Restaurant
Finance
Monitor
R
Volume 25, Number 5 • Restaurant Finance Monitor, 2808 Anthony Lane South, Minneapolis, MN 55418 • ISSN #1061-382X
May 20, 2014
OUTLOOK
All Hail The Restaurant EBITDA Creators
Warren Buffett reminded his shareholders earlier this month
that cash is absolutely the worst investment. Corporations,
banks, private equity funds and even individuals sitting on
piles of it, know the feeling.
Afterwards an analyst questioned the Oracle about Berkshire
Hathaway’s enormous $48 billion cash horde. How much was
enough? Buffett defended the amount, saying he wouldn’t be
compelled to spend the cash unless he found a productive
acquisition. That’s the problem. Finding a good investment
these days is as rare as a traveling call in the NBA playoffs.
The issue here is excess liquidity—a.k.a. cash sloshing around
in corporate and individual accounts earning nothing. Nonfinancial companies held $1.6 million in cash at the end of
March, an all-time record.
Finding that good investment, or a decent loan if you’re a
lender, is the dilemma du jour of those in the money trade. The
liquidity explosion, brought on by the Federal Reserve’s money
printing exercise, has driven higher the valuations of stocks,
bonds, private businesses, apartment buildings, net-lease real
estate, top-tier franchisee restaurants, and God forbid, even
small, emerging restaurant chains. The deal bargains that
existed during the recession and shortly thereafter are long
gone. Sellers are hanging on to businesses, either because they
anticipate a higher price in the future, or because they have
nowhere to reinvest the sales proceeds.
This hyper-liquidity affects the investor who pays a higher
price and takes on more risk to get a required return, and the
lender, who must now lend more money against the higher
valuation and yet, receives a lower spread for his efforts. With
the enormous amount of the cash in play propping up asset
prices, both buyers and lenders must be alert to risk.
It’s especially an acute problem for the so-called value
investor—one who seeks assets at a discount to intrinsic value.
Their world has been turned upside down by rising valuations.
The concept of value and risk were overriding themes at two
investment conferences I attended recently. The first was the
Association for Corporate Growth’s InterGrowth Conference
(ACG), an annual event for private equity fund sponsors and
investment bankers networking for deals. One speaker after
another argued the investment climate was oh-so perfect for
sellers, but not so cheery for buyers or lenders.
Shift Your Development Into High Gear!
Restaurant Finance & Development Conference
November 10-12, 2014 at Bellagio, Las Vegas
At the annual Restaurant Finance & Development
Conference, you won’t find food, equipment, uniforms,
glassware, or the next generation of kitchen floors. But,
you will find equity capital to grow your business, lenders
interested in financing new-unit development or refinancing
your existing operation, and experienced investment bankers
and brokers angling to sell your business, or help you find
more units to acquire.
The Restaurant Finance & Development Conference is the
restaurant industry’s “dealmaker’s event.” It attracts the top
owners, operators, and financial, franchising and development
executives in the industry. There is no better business event to
get up to speed on the financial side of the restaurant business
than this one.
The conference features the Finance & Development Mall,
where attendees can source their financing, development
and financial service needs for 2014. We’ve also assembled
a quality educational program covering the capital markets,
financing, mergers and acquisitions, private equity, valuation,
and restaurant strategy. The conference is a perfect venue for
management teams to meet and finalize their 2015 plans.
We’re pleased to announce an outstanding lineup of speakers
at this year’s event. They include our luncheon headliner,
comedian Dennis Miller; and general session speakers Peter
Ricchiuti, Assistant Dean of the A.B. Freeman School of
Business at Tulane University; Robert P. Miles, author of
The Warren Buffett CEO: Secrets From the Berkshire Hathaway
Managers; Brian G. Belski, Chief Investment Strategist, BMO
Capital Markets; top restaurant analysts David Palmer, RBC
Capital Markets; Nicole Miller Reagan, Piper Jaffray; and
restaurant strategists Darren Tristano, Technomic, and Allan
Hickok, Boston Consulting Group.
The Restaurant Finance & Development Conference
is the place to look for capital, make deals, find business
opportunities, build excellent contacts and revamp your
business plans. Multi-unit operators, both franchised and
independent should make plans to attend. Registration is
available on-line at www.restfinance.com.
Continued on Page 4
© 2014 Restaurant
Monitor
Page Finance
1
FINANCE SOURCES
Bank of America and RBS Lead $250 Million Many of these franchisees, like Perales, built businesses in
piecemeal fashion and are now getting large credit facilities
Transaction
Briad Restaurant Group, a Livingston, NJ-based operator of
63 TGI Friday’s and 57 Wendy’s restaurants, recently completed
a re-capitalization and expansion of its senior credit facilities.
A new, $250 million credit facility includes a larger $50 million
development facility, which in addition to providing capital
for acquisition and development of Friday’s and Wendy’s,
will provide financing capacity for Briad’s Zinburger and
Cups brands.
Zinburger, a higher-end burger and wine bar, recently opened
its 5th and 6th restaurants respectively in Charlottesville, Va.
and Durham, NC, with two more openings soon to follow.
Sunrise, Fla. will open in May, and No. 7 will open in Atlanta
in June.
The $250 million credit facility was assembled with Bank of
America Merrill Lynch and RBS Citizens Franchise Finance
as Joint Lead Arrangers. Participants included BMO Harris
Bank, M+T Bank, Capital One, Wells Fargo Restaurant
Finance, Cadence Bank, Regions Bank and Sovereign Bank.
BBVA Arranges $145 Million Facility for Sun
Holdings
Guillermo Perales has built his business piece by piece. The
longtime franchisee was never able to get a big lending deal to
fund his restaurants, be they Burger King or Arby’s. Instead,
he relied on many, smaller mortgages.
As Perales’ Dallas-based Sun Holdings grew into one of the
largest restaurant franchisees in the country, based on our
annual Monitor 200, this resulted in a complex operation,
with many loans through many lenders. And numerous loans
held personal guarantees.
So Perales recently restructured, securing a $145 million
lending facility through seven lenders, with BBVA Compass
the administrative agent. The facility includes a $110 million
term loan, and a $35 million development line of credit. The
deal consolidates the loans for three of his brands, Burger
King, Popeyes and Arby’s, and gives him funds to remodel
units and buy others.
“It’s a game changer for us,” Perales said. “Now we have
to rethink how we manage everything. I know we’ll be
successful.”
The deal represents another big splash for BBVA, which
launched its restaurant lending group in 2012. The lender is
one of a number of financiers that have entered the restaurant
market in recent years, which has intensified competition.
The addition of numerous lenders has helped fuel a
consolidation boom, as big franchisees get bigger by
buying refranchised units or through acquisitions of
smaller franchisees. “If you think of the headwinds that
face franchisees right now, same-store sales certainly aren’t
going through the roof,” said James Short, director of food
franchise finance for BBVA. “At the same time, there’s a lot
of cost pressure. That’s going to force consolidation. Larger
franchisees are creating economies of scale.”
to make their businesses more flexible.
“At the end of the day, if you’re tied up to 20 different credit
agreements, it can be tough to keep up with all of those
covenants,” Short said. “Now the CFO just has to look at one
credit agreement, and have one set of covenants.”
The Sun Holdings deal involved a number of different players.
Six other banks are part of the transaction—which proves the
merits of the deal and its parameters. “It took us some time to
put together,” Short said. “It was a transaction we were very
comfortable with internally. The nice thing is, when you’re
doing a lead-arranged transaction, it proves itself out.”
One unique aspect of the deal is it involved multiple brands,
in this case Burger King, Arby’s and Popeyes. Lenders usually
focus on a single brand. “We were able to work through all
three different brands under one facility,” Short said.
The funds should help Perales build new units and remodel
existing locations. Short said the credit facility shouldn’t
only make administration easier for Sun Holdings. He said it
should also give the company more flexibility. “He now has
more levers to pull,” Short said of Perales. “He’s diversified
more. If one brand is performing better than another, he can
focus on that one. It creates something of a mutual fund for
him.” Thus, Short said, the loan won’t be held up by a poorly
performing brand or a geography.
