Restaurant
Finance
Monitor
R
Volume 25, Number 1 • Restaurant Finance Monitor, 2808 Anthony Lane South, Minneapolis, MN 55418 • ISSN #1061-382X
January 22, 2014
OUTLOOK
2014 Outlook: Improving Sales, But Intensifying
Competition
Restaurant chain executives at the recent ICR XChange
Conference in Orlando were surprisingly confident this year
considering their recent sales had been frozen in a Polar Vortex.
Perhaps they should be confident. After all, this was an
investors’ conference, and many of these same investors had
helped build up restaurant stocks last year in spite of broadly
weak sales. Executives used share buybacks, dividends,
discounting and other methods to hide the impact of those
sales, and their stocks rose 45 percent on average, 50 percent
higher than the broader markets.
And then consider that many enter a year in which
comparisons get awfully favorable. That’s the thing about the
restaurant business: Weather might make your sales horrible
this month, but in a year your comps will soar and you’ll look
like a genius.
But many of the same afflictions that troubled the industry
in 2013 aren’t going away in 2014. The economy remains
bifurcated, good for consumers who own homes and stock,
but not so good for a middle class hit by that payroll tax
increase last year. Many of those consumers will pay health
care premiums this year, or substantially higher premiums,
thanks to Obamacare.
“I’m not particularly optimistic,” said Wally Doolin, the CEO
of Black Box Intelligence, publisher of the closely watched
Black Box sales index. “Disposable income just isn’t growing.
And we’re in the disposable income business.”
That disposable income isn’t growing because employment
growth remains weak overall. Unemployment is hovering
around 7%, and until job creation speeds up markedly, the
industry will keep spinning its wheels. Some chains will be
able to increase traffic and sales, but that traffic and sales will
come at the expense of other restaurants.
The National Restaurant Association this month predicted
restaurant sales would increase by 3.6% in 2014, to $683
billion. That might seem relatively healthy, but when adjusted
for inflation that growth is just 1.2%. And that is low by
historical standards, said Hudson Riehle, senior vice president
of research and knowledge for the NRA.
Franchise Finance & Growth Conference
March 26-27, 2014 • The Venetian Las Vegas
Make plans to attend our Franchise Finance & Growth
Conference, March 26-27, 2014 at The Venetian in Las
Vegas. The conference provides an excellent opportunity
for franchise owners and executives to connect with
franchise lenders and investors over the two-day event.
The conference is jointly produced by the Monitor and its
sister publication, Franchise Times magazine.
At this year’s event, we’ve collaborated with BoeFly, an
online lending marketplace, to create a national version
of their successful regional Franchise Lending Spotlight
Conferences, which matches up lenders with growing
franchise chains.
The Franchise Finance & Growth Conference will feature
presentations from 30+ successful franchise companies,
including Arby’s, Bojangles, Carl’s Jr., Corner Bakery,
Culver’s, Dairy Queen, Hardee’s, McAlister’s, Newks
and Zaxby’s. The companies will discuss their growth
and brand initiatives. Franchise lenders, investors and
prospective multi-unit franchisees will be especially
interested in their growth plans.
In addition to the franchise company presentations,
conference attendees will hear keynote presentations on best
practices from franchising’s best and brightest, including
sessions highlighting the current lending and investment
environment for franchised businesses.
Dealmakers of the Year
Franchise Times is celebrating franchise dealmaking by
honoring the best financial transactions in franchising in
2013. Winning Dealmakers will take center stage during
the Dealmaker’s Awards Luncheon at the Conference
on March 27th.
Jimmy John To Keynote
Jimmy John Liautaud, founder and CEO of the successful
Jimmy John’s Gourmet Sandwiches concept, will keynote
the opening general session on March 26th. Jimmy’s passion
for excellence is what drives him and his team members
in their 1,800 stores. He’ll reveal some of his winning
ways during his talk.
Register now for the conference at www.restfinance.com
or call us at 800-528-3296. Space is limited.
