice industry, it’s hard to talk about competition without thinking about the chain—not the supply chain, but rather the food chain. Limited capital, real estate, and market share suggest that, like the rule of the jungle, the proven concepts will succeed, often at the expense of their competitors.
In the last year or so, the restaurant world has experienced more than its fair share of mergers and acquisitions (M&A). JAB Holdings pulled Panera Bread off the ticker tape when it closed an estimated $7.5 billion deal to buy the public company in July. Burger King’s parent company Restaurant Brands International (RBI) purchased Popeyes Louisiana Kitchen this February, a little over two years after it acquired Tim Hortons. Roark, already a well-respected private equity firm in the restaurant space, added Jimmy John’s to its portfolio last September.
Those make up just a sampling of the recent activity in quick-service acquisitions and don’t encompass the mergers occurring among competitors. Within the crowded fast-casual pizza category, Pieology purchased Project Pie, while Firenza Pizza merged with Persona Wood Fired Pizzeria. In the similarly packed field of frozen yogurt, SweetFrog publicly stated its intention to grow by acquiring other fro-yo brands.
But as cutthroat as any industry can be, the string of restaurant M&As seems less dog-eat-dog and more akin to a school of fish: strength in numbers. Whether it’s an infusion of capital and resources or the addition of an existing pipeline, these brands are getting a leg up—and other investors are taking note.
The M&A craze
Like the economy, M&A activity fluctuates over time. As Motley Fool analyst Jason Moser points out, the market has entered a phase wherein Wall Street is on the purchasing prowl. But, in contrast with past equity booms, investors seem less likely to buy for a quick cash-out.
“There was a lot of that behavior back in the ’80s and early ’90s, where leveraged buyouts were the rage and there was a lot of buying brands and assets in order to unlock value and spin it back off,” Moser says. The information revolution has since facilitated the research process, making it easier for investors to get the stats on potential purchases and commit to longer time frames. “Investors are generally a bit smarter today than they were 20 or 30 years ago, simply because the flow of information is so much more rapid. … It’s certainly more of a level playing field.”
Combine an increased appetite for acquisitions with a more robust knowledge base and it leaves the market with a surplus of funds just waiting to be funneled into an enterprise.
“If you look at capital to be invested across America now … the restaurant industry has been a favorite. Part of that fundamental relates to American consumers: Through bad and good times, they enjoy going to restaurants,” says Hudson Riehle, senior vice president of research and knowledge at the National Restaurant Association (nra). He adds that pent-up demand for foodservice has remained elevated since the Great Recession, with two out of five adults not using restaurants as much as they would like to.
Compared with other industries like commercial real estate, healthcare, and retail, foodservice is, more or less, a safe bet. Consumer spending might fluctuate with the economy, but it has yet to experience a bottom-out like the housing or financial sectors.
Within the restaurant sector, limited service is especially appealing. According to the NRA’s 2017 Restaurant Industry Outlook, limited-service sales (including traditional quick service and fast casual) were projected to increase 5.3 percent, compared with full service’s estimated 3.5 percent growth.
“Fast casual is taking market share from casual dining. Fast casual has a smaller footprint from a real estate standpoint, and there could be situations where the returns are more compelling,” says Michael Morales, chief financial officer of Reach Restaurant Group. In May, private equity firm Balmoral Funds, in conjunction with investment company Gala Capital Partners, purchased Dallas-based MOOYAH Burgers, Fries & Shakes from Reach Restaurant Group.
For investors doing their homework, restaurants—particularly those already running like a well-oiled machine—are an ace in the hole.
While some firms specialize in restaurants, many have diverse portfolios. JAB Holdings, for instance, counts luxury and retail brands like Jimmy Choo, Marc Jacobs, and CoverGirl among its investments. Nevertheless, Panera wasn’t its first foodservice purchase; the firm also owns two coffee wholesalers, as well as Krispy Kreme and Caribou Coffee.
Meanwhile, holdings giant Berkshire Hathaway specializes in real estate but also owns Nebraska Furniture Mart (based in Warren Buffett’s hometown of Omaha) and Dairy Queen. Even firms like Roark and Sun Capital, which are well known for their restaurant properties, have interests in other industries, too.
“It does look odd perhaps on the surface,” Moser says. “The best way to invest is to make sure you’re diversified in your exposure. You may have businesses that feel this adds a certain diversity to their operations.”
Hands on, hands off
Experts are split as to how involved private-equity firms should be. Investors also differ greatly in their timelines. Many, like Roark, bring a business into the fold with a long-term vision, while others, like KKR, a multinational firm specializing in leveraged buyouts, acquire en masse and spin those companies off relatively quickly.
Gala Corporation (which, along with Balmoral, bought MOOYAH) plays the long game—a decade being the shortest projected time frame to hold one of its purchases. That’s not to say that the company would walk away from a lucrative opportunity, but that’s hardly the norm, says president and CEO Anand Gala.