Still, Perales admitted he needed some convincing. “It was
not an easy decision,” he said. When he had a number of
lenders, he had personal guarantees, but no one lender had a
lot of influence. With one big lender, “The bank has a lot more
say,” Perales said. “They have total control over your destiny.”
Perales said BBVA put together the best deal, and convinced
him to go with it. “They beat everybody else out there,” he said.
“I’m glad there are new players in the segment,” Perales added,
“So we have options to keep growing.”
For more information on BBVA Compass, contact James Short,
director of food franchise finance, at james.short@bbvacompass.
com, or at (602) 285-3691.
Advanced Restaurant Sales Advises on Sale of 20
Popeyes
Quantum Leap QSR recently sold 20 Popeyes Louisiana
Kitchen Restaurants to SRG Capital City Holdings and
Michael Shelton. The restaurants are located in Baton Rouge,
La. and surrounding markets. Advanced Restaurant Sales
was the advisor to Quantum Leap, which included valuation,
marketing and utilizing an auction process to bring maximum
value to the sale. Shelton and his affiliated companies will now
own and operate 64 Popeyes located primarily in Louisiana.
Advanced Restaurant Sales represents franchisees of major
restaurant concepts, and has reltaionships with private equity,
lenders and franchisors in order to provide the best opportunities
for their clients. For more information on Advanced Restaurant
Sales, contact Rob Hunziker, managing partner, at (678) 2292384, ext. 2, or by email at rhunziker@arsales.biz.
Page 2
Auspex Capital Advises on Debt Placement Deals
McClure Joins First Franchise
Auspex Capital, a boutique investment banking firm, recently
advised on the following debt placement transactions:
• Represented TB Restaurant Management, Inc., a Salem,
Mass.-based KFC and Taco Bell franchisee, in securing
a $4.4 million senior secured term loan to refinance its
existing debt. The transaction was financed by City National
Bank. TB Restaurant Management, controlled by long-time
franchisee Dan Benson, owns and operates seven Taco Bell
restaurants, five Taco Bell / KFC co-branded restaurants and
one stand-alone KFC restaurant. The restaurants are located
in Massachusetts and New Hampshire. Auspex structured the
transaction and acted as the debt placement agent.
• Represented PHIG Houston, LLC, a San Antonio, Texasbased real estate family office in refinancing a $8.7 million senior
secured real estate term loan collateralized by the properties’
underlying 15 Pizza Hut restaurants. The transaction was
financed by Frost Bank. Auspex Capital acted as the debt
placement agent.
• Represented HEK Investments, LLC, a Long Beach, Calif.based real estate family office in financing a $3.75 million
senior secured real estate term loan collateralized by the
properties’ underlying five KFC restaurants. The transaction
was financed by North American Savings Bank. Auspex
Capital structured the sale/leaseback transaction and acted
as the debt placement agent.
Auspex Capital is a boutique investment banking and financial
advisory firm specializing in the restaurant industry. Auspex’s
services include buy-side and sell-side M&A advisory, debt
placement, asset valuation, institutional private equity and
mezzanine placement, sale leaseback structuring and placement
and financial restructuring. For more information, contact
Chris Kelleher at 562-424-2455 or by email at ckelleher@
auspexcapital.com.
First Franchise Capital recently added Jon McClure as a
marketing vice president. McClure will serve clients in the
southwest region including Arizona, California, Colorado,
Nevada, New Mexico, Texas, and Utah. He will be based in
Castle Rock, Colorado.
Provenzale Joins William Blair
Laura Provenzale, formerly with Raymond James &
Associates, has joined global investment bank William Blair
& Co. as managing director in the firm’s consumer and retail
investment banking group.
“I’m thrilled to be part of the team and the firm,” she said.
William Blair has a reputation for capital raising for growth
companies, Provenzale added, and the firm is highly regarded
by PE firms as a group that can execute on deals.
Provenzale led Raymond James’ restaurant investment banking
practice, and she’ll spend the majority of her time working
within the restaurant sector at William Blair, as well. With
20 years of experience, she’s most recently executed on IPOs
such as Zoes, Papa Murphy’s and Bloomin’ Brands.
“There’s opportunity and appetitite for growth restaurant
companies, and we’ll continue to see more offerings in the
public markets,” she said about the coming year. And, as long
as bank lending is still attractive, “we’ll have a healthy M&A
market.” You can reach Laura Provenzale at (415) 248-5919,
or by email at lprovenzale@williamblair.com.
Larissa Bohac also recently joined First Franchise as an
account manager. Bohac will serve clients in the northeast
region including New Jersey, New York, Connecticut,
Maryland, Virginia and the New England states. She is based
in Columbus, Nebraska.
First Franchise Capital specializes in lending to the franchise
restaurant industry and works with well-known restaurant
brands across the country. The company’s team provides
financial solutions to help clients purchase real estate and
equipment, remodel current stores, finance new construction,
acquire an existing location, refinance debt or restructure
ownership. It is a subsidiary of First Financial Bancorp, which
has $6.4 billion in assets.
You can contact Jon McClure at 720-733-1169 or by e-mail
at jon.mcclure@firstfcc.com. Contact Larissa Bohac at (402)
562-5110 or by email larissa.bohac@firstfcc.com.
Dealstruck Taps Finance Veteran Fox to Lead
Franchise Effort
John Fox, an expert with over 30 years of experience in franchise
and restaurant finance, has joined Dealstruck as senior liaison
for restaurant operators, franchisees, SBA lenders, banks and
specialty finance companies.
Dealstruck is a peer-to-peer lender offering term loans and
lines of credit to successful, young businesses that often have
been turned down by banks or SBA lenders. Dealstruck’s
typical loans range from $50,000 to $250,000 for businesses
that have been operating for at least one year and have annual
sales in excess of $250,000. All loans are fully underwritten
and fund as quickly as five days. According to the company,
Dealstruck is the first crowdlending platform to offer multiple
products to small and medium-sized businesses, and the first
to allow investors the freedom to choose specific investments.
Fox says, “Between quality bank loans and high-priced
alternative loans, there is a tremendous void in financing for
restaurants. I am excited to join Dealstruck where we can fill
that void by delivering transparent, fair and fast financing.”
Ethan Senturia, Dealstruck co-founder and CEO notes,
“Having John on board helps us do what we do best – identify
the financial problems small owners face, then give them the
best option for moving their business forward.”
For more information on Dealstruck, contact Candace Klein
at Candace@dealstruck.com or by phone at (859) 803-9499.
Page 3
OUTLOOK
Continued from Page One
Representing the “it’s a great time to be a seller” viewpoint
was Hiter Harris, co-founder of middle-market M&A advisor,
Harris Williams & Co. “The M&A market is smoking right
now,” he said.
Harris added that “extreme liquidity” brought on by artificially
low interest rates made it easier for corporations and investors
to justify deals.
“Buyers are craving for growth and yield and that’s good for
sellers,” said Harris.
Stewart Kohl, Co-CEO of private equity fund The Riverside
Company, representing the buy-side of the equation, was more
cautious. Acknowledging Harris’s analysis, Kohl argued the
“risk-reward proposition is much different for buyers.” In order
to make a good deal in a high-valuation market, you “must be
a better buyer and manager of companies,” said Kohl.
Translation: You better be sure you can grow the business after
you overpay to acquire it.
On the lending side, John Martin, president and CEO for GE
Antares Capital, a middle-market lender, sounded an alarm
bell. Martin said he was “astonished” at all the liquidity in
the market and was afraid lenders were acting as if it were
2006 all over again.
“Memories are shorter when the cycle goes longer,” said
Martin.
The themes were similar at Robert Miles’s Value Investing
Conference, held in conjunction with Berkshire Hathaway’s
annual meeting in Omaha. The conference, a paean to Buffet’s
value-investing style, was unique this year because so few
speakers could actually tell attendees where there was value.