Continued on Page 8
© 2014 Restaurant
Monitor
Page Finance
1
FINANCE SOURCES
Eagle Merchant Partners Becomes Second-Largest DQ Zee; Cadence Bank Provides Senior Debt
Everyone has a favorite Dairy Queen story, and that’s the
case for longtime PE exec Stockton Croft, as well. Years
ago he was driving his girlfriend—now wife—to his parents’
cabin in northern Georgia to pop the question. On the way,
they stopped at Dairy Queen for a Reese’s Peanut Butter
Cup Blizzard. “There’s something about it (the brand) that’s
emotional,” he said.
expedited the process.
It’s that Blizzard and its sister products that have helped turn
Dairy Queen into a 70-year-old iconic brand. That legacy
is one of the reasons Croft’s PE firm bought into it. In fact,
with its first $20 million fund, Eagle Merchant Partners
purchased the second largest franchisee in the U.S. system,
Vasari LLC, in December.
Dairy Queen Chief Financial Officer Mark Vinton said, “We
welcome EMP and Cadence Bank to the DQ system and we
look forward to a successful future working together. While
the structure and ownership of our franchisee Vasari LLC/
EMP may be different than what we’ve traditionally seen in
the DQ system in the United States, the importance of the
relationship between franchisee and franchisor remains as
one of the most important aspects for success in our business.
The principals of EMP provide a solid foundation for such a
relationship so we can achieve our common goals.”
The deal consisted of 74 restaurants, the majority of which
are located in and around the Dallas-Fort Worth metro area.
It includes the development rights to 16 additional locations
in the area, and a commitment to remodel 70 of the units.
“They weren’t used to a PE firm coming in to buy units, but
things came together in a relatively short period of time,” he
said. “I would say having a group like Eagle in the DQ system,
someone who is investing in stores and upgrading locations
and the returns that brings, is good for the brand.”
“There are many, many acquisition opportunities, too,” said
Croft, speaking of the many single- and multi-unit operators
dotting the DQ landscape.
Croft reports the firm will continue to raise additional funds
for future investments in the restaurant industry. The team
is responsible for raising more than $200 million of capital
since 2010 for investments.
Croft and his partners at Eagle Merchant Partners have been
down this road before. In 2004, when he was a partner with
PE firm Argonne Capital, they purchased the largest IHOP
franchisee in Texas, which has almost doubled its store base
over the life of that investment.
For more information on Eagle Merchant Partners, contact
Stockton Croft, Partner, at (404) 974-2480, or by email at
scroft@eaglemerchantpartners.com. For more information on
Cadence Bank, contact Dan Holland, Executive Vice President, at
(770) 551-8180,or by email at daniel.holland@cadencebank.com.
“I think our internal goal would be 150 to 200 total units in
the next 10 years,” Croft added, “with the majority of them
being new builds in the next couple of years.”
Sanger Joins Bank of America Merrill Lynch
Dan Holland, Executive Vice President of Cadence Bank, had
never financed a Dairy Queen operator until this transaction, in
which the bank provided $18.5 million of senior debt. It was a
vote of confidence for the Eagle Merchant Capital principals—
Holland had provided senior financing on Argonne’s initial
IHOP deal with a previous bank, so he knew Croft from that
transaction. But he also liked what he saw when he started to
“peel back the layers of the onion” on the deal.
“It could have been an easy deal to dismiss,” he recalled. “We
could have said, ‘We’re not looking at Dairy Queen right
now.’” But the history of the EMP principals got him and his
credit team to take that second look.
“As I started to do more research on the brand, it has so many
positives,” said Holland. It’s owned by Berkshire Hathaway,
for starters, and boasts 6,000 locations worldwide. “When we
went through it, we started checking off all the boxes: Vasari
has some of the highest unit-level economics in the system,
and they are located Texas, which is a great restaurant market.
This is coloring outside the lines a bit for us, but we’re still
utilizing the same underwriting metrics as with other brands.”
And according to Holland, the brand hasn’t been followed by a
lot of the national lenders—most franchisees receive financing
from their local bank—but working with the franchisor
Bank of America Merrill Lynch has appointed Valerie
Sanger as a Managing Director and Senior Client Manager
in the company’s Restaurant Finance Group. In this role,
Sanger delivers strategic financial solutions to large, multi-unit
restaurant franchisees and franchisors across the U.S.
Based in Houston, Sanger reports to Cristin O’Hara,
Managing Director and Market Executive of the Restaurant
Finance Group. For 30 years, the group has provided operating
companies, franchisors and franchisees with a wide range of
solutions, including financing for new unit development and
remodels, acquisitions, recapitalizations and working capital.