“Our intention here is really to grow a sustainable business over time,” he says. That commitment extends to Gala Corporation’s involvement in the business. “We can take away the things that they may spend material time, effort, and energy behind, but otherwise may not necessarily align with or directly contribute to the success of the franchisees and of the brand and business overall.”
Whether it’s supply-chain negotiations or administrative duties, Gala Corporation sees itself as a support system that can step in with its resources and expertise, allowing MOOYAH’s management to refocus on its operations and franchisees. Gala says some businesses may consider such responsibilities to be low-value or mundane, but he knows removing the red tape creates space for the restaurants to excel.
Similarly, successful chains that buy companies within the same category—whether they’re formidable competitors or small independents—will often super-impose their own operations onto the acquired brands. In fact, this May, self-serve frozen-yogurt brand SweetFrog announced its intention to purchase and rebrand other concepts.
“We’re trying to get other, smaller frozen-yogurt brands or mom-and-pops to join the SweetFrog system,” says CEO Patrick Galleher. He adds that leveraging the brand’s name, supply chain, and product would help acquired concepts boost their business and cut costs. “I equate it to the banking space. When two banks merge, the branch office takes down one sign, puts up another sign, and then they put the systems in place from the acquiring bank. They don’t have to rebuild a new branch from scratch; they don’t have to hire new people.”
Galleher adds that SweetFrog is second only to Menchie’s in terms of size and scale within the frozen-yogurt category. The brand is in 29 states but aiming for 40 within the next year. Galleher is optimistic that through new build-outs and acquisitions, the company can reach that goal.
Both SweetFrog’s rebranding plans and Gala Corporation’s operational support illustrate a more active role for the purchaser. Moser points out that many private-equity firms are very hands-off. JAB Holdings, for instance, will funnel capital into Panera, but since the brand has already demonstrated self-sufficient success, Moser says, JAB is unlikely to overhaul it.
From an outsider’s perspective, JAB Holdings, Roark, and others like Arlon Group, CenterOak Partners, and Oak Hill have made no indication that they plan to clean house at their recent acquisitions. (All declined interview requests.)
The one example that hints at major changes behind the scenes is RBI’s $1.8 billion purchase of Popeyes this spring. The deal prompted CEO Cheryl Bachelder, chief brand officer Dick Lynch, and CMO Hector Muñoz to leave. Bachelder and her team are largely credited for rebranding and turning around the ailing Popeyes Chicken & Biscuits.
Their departures raise the question: Why would RBI parent company 3G Capital mess with a good thing? Burger King was more of a fixer-upper when 3G purchased it in 2010. Perhaps the firm spied similar potential in Popeyes as it did in its second purchase, Tim Hortons. While successful, the Canadian concept still had a long runway for expansion in the U.S. With more than 2,000 stores, Popeyes has a strong presence stateside but not so much abroad.
“Popeyes is a brand with huge potential for U.S. and international expansion,” writes RBI chief executive Daniel Schwartz in an email. “The brand has already performed extremely well in the U.S. and we see great potential for continued success.”
The exit of Bachelder and other company leaders might appear a harbinger of misfortune ahead, but the early financials are promising: Same-store sales for 2017’s second quarter were up 2.7 percent compared with the previous year. And by all accounts, RBI is in it for the long haul.
“When we acquire brands, we invest for the long term. ... We’re here to foster sustainable, long-term growth,” Schwartz says. “We are confident we have the right people in the right roles to serve the Popeyes brand, our franchise community, and our guests for many years to come.”
Growth—specifically fast-paced growth—is the most obvious advantage for a quick serve to be acquired by a private-equity firm or fellow restaurant company. At MOOYAH, CEO Michael Mabry says Gala Corporation and Balmoral Group’s understanding of the brand and the importance of its franchisees were key factors in determining a match.
“I met [Gala] a few years back, and he always expressed interest in the better-burger segment. And with his ties to the restaurant community, he felt he would be a good fit for us,” Mabry says. Years later, when talks of an acquisition first surfaced, the perceived compatibility compounded. “Balmoral and Gala came here during their due diligence and met one-on-one with each member of the leadership team. They really came to the conclusion that we had something that was special, and it was the right opportunity for them to come onboard.”
For Bill Phelps, cofounder and CEO of Wetzel’s Pretzels, the brand’s acquisition by CenterOak Partners last September was less about rapport than it was goal alignment. And he would know; Wetzel’s had been on the receiving end of investor funds a number of times over its 20-plus-year history. Wetzel’s received angel investments from a movie producer and a Northwest Airlines exec in the mid-’90s before being purchased by Levine Leichtman Capital Partners in 2007.