Perhaps that’s because the Dow Jones and S&P averages are
at record highs. The current price-earnings ratio of the U.S.
stock market, according to Yale professor Robert Shiller, is
25.4 times earnings, compared to a median PE of 15.9.
Most of the equity money managers on the Value Investing
rostrum sounded more like high-flying momentum investors
than adherents to the Benjamin Graham style of investing.
Speakers even suggested the high valuation of good growth
companies represented their own unique form of “value.”
Rob Vinall, a Swiss investor, said investors “shouldn’t fear
paying a high multiple for a truly great business.” He penciled
out a positive example of an investor paying up for a growing
business at a high multiple, versus buying an average business
at a low multiple. Of course, the high-growth company won.
“Don’t focus on the multiple,” was Vinall’s advice, “especially
if you have a longer time horizon for the investment.”
Chuck Akre, a money manager with a firm bearing his
own name, told attendees investors should focus on finding
high-growth, high-multiple companies, which he calls
“compounding machines.” Akre said he was okay with price
risk in the short term as long as his compounding machines
could generate above-average returns in the long term.
Restaurant chains as long-term compounding machines is a
stretch, although Chipotle and McDonald’s would probably
qualify. Too many restaurant businesses, as they age or lose
relevance, turn into capital expenditure machines, and
hemorrhage cash instead.
Value investing and restaurants aren’t used very often in the
same sentence, either. You know the old joke: How do you
make $1 million in the restaurant business? Start with $2
million. Restaurant assets priced below replacement value
usually signifies a concept on life support.
Growth is where the action has always been in restaurants.
Whether it’s a hot IPO market of the ‘80s or ‘90s, or
today’s private equity lollopaloozza, growth chains draw
the majority of lookers and command the highest multiples.
Pricing in the restaurant M&A market has never been higher
for restaurants, especially for emerging brands. Example:
Sentinel Capital Partners’ deal to buy Newk’s Eatery, a
Jackson, Miss. restaurant company with 67 company and
franchise locations. The word on the street is Sentinel paid
a multiple of EBITDA in the low-to-mid teens.
Even P.J. United, a slow-growth Papa John’s franchisee that’s
passed around by private equity firms every few years or
so, sold for a premium price, we’re told. One private equity
fund manager involved in the bidding told Monitor reporter
Jonathan Maze, the price was “too frothy for his tastes.”
Kohl of the Riverside Company laments how difficult it is
for passive investors to make money these days in the wake
of the Fed’s policy, without taking on more risk.
“In the day you could buy low and sell high. You could
employ financial engineering. You could even trade the
EBITDA among funds,” said Kohl. Not anymore.
“Now, there is a great reward awaiting the creators of
EBITDA,” said Kohl. “If someone is willing to create
EBITDA, they will be rewarded at 10 times EBITDA versus
five times a few years ago,” said Kohl.
Perhaps that’s what Ben Bernanke had in mind with his zero
interest rate policy. With no reasonable returns coming from
passive income or value investing, investors are faced with
this dilemma: Stay in cash or accept higher levels of risk.
Or, you simply quit the passive route to riches and become
an EBITDA creator like the heroes in the Newk’s deal—
founders Don Newcomb, Chris Newcomb and Debra
Bryson. The trio founded the Newk’s concept shortly after
they sold McAlister’s Deli (they founded that, too) to an
investment group.
Entrepreneurism is alive and well in the restaurant business.
Just remember this: The valuations aren’t always this frothy.
—John Hamburger
Page 4
What Happens When You Think Big?
By Dennis L. Monroe
In last month’s lead article “Five Things That Set Good
Operators Apart,” Jonathan Maze had a wonderful discussion
of the success of large, multi-unit franchisees. One of the
things Jonathan pointed out is that even large operators need
to think small. For years, this has been a key tenet in restaurant
franchising, a world which was initially dominated by owneroperated businesses. These roots have certainly changed over
the years and now the dominant players are large, multiunit operators, some of them genuine behemoths. But most
large operators are sophisticated business people who have
sophisticated operations and operate one or more concepts.
These large, multi-unit operators seem to be the prettiest
girls at the restaurant franchising dance, and they certainly
attract a lot of attention, particularly from emerging restaurant
franchisors. Many large operators that have either single
or multiple concepts are looking for ways to leverage their
overhead and develop a concept within their existing trade
areas. Often their existing concepts do not afford them a great
opportunity for growth. The obvious remedy is to try to find a
successful, emerging concept that the large multi-unit operator
can grow in order to take advantage of its success.
While the emerging concept franchisor may want to secure the
large operator as a franchisee, knowing if this is the right route
to take requires a great deal of thought and consideration. It
may be better for some franchise restaurant concepts to opt for
the owner/operator model rather than casting their lot with a
large, multi-unit operator. It’s a strategy that can be effective,
but it does take patience, a great deal of infrastructure and
time.
Here’s what the large, multi-unit operator (LMUO) wants:
1. Unit Economics. The LMUO wants a clear understanding
of the unit economics it is investing in. Those unit economics
need to equal or exceed the existing concept’s unit economics
within which it operates. The LMUO always benchmarks
off what profit it can make on its existing concepts. If the
operator is out of the development territory, it may not be
possible to continue its current economics; but the multi-unit
operator does not want to have less favorable economics or its
profitability diluted by a new concept.
Here are several things that attract the LMUO: (a) unit
level profitability in the 15% to 20% range; and (b) belowmarket labor costs, reasonable food costs, and options to have
reasonable occupancy as a percentage of sales.
2. Reasonable Return on Investment. The LMUO wants
a reasonable return on its capital investment. In many cases
the amount of capital investment is tied to sales. If this is a
QSR concept, the sales-to-investment ratio is probably 3 to
1; if it is fast casual, the sales-to-investment ratio is probably
2.5/3 to 1; if it is casual dining, the sales to investment ratio
is probably 2 to 1. Moreover, the capital investment needs to
be deployable in an manner. Many emerging concepts spend
too much for a unit. Good operators can normally lower that
cost by 20% to 30%.
3. Tested Concept. The LMUO also needs assurance the
concept has been tested. This means the concept has found
consumer acceptance, and understands its customers and
potential demographics. Further, it means the concept has a
good idea as to what will and will not succeed. Most multi-unit
franchisees are not experts in creating concepts or determining
the consumer fit, so they rely on the franchisor to come up
with something that works and evolves.
4. Value Proposition. The LMUO wants to know what it
gets for its royalty. Is it the standard 5% royalty, or is there a
graduated royalty as profitability goes up? Does the operator
get more than it would get with an established franchise
company? Are the marketing dollars being used correctly?
What is the marketing fee? Will the LMUO control its own
marketing dollars? All of these questions need to be addressed
by the operator.
5. Development Rights. The LMUO wants a clear
understanding of the development rights. What is the approach
the emerging franchise is taking regarding development? Is the
franchise looking at selling the entire country in large blocks,
or is it being more thoughtful and selling it with a reasonable
development schedule? Is there right of first refusal to adjacent
sites? The LMUO’s role in the development process is key.
While LMUOs often want the right to develop many stores,
it is still crucial that development be thoughtful, conservative
and cognizant of the markets and real estate.
Now let’s look at the investment process from the franchisor’s
perspective. The franchisor, while it loves the idea of multiunit operators, has to understand that if things go wrong, the
LMUO has greater resources and can sink the franchise system.
Further, the resources the franchisor has to provide the LMUO
may be less than those needed by an owner-operator, but they
certainly must meet a higher standard of sophistication. What
type of help does the franchisor provide concerning: (a) point
of sales; (b) IT help; (c) product development; (d) site approval
and proto-types; and, (e) getting the concept recognized for
potential financing? The franchisor needs to think about each
of these items in order to be adequately staffed and provide the
appropriate infrastructure to align well with a large, multi-unit
operator. The franchisor might not have to be as hands-on, but
the franchise has to be structured as a sophisticated company
ready for growth.