Sanger was a senior consultant at Peak Franchise Capital, a
boutique advisory firm in the restaurant arena focusing on
distressed transactions, M&A activity, sale-leasebacks and
debt refinancing. Before that, she spent most of her career at
JPMorgan Chase and predecessor organizations.
As division manager of Chase Franchise Finance, Sanger
managed a $2 billion loan portfolio, and her team provided
solutions for such companies as Pizza Hut, KFC, Taco Bell,
McDonald’s, Shell and ExxonMobil. Prior to her experience
in Chase Franchise, Sanger was a senior client manager in
private banking based in Manhattan covering national clients.
For more information on Bank of America Merrill Lynch, contact
Cristin O’Hara, Managing Director, at (617) 434-1897 or by
email at cristin.m.o’ hara@baml.com.
Page 2
Auspex Closes Restaurant M&A Transactions
Auspex Capital, a boutique investment banking firm, recently
closed on the following transactions:
strategic global franchise advisory to companies looking for
growth via franchising.
• Sky Ventures, LLC, a Golden Valley, Minnesota-based Pizza
Hut franchisee owned by Lee and Jeff Engler, has sold 54 Pizza
Hut restaurants located in Minnesota. MUY Pizza Minnesota,
LLC, owned and operated by YUM! Brands franchisee Jim
Bodenstedt, was the buyer. Auspex was the sell-side M&A
advisor for the transaction.
Recently, his firm led and completed an M&A transaction for
a client in Canada—the acquisition of Burger King Canada,
which included 126 restaurants plus master rights for the
country, from Burger King Worldwide. Furthermore, they
also currently provide global franchise advisory services for
Benihana Corp., which was acquired by private equity firm
Angelo Gordon in 2012.
• Plaza Dine, Inc., a Jacksonville, Texas-based Taco Bell
franchisee, secured a $10 million senior secured term loan,
including a $3 million remodel and development line of credit.
The transaction was financed by City National Bank. Plaza
Dine is owned by franchisee Dennis Durrett who owns and
operates 14 Taco Bell restaurants in and around Dallas, Texas.
Auspex structured the transaction and was debt placement
agent.
• Paris and Potter et al., a Fayetteville, North Carolina-based
KFC franchisee owned by Nick Potter, obtained a $12 million
senior secured term loan. The transaction was financed by a
local bank. As part of the recapitalization, the company also
completed a sale leaseback of five properties, which was provided
by a local family office. Paris and Potter owns and operates
31 KFC and KFC co-branded restaurants in North Carolina
and South Carolina. Auspex was debt placement advisor and
sale-leaseback placement agent for the transaction.
Northland Restaurant Group, LLC, a Eau Claire, Wisconsinbased Hardee’s franchisee obtained a senior secured term loan
for the acquisition of four Hardee’s restaurants. The transaction
was financed by City National Bank. Northland Restaurant
Group is owned by franchisee Jon Munger, who now owns
and operates 71 Hardees restaurants in various states. Auspex
Capital was buy-side M&A advisor and debt placement agent
for the transaction.
Auspex Capital’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, Managing Director, at 562-424-2455
or by email at ckelleher@auspexcapital.com.
“What I found was that middle-market businesses, smaller
restaurant companies that currently are franchising or
contemplating franchising, may not have the expertise or
the money to put together a franchise program,” he said.
Outsourcing that may be more effective. It also is about
helping these same companies with capital access, managing
franchisee exits and the renewal process.
In an effort to more quickly grow the M&A practice, DeepBlue
has teamed up with Metronome Partners and its Managing
Director Randy Karchmer, former head of Morgan Keegan’s
middle-market investment banking group.
“I’ve known Manny a long time,” said Karchmer, “and when we
started talking it seemed to be a great match.” At Metronome,
“we had the notion of partnering with operators. We’re never
going to know the operations like an operating guy.” Typically,
Metronome has been engaged on larger deals—$50 million
to $500 million. And while DeepBlue can work on the larger
transactions as well, they also specialize in the $6 million to
$10 million deal range.