“Who are the people that we believe will be good partners to help us grow the business?” Phelps says. “You’re not necessarily looking for nice people; you’re looking for people who have a good track record for building businesses and, ideally, some experience in the franchise/restaurant space.”
Another benefit for acquired brands—particularly for larger companies with bigger stakes—is privacy. A publicly traded company is a victim of admiration and criticism in equal measure, as everyone from investors to everyday consumers can follow along with its ups and downs.
“It’s an attractive proposition to get out of the public eye. A lot of those companies will go public because they’re small and they’re looking to raise money and stoke growth. … You get to a point where you feel like you’ve achieved that growth and then you have the opportunity to do more without necessarily having to be under the scrutiny of the public market,” Motley Fool’s Moser says.
He adds that Panera CEO Ron Shaich mentioned something to the same effect. “[Panera] was making decisions with the longer timeline in mind versus the public market judging them on a quarterly basis,” he says. “For a devoted CEO, for a founder, or someone like that, that’s got to be pretty frustrating.”
For restaurants buying other concepts within the same category, it instantly grows their pipeline and often requires less money to rebrand than a new build-out or extensive retrofits. SweetFrog plans to do some retrofits and incorporate its proprietary flavors into the businesses it acquires, but it will still benefit from existing real estate, as well as customer familiarity with those locations as frozen-yogurt shops.
While many in the industry have referred to the fro-yo space as a bubble, Galleher is quick to disagree. He views frozen yogurt as a category that is here to stay, but one that will weed out weak brands with lackluster products and undesirable locations.
Another benefit of an acquisition is the elimination of a competitor in the crowded restaurant landscape, says Clay Sanger, COO of Pieology Pizzeria, in an e-mail. Last summer, the fast-casual pizza chain bought competitor and fellow California-born concept Project Pie. Like frozen yogurt, the number of build-your-own pizza brands has ballooned to max capacity in recent years. Pieology’s purchase of Project Pie, as well as Firenza’s merger with Persona, points to an impending shrinkage.
“There would be industry consolidation. The ability to acquire a competitor not only provides us with access to strategic assets and locations in a cost-effective way, but it also allows us to grow quicker with established locations,” Sanger says. “Project Pie was opportunistic, as it was facing financial challenges and some key members that were associated with the organization reached out to us to consider purchasing its assets, which we eventually did.”
The equity environment
Project Pie’s proactive strategy dovetails with the notion that all restaurants should be acutely aware of their place in a particular category and the market at large. Or, as Reach Restaurant Group’s Morales advises, all companies should run their businesses in an organized, well-documented way so that if a potential transaction does materialize, they are prepared.
“Every business—whether it’s for sale or not—needs to ensure that they are documenting everything and following processes, and that they are set up so they can easily get through a due diligence process,” he says. “The way you operate your business is going to dictate how well a transaction goes down the road.”
Such preparation ensures a company won’t be left in the dust should fate intercede with a potential new venture. After all, the private-equity market is booming. According to financial intelligence provider Preqin, capital commitments in private equity have exceeded $100 billion in five of the last seven quarters. North America is taking the lion’s share, accounting for some $67.5 billion in 2017’s second quarter.
Private equity’s rising star could possibly be to the detriment of hedge funds. The third quarter of 2016 marked the largest outflow of capital from hedge funds since 2009 (some $28 billion), according to data firm Hedge Fund Research.
Hedge funds have reclaimed some lost ground, with Q2 marking the first time investor allocations have outweighed withdrawals in nearly two years. Nevertheless, private equity hasn’t been negatively impacted, at least not yet; such investments in North America jumped 5.5 percent between the second and third quarters of 2017.
“I just see [private equity] as being a bigger and bigger part of the restaurant business. It’s one that’s worked for the restaurateurs; it’s worked for the private-equity firms. I see much more of it, not less of it,” Wetzel’s Phelps says. “The strategic buyer does not need to make an acquisition. The private-equity firms, by their nature, have to be making deals. They raise these funds to put the money to work, and they have to put the money to work. There’s far more pressure on private-equity firms.”
Indeed, investor dollars must find a receptacle for turning a profit, but successful restaurant companies can bide their time. In saturated categories like fast-casual pizza and self-serve frozen yogurt, the excess of brands will gradually balance out. In some cases, a small concept like Project Pie seeks out a much bigger buyer like Pieology. Other times, companies that are pretty evenly matched combine forces, as was the case with Firenza and Persona.
For his part, Moser says he sees restaurant M&A activity slowing down a bit in the near future. It’s not a simple matter of the pendulum swinging the other way, but rather the finite number of viable quick-service brands. Although the restaurant industry constantly churns out new concepts, few rise to legacy or leaderboard status.
“At some point, there are only so many quality names that are really worth buying. I think companies are finding it more difficult now to just go public and get on with life,” Moser says. “You really need to be able to frame your value proposition, or I think that Wall Street is going to punch you accordingly pretty quickly.”