A word of caution: Jonathan’s article talks about the big
operators moving ahead while still thinking small, and I
would agree with that. I think franchisors should be careful
when they think too big. Good systems evolve slowly and
momentum comes with reasonable growth.
Dennis L. Monroe is a shareholder and Chairman of the law
firm of Monroe Moxness Berg PA. Reach him at (952) 885-5999.
Page 5
Sentinel’s Buying Spree is an Endorsement of the Restaurant Industry’s Future
It’s safe to say Sentinel Capital Partners is bullish on the
restaurant industry.
sometimes six,” he said. A ratio of 6x can fund a purchase
multiple of about 8.5x EBITDA.
Over the past year and a half, the private equity group has
gone on a shopping spree, buying three concepts, including
Huddle House, Checkers/Rally’s and Newk’s. In addition,
the company apparently is nearing a deal for TGI Friday’s.
“We’re in a world where people can pay 8.5,” he said. “The
debt is there. And the debt is cheap and abundant. It’s a very,
very nice party going on.”
The investments come despite an environment in which profits
are under pressure. The sales environment remains uncertain,
especially after a 2013 in which total restaurant traffic actually
fell, according to the 2013 Restaurant Industry Year in Review
from GE Capital, Franchise Finance. Food and labor costs
are rising, and oddly the prices for restaurants and chains
are sky high.
High prices for an industry under profit pressure? Why would
anybody buy into this business?
Simple, said David Lobel, Sentinel’s managing partner: The
economy is improving. “From 2009 to 2012, we didn’t do
a single restaurant deal,” Lobel said, citing the magnitude
of the recession and its impact on restaurant sales. “As we
entered 2012, we started to see improvement, that the rate of
comparable store sales and the rate of decline in traffic had
started to stabilize.”
“We still think the economy has a lot of room left before we
get to the next recession,” he added. “Unemployment is still
persistently high. Growth is still relatively slow. We think the
worst is behind us. It’s a slow, anemic recovery, but we think
the recovery is continuing.”
Sentinel has made a number of restaurant investments over the
years. Lobel himself has made restaurant investments dating
back 24 years to when he worked with Smith Barney in 1990
and it invested in a chain out of San Francisco, Chevy’s.
Sentinel looks at a number of different acquisition opportunities,
including franchisees, franchisors, older chains and upstarts.
“The debt side is very good because the Fed has made debt so
cheap,” Lobel said. “The debt markets are the primary cause
for the very, very highly inflated prices.”
How inflated? Lobel acknowledged Sentinel backed out of
the sale of big Papa John’s franchisee PJ United because of
price. It ultimately went to TPG Growth. “We were very, very
interested in that,” he said. “We would have loved to own that
business. But they paid a price we weren’t comfortable paying.”
Is there a bubble in franchisee valuations? “We wouldn’t
disagree strongly,” he said.
Lobel said when his company bought Southern California
Pizza at the end of 2008, just before the Lehman collapse,
the shaky finance market would only fund a debt-to-EBITDA
ratio of 3x. “Today, you can get 5x debt-to-EBITDA,
That “cheap and abundant” debt has helped fuel Sentinel’s
acquisition spree. The first was Huddle House, an Atlantabased family dining chain, in September 2012. Earlier this
year, the company acquired the 782-unit Checkers system.
And then it turned around and bought Newk’s Eatery.
Both Checkers and Huddle House—and, presumably, TGI
Friday’s—are existing chains with long track records. Sentinel
would make its money by paying off debt, getting some profit
growth and, perhaps, doing things to make the brands more
attractive to the next buyer.
Lobel said that the Checkers deal was relatively straightforward.
The company has experienced management, led by CEO Rick
Silva. “We look at the business and he’s one step ahead of us,”
Lobel said. “We’re reacting to him. We’re not saying, ‘Rick,
why don’t you do this and that.’ It’s, ‘Guys, this is where we’re
going.’ The train is running fast and smooth.”
Newk’s is different, and requires more active ownership on
the part of Sentinel, because the chain is in an early stage of
its development. It’s smaller and newer and more difficult to
acquire. “It’s hot,” Lobel said. “It’s not easy to find attractive
businesses. It’s in an attractive category. It’s growing very
nicely even though unemployment has been bad. There’s lots
of white space in that concept.”
Newk’s, started by Don Newcomb, Chris Newcomb and
Debra Bryson is a unique, Mississippi-based concept with
soups, salads, pizzas, sandwiches and other items, including
an interesting array of grab-and-go items. Chris Newcomb
is “brilliant at understanding who the customer is, and what
the customer wants,” Lobel said. “There’s nothing we can
bring to that.”
But Lobel said Sentinel can supply capital for Newcomb to
execute his strategies, and it can work with him to build the
business. And Lobel said Sentinel has the restaurant experience
to advise Newk’s on what it needs. “We’ve been down that
road before many times,” said Lobel.
Not surprisingly, Lobel said, there was a lot of competition
for the Newk’s deal. “There is more competition for very sexy,
exciting businesses,” he said. “It’s like at a party. The gorgeous
gal will have a flock of guys around her. The reasonably
attractive gal will always get one or two guys. It’s the ugly
duckling that has no one around her.
“We’re not in the business of buying ugly ducklings.”
— Jonathan Maze
Page 6
M&A CENSUS
2013’s Debt-Friendly Market Spurs Franchise Sales and New-Concept Investments
Private equity firms can’t seem to get their fill of restaurants.
Roughly a third of last year’s deal activity in the space—97
closed or announced transactions—involved a PE fund,
according to the “Chain Restaurant Merger & Acquisition
Census.” The annual count is published by Chicago investment
bank J.H. Chapman Group, and is featured on pages 8 and 9.
“It was equity funds in a big way in 2012, and last year we
saw it again,” says David Epstein, principal and author of the
census. He attributes PE’s appetite, in part, to an easing of the
debt market that in turn has provided for attractive returns
on investment.
Last year was also a champion year for refranchising, though
largely among Tier 1 brands, which accounted for another
third of announced or closed M&A activity. We’ll deep-dive
into that in minute.
But it was potential for new growth (along with easy coverage
ratios) that prompted private equity investors to cut checks for
restaurants that few Americans had ever heard of. “The equity
funds realize there’s a new wave of foodservice coming into
the marketplace that looks like it has a lot of potential. It’s a
spark of something different,” Epstein explains.
The spark generally arrives in the form of fast-casual operations
—and small ones, to boot. Last fall, for example, Catterton
Partners is said to have spent about $5 million for a minority
stake in Bruxie Gourmet Waffles, a seven-unit chain in Orange
County, Calif. Earlier, former restaurant CEOs Bill Allen and
Gordon Miles recognized Bruxie’s potential, invested and
spread the word.
taxes, depreciation and amortization.
Nonetheless, the important takeaway from last year’s activity
among private funds is concept creators willing to give up
some control have an audience eager to fund their businesses—
particularly when the concept’s focus is on speed of service,
product quality and up-to-date design.
It’s hard today to over emphasize the importance of design,
particularly in the QSR space. Interiors featuring 10-yearold decors look dated and typically perform poorly. Over the
past few years, major fast-food brands have recognized this
and pitched their aging company restaurants to franchisees,
often on the condition they spruce them up. It turned out to
be a good decision.
Epstein says unit sales to franchisees “were again a major
component of the Census” in 2013. Those sales comprised
more than a third (34 percent) of all announced transactions,
almost all from franchisors to franchisees.
“Refranchising was huge last year,” recalls Rob Hunziker
of Advanced Restaurant Sales. He cites Wendy’s as typical.
“When you buy from corporate you have to do what Wendy’s
describes as ‘freshening up,’ and that costs from $450,000 to
$700,000.”
Valuations for the units climbed as a result. Hunziker worked
out the cost of a unit with the refresh, discovering it was “wellover six times EBITDA.” He also reports an investment banker
told him a Taco Bell transaction (franchisor to franchisee)
registered an earnings multiple of nearly 7x.