For more information on DeepBlue Advisory, contact Manny
Portuondo, Managing Director, at 305-905-9620, or by email
at mportuondo@deepblueadvisory.com.
Meritage Picks Up More Wendy’s Units
Meritage Hospitality, a Wendy’s franchisee with more than
70 locations, has acquired six locations from North Florida
Management. Restaurant industry brokerage Advanced
Restaurant Sales was retained by North Florida Management
Former BK Franchise Exec Forms Advisory Firm to evaluate the transaction and find appropriate candidates
for the sale. North Florida will remain a Wendy’s franchisee
Former Burger King executive Manny Portuondo has formed with seven stores.
DeepBlue Advisory, an M&A and franchise advisory practice.
As vice president of franchise development and director of Advanced Restaurant Sales has represented franchisees of major
strategic franchising at Burger King, he was charged with restaurant concepts, and has relationships with private equity,
traditional franchise sales, working with existing franchisees on lenders and franchisees of those concepts in order to provide the best
M&A deals, and the buying and selling of corporate locations. opportunities for their clients. For more information on Advanced
Restaurant Sales, contact Patrick Silvia, 678-229-2384, ext. 1,
He’s bringing that experience to bear with his new firm.
or by email at psilvia@advanced-restaurantslaes.com.
According to Portuondo, DeepBlue focuses on providing M&A
advisory services in the restaurant industry, as well as global
franchise advisory. Key clients include private equity sponsors
and restaurant companies and franchisees that require either
buy- or sell-side advisory. In addition, DeepBlue provides
Page 3
2013 MARKET REVIEW
Irrational Exuberance In Restaurant Land
With the stock market peaking in 1996, former Federal
Reserve Chairman Alan Greenspan asked this question: “How
do we know when irrational exuberance has unduly escalated
asset values?”
The phrase “irrational exuberance” was described by the
economist, Robert Shiller, as a “heightened state of speculative
fervor.” The stock market declined temporarily after
Greenspan’s comments, but then rose again, peaking in 2001.
When the “tech bubble” burst that year, and stocks retreated
violently, investors remembered Greenspan’s prescient
comments. Later, Greenspan received the blame for the
accommodative Fed policy that lead to the tech bubble, and
then of course, the housing bust of 2008.
Today, economists and market commentators are concerned
again about the levitation of asset prices in general, and
stocks in particular. This comes ironically as Greenspan’s
heir, Ben Bernanke, and now Janet Yellen, have their finger
on the money accelerator. The $85 billion in monthly US
Treasury bond purchases, now tapered to a mere $75 billion,
keeps interest rates low and distorts basic investment decision
making, say its critics.
In a perfect world, the value of an investment is determined
by discounting its future free cash flows at a given rate of
return. The present value should roughly equal the curent
value. James Grant, editor of the highly respected Grant’s
Interest Rate Observer, says the “Fed’s accommodative policy
is distorting the calculations by which the market has been
traditionally valued.”
As Grant told a CNBC audience in December: “If the
interest rate at which you discount is under the thumb of the
government, then every calculation is hash.”
When interest rates remain low for an extended period,
investors chase yield, or pursue momentum stocks with high
multiples, not because they believe in the value, but because
the alternative is so unattractive. Companies eschew hiring
and growth, and instead divert funds to share buybacks and
dividend payouts, not because of the intrinsic value of their
shares, but because debt is cheap, and management knows it
drives up the stock price.
The Fed-induced stock market rally has gone on now for five
straight years, and last year’s performance was a barnburner.
In 2013, the US stock market finished its best year since
Greenspan’s “irrational exuberance” years of 1995 to 1999,
with the S&P 500 index up 29.6%. Social media and digital
companies such as Twitter, Yelp, Netflix and Facebook were so
strong they brought back memories of the dot-com era stocks.
Restaurant stock performance was stellar. In 2013, public
restaurant companies recorded their best share performance
since the Monitor began analyzing these stocks in the early
1990s. Fifty-five of the 60 public restaurant company stocks
we track traded higher over the past year, with an incredible
40 companies beating the S&P 500’s 30% benchmark return.
Speculative fervor in restaurant equities isn’t new. In 1996
and 1997, there were 24 initial public offerings of restaurant
companies, a stretch of offerings that’s never been equaled.
