By Ross Vozar and Adam Berebitsky, BDO USA, LLP
The French Revolution played a pivotal role in the invention of the modern restaurant. Shaking chefs out of the kitchens of the nobility—who were fleeing Paris for their lives—and into their own establishments, the Revolution gave birth to a Parisian phenomenon that became a global cultural institution. Today, sparked in part by the marriage of technology to nearly every aspect of our lives, the restaurant is undergoing a new kind of revolution, expected to give rise to more M&A.
But technology is just one piece of the changing landscape. More consumers are ordering delivery than ever before. A 2018 UBS report titled “Is the Kitchen Dead?” predicts the food delivery sales market will grow 20% per year until 2030, to $365 billion from $35 billion today. As this market grows, foot traffic shrinks, a major pain point for the industry.
Financial pressures abound. Labor costs as a percentage of sales rose steadily throughout 2018, a trend that is expected to continue through 2019—restaurant CEOs on 4Q18 earnings calls said they expect wages to rise about 5% this year. A $15 hourly minimum wage is now mandatory in many states, but some restaurants have already been paying employees above that to retain talent. The industry is also seeing competition from new entrants like grocery stores that are eating into long-held market share. And restaurant industry tax rates can be as high as 30%.
These factors have driven restaurants to try to retain, regain, and capture market share. But as restaurants strive to grow, the infrastructure that supports them needs to grow, too—from the back office through the supply chain. And as they traditionally operate on relatively thin margins, financing such initiatives has spurred a fair amount of M&A to unlock capital and uncover synergies.
In the United States, more than 70 restaurant chains exchanged hands in 2017 and 2018, according to Restaurant Business; in 2018 alone, there were 40 deals across the restaurant industry, according to Nation’s Restaurant News. According to an S&P Global Intelligence report, last year marked a departure from precedent as private equity firms comprised a larger share of buyers.
For those seeking acquisitions, businesses that have a broad asset base like franchises, for example, or that are casual or fast casual restaurants (these segments’ same-store sales are outperforming the rest of the industry, according to BDO’s The Counter: Restaurant Industry Scorecard – 1Q 2019) have been attractive candidates, as have businesses with restaurants in desirable locations or that have already invested in value-driving initiatives.
For example, restaurants that have adopted digital technologies, rolled out delivery services and advertising campaigns, and adapted their brick-and-mortar footprints to quick-service formats are high on the list of attractive candidates. Such investments have helped boost financial and operational results and can be a natural complement to the operations of either a traditional restaurant that may be struggling to turn itself around, or a private equity fund whose existing restaurant portfolio would benefit from their inclusion.
In last year’s largest restaurant deal, Inspire Brands acquired Sonic Corp., the drive-in restaurant chain, for $2.3 billion. Inspire Brands, which is majority-owned by Roark Capital, cited Sonic’s “significant focus on innovation, especially in guest-facing digital technologies” and “largely differentiated” brand as part of the rationale for the deal. Inspire Brands itself was formed by private equity-owned Arby’s Restaurant Group after the latter closed on its $2.9 billion acquisition of Buffalo Wild Wings in February 2018—the fourth largest U.S. restaurant deal ever, according to S&P Global Market Intelligence data. Buffalo Wild Wings already owned Rusty Taco, the rebranded name of R Taco, which it acquired in 2014.
Having a well-established brand is also key for some players. Private equity fund High Bluff Capital last year acquired QSR Quizno’s and, later, fast casual chain Taco Del Mar, in both cases citing the brands’ well-established names as well as their tenured relationship with customers as part of their strategy.
With no expectation that pressures on the industry are set to release, there will be a healthy amount of M&A in 2019: strategic buyers will continue to need to scale up and partner with or acquire businesses that have complementary operations, and private equity’s coffers are overflowing and seeking lucrative opportunities.
As restaurants evaluate their industry positioning, balance sheets, and the question of whether there’s a strategic rationale for a deal, there are some important tasks to check off of their due diligence lists, both financially and operationally. This insight guides you through some critical considerations ahead of a deal.