Bruxie had just six restaurants (each reportedly averaging
$2 million in sales) at the time Catterton’s investment. The
Greenwich, Conn. firm, incidentally, invested in three other
fast-casual chains last year, none of which had more than 15
units. Their entrepreneur founders were left in place.
Last year’s low interest rates, however, kept coverage ratios
in line, and therefore lenders were only too happy to loan.
“Circumstances were so good, credit-wise that some lenders
might have encouraged borrowers to take a look at some
opportunities,” Epstein says.
That’s one significant difference from the type of equity
sponsorship witnessed in the early part of the last decade.
“This is not a situation where they are taking someone out
in a recap,” Epstein says. “[Private equity] is willing to make
a nice deal for owners while the money stays in the business
for expansion.”
Public stock offerings including follow-ons climbed, 14 in
2013 vs. nine in 2012, according to the Census. The most
publicized were the two initial public offerings—Noodles
& Co. (NDLS), which debuted as a public company in June
and Potbelly Corp. (PBPB) in October. Both stocks have
demonstrated volatility since their IPOs. In early May PBPB,
for instance, had lost nearly half of its per-share value after
climbing to $32 a share last fall.
Moreover, he adds, founders and management teams are
likely get sound advice from their new investors, particularly
if the PE firm controls other successful restaurant properties.
Consultant Fred Lefranc of Results Thru Strategy, who does
due diligence for private equity firms, says, “They are all
looking for the next Chipotle and willing to invest from $2
million to $15 million to find it.”
Not all of last year’s private equity transactions involved
new-wave eateries. Centre Partners acquired the rejuvenated
Captain D’s; Roark Capital purchased CKE (parent of
Hardee’s and Carl’s Jr.) from Apollo Global Management and
Miller’s Ale House from KarpReilly; and Sun Capital took
control of Johnny Rockets in a deal reportedly worth between
$100 million and $150 million, or 12x earnings before interest,
The inconsistency in public valuations worries Managing
Director Kevin Burke of Trinity Capital, who believes it’s
better for exiting owners to get paid upfront via a private sale
than leave to chance the vagaries of the public markets, which
might hamper follow-on offerings.
Although an IPO may be appropriate for expansion-minded
chains, the stock market has not been kind to small-cap and
micro-cap companies in periods of uncertainty. “The fact that
some of these [chains] have gone public as micros,” he warns,
“leaves them as the very first things to be sold in the event of
an economic slowdown.”
— David Farkas
Page 7
M & A CENSUS
Page 8
Page 9
MARKET surveillance
Carrols Restaurant Group
Papa Murphy’s
Good Times Restaurants
TAST · nasdaq
FRSH · nasdaq
GTIM · nasdaq
Follow-on Equity Offering
Initial Public Offering
Exercise of Warrants
Date Completed: April 24, 2014
Shares Sold: 11,500,000 shares
Price Per Share: $6.20
Net Proceeds: $67.2 million, net of
expenses
Use of Proceeds: The company
intends to accelerate remodeling of the
company’s Burger King restaurants to
the new 20/20 image and has plans to
acquire additional franchised Burger
King restaurants.
Underwriters: Raymond James &
Associates and Stephens Inc. were joint
book-running managers.
Date Completed: April 24, 2014
Shares Sold: 5,833,333 shares
Price Per Share: $11.00
Use of Proceeds: The company intends
to repay $54.9 million in principal on
its senior secured credit facility and
pay a $1.5 million termination fee on
its advisory services and monitoring
agreement with Lee Equity, its private
equity sponsor.
Underwriters: Jefferies & Co., Robert
W. Baird & Co. and Wells Fargo
Securities were joint book-running
managers. William Blair & Company;
Raymond James & Associates and
Stephens Inc. acted as co-managers.
Date Announced: May 7, 2014
Amount Raised: $3,110,500
Shares Issued: 1,227,550 shares
Price per Share: $2.50
Terms: The warrants were issued in
connection with a public offering of
2.2 million shares of common stock
completed in August 2013.
INCOME STATEMENT
Three months ended March 30, 2014
Revenues:.....................$151,453,000
Net Loss:...............................($7,429,000)
Net Loss Per Share:............................($.32)
BALANCE SHEET
As of March 30, 2014
Cash:.................................$1,402,000
Long Term Debt:..................$158,753,000
Shareholders’ Deficit:...............($141,000)
SUMMARY:
Carrols Restaurant Group, Inc. is
Burger King’s largest franchisee, with
560 restaurants as of March 30, 2014.
Comparable restaurant sales decreased
2.5% in the first quarter of 2014, due
to lower customer traffic of 6.7%,
reflecting the impact of winter weather.
The company expects to have adjusted
EBITDA of $38 million to $42 million
in 2014.
INCOME STATEMENT
Six months ended March 31, 2014
R e venue s:................ $12 ,152 ,0 0 0
Net Loss:................................($762,000)
Net Loss Per Share:........................($.10)
BALANCE SHEET
As of March 31, 2014
INCOME STATEMENT
Fiscal year ended December 30, 2013
Revenues:.....................$80,495,000
Net Loss:...............................($2,572,000)
BALANCE SHEET
As of December 30, 2013
Cash:.................................$3,705,000
Long Term Debt:.................$170,000,000
Shareholders’ Equity:............$33,925,000
SUMMARY:
As of December 30, 2013, Papa Murphy’s
had 1,418 system-wide stores, consisting
of 1,349 franchise and 69 companyowned stores, located in 38 states,
Canada and the United Arab Emirates.
From 2004 to 2013, the company’s
system-wide sales increased from $385.9
million to $785.6 million.
For fiscal year 2012, the company’s
domestic franchise stores open for at
least one full year generated average
weekly sales of approximately $11,100
and generated a store-level EBITDA
margin in excess of 15% after royalties
and advertising, but before the impact
of manager/owner salary.
Upon completion of the offering, Lee
Equity will own approximately 41% of
the outstanding common stock.
Page 10
Cash:.....................................$5,594,000
Shareholders’ Equity:.............$7,614,000
SUMMARY:
Good Times Restaurants operates
Good Times Burgers & Frozen
Custard, a regional chain of quickservice restaurants located primarily
in Colorado. Good Times provides a
menu of hamburgers, chicken tenders,
fries, frozen custard and lemonade.
Good Times currently operates and
franchises 37 restaurants.
The company also owns and operates
Bad Daddy’s Burger Bar restaurants
and will franchise the concept
through its 48% ownership of Bad
Daddy’s Franchise Development
LLC. Bad Daddy’s features gourmet
burgers, chopped salads, appetizers
and sandwiches with a full bar and a
focus on a selection of craft microbrew
beers.
The Company also appointed Robert
Stetson as a director effective May
2, 2014. Stetson is a former officer
of Burger King and Pizza Hut Inc.
Beginning in 1994, he built one of
the largest public REITs focused on
restaurant property development,
which later merged into GE Capital.
analyst reports
Texas Roadhouse
TXRH-NASDAQ
(Buy)
Recent Price: $24.33
Texas Roadhouse operates a full-service casual dining restaurant chain. The
company has 425 locations in 48 states. The chain was founded in 1993 and is
based in Louisville, Kentucky.
Zoe’s Kitchen
ZOES-NYSE
(Overweight)
Recent Price: $28.46
Zoe’s Kitchen operates a fast-casual Mediterranean food chain. The company has
111 restaurants in 15 states. It was founded in 1995 and is based in Plano, Texas.
Bloomin’ Brands
BLMN-NASDAQ
(Strong Buy-1)
Recent Price: $21.57
Bloomin’ Brands operates casual and fine-dining restaurants. It operates Outback
Steakhouse, Carrabbas Italian Grill, Bonefish Grill, Flemings Prime Steakhouse
and Wine Bar and Roys. It owns and operates 1,500 restaurants. The company
was incorporated in 2006 and is based in Tampa, Florida.