Some of the restaurant companies that went public then, such
as Famous Dave’s and Einstein Noah Restaurant Group, are
still in business. However, the majority of restaurant companies
that issued new shares in that era, like Ciao Cucina and Big
City Bagels, disappeared only a few years after going public.
The hot stocks in the ‘90s were bagels and coffee. The
highflyers of today are fast casual—Chipotle, Noodles and
Potbelly. Their shares trade in excess of 20x EBITDA, a level
that gives value investors pause. High valuations of a few
restaurant stocks isn’t necessarily evidence of a general asset
bubble, though. Historically, restaurant companies that carry
a multiple of 10x EBITDA or higher have a long runway of
growth in front of them. Investors have long argued they are
simply paying up for future earnings.
Not all high-flyers are created equal
But, what about companies whose share performance beat the
S&P index in 2013, and don’t have a growth runway? Some of
the market’s best performers in 2013 were in casual dining, a
sector that has serious operational issues, the most important
of which is hanging on to customers.
Brinker International’s (Chili’s and Maggiano’s) share price
appreciated 50% in 2013, and 240% over the past three years.
You wouldn’t know it from the company’s restaurant operating
performance. Chili’s, the mass market casual dining giant,
has had negative guest counts in eight of the last nine years.
And, in the quarter just ended in September, company-store
traffic was down 3.3%. Brinker’s stock is valued around 10x
EBITDA, and at $47, trades near its all-time high.
Why would Brinker’s shares trade at an all-time high when
the Chili’s business remains, shall we say, Red Lobsterish?
Welcome to American finance in the Bernanke era
Egged on by an accommodating Federal Reserve that favors
cheap borrowing to drive up asset prices, today’s captains of
industry have joined with private equity managers and activist
investors to rewrite valuation history.
Investors and acquirors can borrow at will, while corporations
practice a model that emphasizes the mathematical motherlode of corporate wealth creation: share buybacks. Buy shares,
earnings per share goes up, and voilà!, the stock price rises.
Since 2010, Brinker has repurchased over $1 billion (as in B)
of its common shares, retiring 28% of its outstanding issuance.
In its recent quarter, the company bought back 1.6 million
shares for $66.3 million ($41.43 per share) and increased its
dividend from $.20 to $.24 per share.
Brinker isn’t alone. According to FactSet, McDonald’s and
Yum Brands also bought back $1.3 billion and $489 million
of their shares, respectively, in the first three quarters of 2013.
Last month, the Wall Street Journal reported corporate stock
buybacks and dividends totaled $207 billion in the third
Page 4
quarter, the highest in nearly six years. PIMCO’s Bill Gross
suggested share buybacks were the main reason stocks were
appreciating.
Brinker bought back shares in 2010 and 2011 when the market
valued the company at about 60% of the multiple it gets on
its shares today.
What’s wrong with giving it back to the shareholders?
Warren Buffett argued in favor of share buybacks in his 1984
and 2011 Berkshire Hathaway shareholders letters. He said
share buybacks were advantageous especially when “shares
were trading at a material discount and priced well below
per-share intrinsic business value.”
If the current stock market multiple for a casual dining
company like Brinker is say, 10x EBITDA, it doesn’t
necessarily follow that a share buyback, or acquisition at less
then 10x EBITDA, is at a “material discount” to intrinsic
value. That’s because restaurant equities are trading at alltime highs. Jefferies restaurant analyst Andy Barish, in a
recent report, worries restaurant equities now trade at peak
valuations, even with broader industry fundamentals mixed.
What exactly is “intrinsic value” and how does a company
determine whether its shares are trading at a material discount,
especially in this gun-slinging era?
At Buffett’s Berkshire Hathaway, a conglomerate of insurance,
retail, railroads, media and a large investment portfolio,
Buffett uses per-share book value as a guide to intrinsic value.
Buffett says in his case, book value roughly tracks business
value and is a conservative valuation measure. If he can, Buffett
likes to buy back his shares around book value.
The Oracle’s emphasis on book value may not apply
However, book value has never been a very meaningful
valuation measure in the restaurant business, primarily
because assets and liabilities aren’t properly accounted for.
The carrying value of corporate real estate is generally on the
books at less than fair market value, and liabilities such as store
leases are often left entirely off the balance sheet.