Texas Roadhouse issued a “solid” first quarter release, causing Stifel Analyst
Paul Westra to reiterate his Buy rating on the company’s stock. The company
reported operating EPS of 37 cents, and April company store comps of 1.6%
(which would have been 3.1% were it not for the Easter shift). The company’s
performance easily beat the 0.9% decline for casual dining, according to Knapp
Track. “We continue to expect TXRH to outperform its mass-casual peers
through its superior operations and strong brand positioning—enhanced by its
current ‘age of development’ where a majority of its stores are now in markets that
are at least 25% penetrated,” Westra said. The company reiterated its full-year
guidance, including positive same-store sales growth, 25-30 openings and low
single digit food cost inflation. The company’s P/E ratio of 19x “fails to reflect
TXRH’s above-average long-term growth prospects and the company’s strong
operating model.”
Piper Jaffray Analyst Nicole Miller Regan initiated coverage of Zoe’s Kitchen,
shortly after the chain’s successful IPO. She was one of several analysts that
initiated coverage with strong ratings for the fast-casual chain. Miller Regan
initiated coverage with an Overweight rating and gave the chain a $32 price
target, which is 18x estimated EBITDA in FY15. “We believe this multiple is
warranted given the scarcity value due to very few restaurant growth options from
a public company perspective as well as a proven strategy to continue market share
gains, the pipeline value of future development and the resulting opportunity
for operating margin leverage that generates earnings upside,” she said. She
added that “human capital trumps financial capital” and views the pedigree of
the company’s team and its historical success as critical. She said the company
is a proven brand, which is “on-trend from a food perspective.” And she said the
growth story is “multi-dimensional,” in that it covers both same-store sales and
restaurant unit growth.
Raymond James Analyst Bryan Elliott reiterated his Strong Buy rating on
Bloomin’ Brands despite the company’s mixed first-quarter results. Comps were
in line, but margins disappointed. Management reiterated its earnings guidance,
which included significant margin improvement from the second through fourth
quarters. Investors seemed to question this, and sent the stock down 2.5%. “BLMN
is now down over 20% since reaching $26.21 on February 25 and now trades at
the lowest EV/EBITDA in our broad universe of restaurant stocks. We believe
this is a material mispricing and that management’s guidance seems achievable
assuming industry comps continue to stabilize.” Elliott said that this was the
18th straight quarter where the company’s comps exceeded The Knapp Track.
Page 11
CHAIN INSIDER
Former Quiznos executives, including ex-Chairman Rick
Schaden responded recently to claims made in bankruptcy
court they misled lenders who took over ownership of the
chain in a 2011 restructuring. In short, they say they’re
protected from legal liability based on that deal, and the
agreement included many “risk factors” that warned of
potential problems. Also, they seem to suggest those lenders,
Avenue Capital and Fortress Investment, as large, sophisticated
lenders, had plenty of resources with which to do their due
diligence and couldn’t possibly be misled by former managers.
Perhaps more interesting, however, is the 1,200-page filing
includes the 2011 agreement. And that agreement makes note
the company had actively considered a bankruptcy filing back
then. Many of those very risk factors, in fact, cover various
contingencies from bankruptcy. Alas, Schaden’s filing didn’t
work: The bankruptcy court approved Quiznos’ reorganization
plan, including the litigation issues.
Speaking of Quiznos, those wondering why Avenue and
Fortress would take over the company, with $600 million
in debt still on the books, should look at the profit numbers.
In 2010, the last full year before the company’s previous
restructuring, the company’s operating profit was $81.9
million, off of revenue of $466.3 million, according to the
sale agreement in the Schaden filing. That’s a 17.5% margin.
And that margin actually increased to 20% in the first nine
months of 2011.
Panera Bread made a lot of noise recently with its “Panera
2.0” concept, which includes stand-alone kiosks for to-go
ordering, tabletop kiosks for in-store dining, and online
ordering. The idea is to improve throughput. Franchisees
have been implementing these changes, but there’s a problem:
confusion. Apparently, the changes have been problematic for
both operators and staff as they try to adapt to the radically
different store strategy.
Restaurant sales were supposed to improve as the weather
warmed, but we’ve seen little evidence of this. According to
Black Box Intelligence, same-store sales rose 0.6% in April.
Improvement? Yes, but traffic fell 1.1%. And of course, casual
dining remains bleak. According to the Knapp Track Index,
casual dining traffic fell 2.4% in April, while comps were
down 0.8%.
Speaking of casual dining, one operator told us recently
he thinks casual dining margins on average have fallen 200
basis points since the recession, thanks to a confluence of ugly
events: falling sales and rising labor and food costs.
Monitor he left the company in March along with a credit
officer. The size of AIG’s restaurant and convenience store
portfolio peaked at around $350 million in 2007 and was
roughly $150 million when the decision was made to cease
operations. For more information, contact Greg Burns at 612940-0960 or daburnsmn@msn.com.
Beverage consultant George Hiller says that consumption
of carbonated soft drinks by consumers continues to decline,
being driven by a focus on health and wellness as well as a
demand for variety. Hiller thinks this will continue to create
significant challenges (as well as opportunities) for restaurant
companies that rely on these products for a significant portion
of their profitability. More focus is on categories such as
flavored and vitamin-enhanced waters and specialty drinks
made from tea. For more infomation, contact George Hiller
at (515) 226-7812 or georgehiller5@gmail.com.
Madison Jobe has been named vice president of franchise
development at Dickey’s Barbecue. He was formerly chief
development officer at Pizza Inn.
Citizen’s Financial Group, a wholly owned banking
subsidiary of RBS (Royal Bank of Scotland), has filed to go
public. The bank’s franchise finance group, RBS Citizens
Franchise Finance, provides financing to restaurant
companies, convenience stores and gas stations on a national
basis.
Lenders are still looking for good credits, and it helps that
Newk’s Eatery is posting good numbers. When founding
shareholders Don Newcomb, Chris Newcomb and Debra
Bryson sold a 55% interest to Sentinel Capital Partners last
month, Regions Bank was the lead arranger on the senior
debt in the deal. Cadence Bank also participated.
National Restaurant Search is now known as NRHSearch
(National Restaurant Hospitality Search). Still heavily rooted
in the restaurant business, the firm has broadened its base to
serve private equity firms and other businesses crossing into
the hospitality sector. For more information contact Ron
Stockman, CEO, at ronstockman@nrhsearch.com.
Bill Spae, former chief operating officer of CiCi’s Enterprises,
is the new CEO of Vasari LLC, the second largest Dairy
Queen franchisee with 74 units in Texas and Oklahoma.
And food costs are surprising some people. Pork prices have
skyrocketed this year because of a virus hitting infant hogs. As
prices have risen for pork, chicken prices have gone up, too,
and beef prices remain ridiculous. Meanwhile, cheese prices
are high. Pizza Hut franchisee NPC International said its
food costs are up 2% to 3% this year, which is unfortunate
given the company had expected food cost deflation in 2014.
The AIG Franchise Finance group was disbanded recently.
Greg Burns, formerly vice president of the group, told the
Page 12
Ovation Brands’ ‘Reinvention’ Generates Some Strong Sales
Here’s a tip the next time you speak with Anthony Wedo, the
CEO of buffet chain operator Ovation Brands: Don’t call his
company’s current upgrade program a “remodel.” I did that
during a recent interview at one of the chain’s remodeled Old
Country Buffet units in suburban Minneapolis, and Wedo
was quick with a correction.
“It’s way beyond a remodel, it’s a reinvention,” he said. “It’s
the biggest initiative in the company’s history.”
Wedo was emphatic for a reason: The change is big, and it’s a
change his company badly needs to make.
Ovation is the former Buffets Inc., the company that filed for
bankruptcy twice in four years before Wedo took the helm
in late 2012. The company’s brands, including Old Country
Buffet, Hometown Buffet, Ryan’s and others, have locations
and reputations that are badly outdated and a business model
that encouraged gluttony.
My own last visit to an Old Country Buffet didn’t exactly
inspire fond memories. That was six years ago, in 2008. At
the time, I wrote the restaurant “looked as if it hadn’t been
updated since the Reagan administration,” with old curtains
and Norman Rockwell paintings and family seating.
The food, served in the traditional buffet “pile-your-plate”
fashion, was lowest common denominator stuff. The fare
was hardly inspirational, and there were few vegetables. Still,
we stuffed our faces as if we’d just spent the previous month
eating nothing but stale crackers. If we couldn’t get quality,
we were certainly going to get quantity.
And that was a big problem for the company and its
concepts—well, that and more than $600 million in debt left
from the 2006 merger of Buffets with Ryan’s, not to mention
a big sale-leaseback of nearly half of its 634 locations the next
year, which happened to be the height of the market.
Lots of debt, lots of leases and a declining economy quickly
took its toll on the company and it filed for bankruptcy in
2008. Buffets cut its debt in half, but still suffered many of
the same problems—and those leases started looking even
worse as sales kept falling—and thus another bankruptcy
was filed in 2012.
Lots of debt and expensive leases keep companies from making
changes necessary to get customers back in the door. Brands
have to keep fresh, and Buffets was anything but back in late
2012 when Wedo took over.
Wedo was a veteran of KFC and Boston Market who later
became a turnaround specialist with Mainline Capital
Advisors before taking the Buffets job. Almost immediately
he started working on a new model for the company’s chains,
which also include HomeTown Buffet, Fire Mountain
and Tahoe Joe’s. Buffets also changed its name to Ovation
Brands—short for “innovation,” Wedo says.
It’s a much smaller company today than it was in 2007,
incidentally. The company has 340 units, just more than half
it had at its peak.
Reinventing the business was a key point in Wedo’s strategy,
because of the company’s years-long sales struggle. That
reinvention includes the remodel to a new image, which is
brighter, more airy and updated in stark contrast to the dated
locations of old.
Old Country’s buffet is now divided into stations with
individual names, including Main Street Bakery, which is set
up like an actual bakery, with workers making baked goods
behind the counter. The company also serves more individual
portions, which reduces waste and helps Old Country Buffet
control food costs, which have been skyrocketing in recent
years and, arguably, helped push the parent company into
bankruptcy.
The food also tastes better. The company changed many of
its recipes. During our visit we tried the pot roast, and it was
delicious, as was the cornbread stuffing and the rolls. We got
our drink from one of the Coke Freestyle machines at the
drink station.
It was a much different experience than I remember. Thus
the “reinvention” Wedo speaks of. “It’s a different chemistry,”
he said.
It’s also geared toward a different customer: families. Old
Country Buffet has long targeted families, because parents
with children love the variety the restaurants can offer, and
the quicker service. It’s the same pull that brings parents of
children to pizza buffet chains like Pizza Ranch and CiCi’s.
So the remodeled stores include game rooms where kids can
play video games. “Our primary target is new, young families,”
Wedo said.
“We combine the very best of casual dining with the very best
of an all-you-can-eat buffet,” he added. “And at a price that’s
an enormous value.”
So far, the effort is working. As Ovation has remodeled Old
Country locations in specific markets, it has backed those
remodels with television ads featuring Wedo himself, talking
up the chain’s benefits.
When the ads were shown in Denver after the remodels,
sales in that market went up 50%, Wedo said. With no ads,
the remodels still generated a 35% sales lift. “We’ve enjoyed
consistent performance along the same lines of Denver in other
markets,” Wedo said. “We anticipate the same performance
here.”
— Jonathan Maze
Page 13
Taxes and Real Estate: Some Considerations
By Christopher Volk
For most real estate-intensive restaurant companies, leasing
real estate is preferred to ownership. Leasing can lower their
cost of capital, create greater shareholder wealth and enhance
corporate flexibility relative to other financing options.
But, what if the sale of real estate triggers a material tax
consequence? This can be especially true for companies and
individuals that’ve held their real estate for a long time during
which they substantially depreciated the improvements. For
individuals (which includes S-Corporations and LLC’s), the
“recapture” of depreciation is taxed as ordinary income. The
highest personal marginal federal tax rate is currently 39.6%,
which will certainly take a bite out of the proceeds. For
C-Corporations, where all income is treated equally, the rate
most commonly used is 35%, which is also punitive.
Summary State Tax Facts
Personal
Corporate
Average Rate For States With Taxes
6.6%
7.3%
Maximum Rate
12.3%
12.0%
States with Taxes
42
45
States With No Taxes
9
6
Tax leakage from real estate sales can cause a reevaluation of
the merits of selling real estate. A summary financial model
using the highest marginal tax rates can best illustrate this:
Corporation Type
State Tax Rate
Model Output
LLC
9.74%
Average Added Cost Over
Pre-Tax Lease rate
2.24%
2.0
Initial Lease Rate
Pre-Tax Proceeds
R.E. Multiple
6.67X
7.5%
After-Tax Proceeds
R.E. Multiple
5.13X
Land Portion
of Value
20.0%
After Tax Multiple
Lost
1.53X
% Gain(Loss)
Over Cost (2)
10.0%
% of Proceeds Lost
22.98%
% Improvements
Depreciated
60%
1. The ratio of store-level EBITDAR to Rents
2. Gain spread evenly over land, building and improvements
The tax impact is material and can rightly cause one to
question the wisdom of selling real estate given such punitive
charges. A tax trap like this is not uncommon across businesses
from small to large and can have varying implications as
illustrated below:
Highest
Marginal
Corporate Tax
Rate 35%
40%
50%
60%
70%
80%
11.2%
14.0% 16.8%
19.6%
22.4%
12.7% 15.8% 19.0% 22.2% 25.3%
Highest
Marginal
Personal Fed Tax
Rate 39.6%
Average Allin Highest
Corporate Rate
42.3%
13.5%
16.9% 20.3% 23.7%
27.1%
Average All-in
Highest Personal
Rate 46.2%
14.7%
18.5%
29.5%
22.2% 25.8%
1. to simplify this illustration, tax leakage excludes capital gains taxes.
Effective After tax
Lease Rate
Unit Level Lease
Coverage (1)
The pre-tax lease rate may be 7.5%, but with the nearly 23%
in tax leakage, the after-tax lease rate escalates to nearly 10%
(this is computed by dividing the annual rents into the aftertax proceeds).
% Proceeds Due To Tax Leakage(1)
With state taxes the bite just gets bigger, unless you are
fortunate to live in one of the few states having no personal
or corporate income taxes. Add the state taxes to the federal
taxes and we are talking about average marginal tax rates in
the area of 46% for individuals and 42% for corporations.
And the average can get much worse, especially if you happen
to live in California or Iowa, which have the nation’s highest
personal and corporate tax rates.
Model Inputs
Using a fairly typical company illustration, and adding a
modest capital gain of 10%, the amount lost to taxes is
almost 23% of proceeds, or more than 1.5x EBITDA. In this
illustration, in addition to federal tax on recapture, there are
also federal taxes on the 10% of capital gains, which includes
the new 3.8% Net Investment Income Tax.
So, what can be done to avoid being a victim of a tax trap that
can result in electing sub-optimal financing options?
There is a range of choices, but the important thing to
remember is business leaders should take charge of their
own tax issues. That means addressing tax issues before ever
considering selling a business, because prospective buyers tend
not to show up with the answers.
In this regard, it is important to mention that selling real
estate in advance of a business sale will generally not detract
from corporate valuations. In fact, most financial sponsors
and other sophisticated investors tend not to want to own real
estate anyway and will sell it off concurrent with an acquisition.
Therefore, if forward tax planning is effective, the after-tax
value of a business can be greatly enhanced.
Page 14
How Much Was That Red Lobster Multiple Again?
As noted in the initial model, the value of this profit-center
real estate equates to a pre-tax EBITDA multiple of 6.67x.
However, this is not the value of the whole enterprise, because
companies that lease all of their real estate are often sold for
EBITDA multiples ranging from 4x to 6x. At a 5x business
multiple, the effective total pre-tax EBITDA multiple,
inclusive of the value of the profit center real estate, increases
to 9.17x as illustrated below.
Corporate Valuation Summary:
1. Leased Cash Flow Purchase Multiple
5.00X
2. Unit-Level Rent Coverage
2.00X
15.0%
4. Initial Lease Rate
7.5%
5. EBITDA/Real Estate Proceeds (3-4)
7.5%
6. Post Rent Value/Real Estate Proceeds (5 X 1)
37.5%
7. Total Value/Real Estate Proceeds (100%+ 5)
137.5%
8. Real Estate EBITDA Multiple (100%/3)
6.67X
Total EBITDA Multiple (7 X 8)
9.17X
Indeed, Darden said in its release that the purchase price was
9x forward EBITDA—which, at first blush, is proof once again
the M&A markets have reached bubble status. Who would
pay 9x for a reclamation project like Red Lobster?
The answer to that question isn’t Golden Gate Capital,
however. Because the true multiple for the Red Lobster
business is much lower.
Total Business and Real Estate Valuation
3. EBITDAR/Real Estate Proceeds (4 X 2)
Darden Restaurants announced a deal last week to sell Red
Lobster to Golden Gate Capital for $2.1 billion. It seemed like
a high price for a chain whose earnings have declined 21% in
the past two years.
On the same Friday morning Darden announced the Red
Lobster sale, American Realty Capital Corporation announced
it made a deal to buy 500 Red Lobster properties from Golden
Gate in a sale-leaseback transaction. The price: $1.5 billion.
That makes the real value for the Red Lobster business to be
$600 million. That’s a far more reasonable price for the chain.
Indeed, we estimate the real multiple Darden received for the
Red Lobster business to be in the 5 to 6x EBITDA range, more
in line with the poor condition of the business.
What are some of the choices business leaders can make to
increase the after-tax values of their businesses? It will depend
upon their objectives. For example, is the objective to realize
cash proceeds or to diversify holdings into assets of equivalent
value?
To maximize cash proceeds, options range from selling
property companies (the stock in a property company, rather
than the underlying real estate) to real estate retention using
various mortgage, participating mortgage or hybrid mortgage
options.
If the objective is to realize in-kind valuations, 1031 real
estate exchanges or real estate investment trust UPREIT
operating partnership unit exchanges are two of many
options. In selecting a path, it will generally be important
to simultaneously work with tax advisors and also with the
capital sources in the lease drafting process.
Tax traps are commonplace. However, with some planning,
business leaders can minimize their impact in order to
better optimize the after-tax valuations of their businesses.
Creating a successful business is very hard work. Preserving
that value entails, among many things, being attentive to tax
considerations. This is especially true for the leaders of real
estate-intensive businesses.
Christopher Volk is CEO of STORE Capital. For nearly 30 years,
Volk has directed companies that supply real estate mortgage and
lease solutions to businesses that use real estate. You can contact
him at 480-256-1100.
The initial cap rate Golden Gate will pay to American Realty
Capital on the Red Lobster sale-leaseback is 7.9%. That sounds
like a teaser rate to us. Over the term of the lease, the rate is
closer to 10%, as rents compound at 2% per year throughout
the 25-year term. Who signs 25-year leases on old casual
dining properties?
Golden Gate has its work cut out for themselves. The Red
Lobster brand has high costs and weak sales. Its price points
are high in an environment in which consumers are seeking
value. And many diners, notably families, are shying away
from casual dining chains largely because of those prices.
But it also has high unit volumes and a well-known brand
name that at one time or another resonated with customers.
The real estate sale, coming on the same day Darden
announced the Red Lobster deal, puts an exclamation point
on the primary concern of activists, that Darden is ridding
itself of a huge chunk of value by unloading Red Lobster.
Starboard Value and Barington Capital have been pushing
Darden to hold off on the sale, as they seek a broader change
at Darden—including a split of the company and a spin-off
of the company’s real estate. Darden has been pushing ahead
with the Red Lobster plan. Now, apparently, we know why.
— Jonathan Maze
Page 15
ANSWER MAN
Answer Man Gets the News He Needs From the Weather Report
You’re skeptical about weather’s impact on restaurants.
What about the reports from restaurants and retailers
about how terrible the previous winter was?
That the weather was nasty is not in question. It was pretty
bad. You see it mentioned ad nauseam in the quarterly reports
for many chains. It’s a short-term phenomenon, though. The
lousy weather exacerbated what’s already underway in the
restaurant and retail business. We’re in the midst of a major
transformation from old to new, baby boomer to millennial,
casual to fast-casual, and mall-based retail to on-line
commerce. The digital and social revolution has impacted our
business more than weather. Weather shmeather!
Where are you going with this?
There’s a lot more going on here than a snowstorm or two. Look
at what’s happening in retail. Old-line retailers are closing
stores left and right. Sears, J.C. Penney, Barnes & Noble,
Staples, Radio Shack and Office Max have all announced
big store closures. Malls have not recovered from their peak
vacancy rates during the recession. Restaurants may be next.
I don’t see a lot of big restaurant closings, do you?
But, haven’t you lost that business for good?
In the restaurant business, bad weather is merely a postponement
of spending, not an elimination of it. Customers delay their
visits, but they should return if the restaurant is one they
want to return to. A snowstorm that shuts down a restaurant
business during a weekend in January can be made up with
good weather in March. In the course of a year, good weather
levels out the impact of bad weather. You don’t see CEOs
praising the good weather when their sales are up, do you?
I’m not too sure these CEOs would agree with you.
Of course they wouldn’t. Chipotle’s comp restaurant sales
were up 13.4% in January, February and March. Was that
because bad weather is actually good for Chipotle, and bad for
everyone else? Did consumers drop other restaurants because
of the bad weather, in favor of visiting Chipotle? Who knows.
Weather has absolutely nothing to do with what’s really going
on in the restaurant business, in the long run.
How do you explain the negative impact of the weather
on one chain, versus a chain such as Chipotle that had
no impact?
Unless you have a high-profile bankruptcy, restaurants close
their stores very quietly. When a lease expires in an old
restaurant, management doesn’t make a big announcement,
nor puts out a press release. They quietly take down the signs
and tell the customers to visit one of their other locations. You
can see old restaurants all over the country that have been
transformed into other businesses. I’ve seen restaurants become
banks, pawn shops, liquor stores and dry cleaners. Next time
you are driving around town and see a Title Max store, or
pawn shop, look closer, and you’ll see it was once a QSR like
Burger King or Arby’s. Old fast food buildings on the wrong
side of Main and Main, make great title loan businesses.
As I said earlier, weather is a temporary situation. You have to
look at other factors. Bad weather can be extremely hazardous
to a chain that’s undercapitalized or overextended. With a bad
winter, they might not have enough time to hang on for the
good weather to catch up the cash flows. I remember working
for a casual dining chain in the mid-‘80s. We suffered six
straight weekend snowstorms. The weather eventually came
around and we went back to normal. However, it did put a
crimp on our cash flows. The answer is this: Don’t overextend
yourself and you don’t have to worry about the weather.
So blaming weather for a restaurant’s problems is a bad
excuse?
I would tell all of your CFO readers to build in a few crappy
weekends in their forecasts for 2015. And, if we’re lucky to get
a warm winter, they can tell their CEO to stand up and take
a bow for what a great job he did building sales. You know
most CEOs will.
Yes. It’s an excuse that gets every CEO and restaurant owner
off the hook from having to deal with the real issues in their
brand. If traffic has declined in seven out of the last eight
years in casual dining, how do you say with a straight face
that weather was the cause of the decline this year?
How would you forecast next winter?
Answer Man, a former casual dining restaurant executive, has
been out of work for so long the Bureau of Labor Statistics classifies
him as MIA.
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