At the end of 2013, there wasn’t a single restaurant company
in the Monitor’s universe of 60 companies whose share price
was less than book value. Brinker’s share price was roughly
twice its book value.
Public restaurant companies are typically valued based on a
price-earnings ratio, or more common, a multiple of EBITDA.
One might examine the reasonableness of share repurchases
comparing the multiple at which the company is repurchasing
shares to the company’s historical average.
But, even that can give a false reading. Restaurant valuation
expert Scott Roehr points out in a Monitor white paper
(download it at www.restfinance.com), that a common error
in the valuation of restaurants is the use of EBTIDA as a proxy
for debt-free net cash flow.
“EBITDA is not cash flow,” says Roehr.
As Roehr points out, EBITDA in any restaurant company
must be reduced by projected capital expenditures that may
include specific remodeling or reimaging requirements to
maintain operations at existing levels. Many a restaurant
acquiror has celebrated a low multiple acquisition only to
discover the remodeling expenditures were extensive.
Restaurant valuations are much more subjective, and a material
discount to intrinsic value is harder for company management
to determine. Positive changes in unit economics, or sustained
same store sales gains might not be recognized by the market.
“P/E and EV/EBITDA valuations have climbed to new peaks
well above the old historical high ends of ranges of 20x P/E and
10x EV/EBITDA, and the risk/reward for the group remains
challenging,” says Barish in his 2014 outlook.
Bank of America Merrill Lynch analyst Joe Buckley points out
in a recent note that the average price-earnings ratio (P/E) of
restaurant companies in his research universe moved nearly
five points higher over the course of 2013. That doesn’t leave
many bargains out there.
Each share bought back at a high multiple of EBITDA may
get the momentum crowd excited, and provide investors with
what one analyst told me is “window dressing.” However, the
share buyback may reduce, rather than increase, the value of
the company. An ongoing share repurchase program, without
material improvement in the underlying business, or at prices
above the intrinsic value, may be as Buffett points out, simply
“overpaying departing shareholders at the expense of those
who stay.”
In Yum’s case, CEO David Novak is so certain of a recovery
in KFC’s China business that he is buying back shares even
when the market already places a high value of 22x 2014
earnings and 11x-12x EBITDA on his company. Wouldn’t it
be more advantageous to buy back Pizza Hut and Taco Bell
franchisees at 5x to 6x EBITDA? And what about Wendy’s?
It just announced a $275 million share buyback, yet its shares
trade at 25x earnings and near 12x EBITDA, all the while it
sells off company stores to franchisees at 5x to 6x EBITDA.
Share buybacks at these high restaurant valuation levels aren’t
adding value. As the price of the shares gets increasingly
expensive, a company must purchase ever increasing amounts
to have the same effect on reducing earnings per share.
Money manager and former restaurant analyst, Roger Lipton,
thinks it makes no sense to buy back shares at these valuations.
“If I were running a mature restaurant chain, I would be selling
stock at 10x to 12x EBITDA, not buying it,” said Lipton.
Yet, companies keep buying shares at valuations that make
most long-term investors cringe. As long as rates stay low and
debt capital remains plentiful, the share buyback game will
continue.
—John Hamburger
Page 5
2013 MARKET REVIEW
Nowhere To Go But Up
The year 2013 was, as they say on
Wall Street, a “back-up-the-truck”
kind of year to buy restaurant stocks.
Everything went up. The second straight
year of giant-sized investment gains in
public restaurant equities drove most
of the restaurant stocks to “priced-forperfection” levels.
How hot was the year for restaurant
stocks?
According to the Monitor’s analysis of
public restaurant company performance
in 2013, nine restaurant companies
doubled their share price from a year ago,
and a whopping 40 of the 60 companies
we track beat the 29.6% gain of the S&P
500 index, a common benchmarking
index for investors.
Just about any restaurant company you
picked made big money for investors in
2013. Consider that 53 of the 60 public
restaurant companies returned greater
than 10% for the year.
The superstar performer of the year,
Fiesta Restaurant Group, operator and
franchisor of 172 Taco Cabana and 138
Pollo Tropical restaurants, finished the
year at $52.24 per share, a gain of 241%.
That gain came on the heels of an equity
offering of 2.7 million shares of common
stock at $46 which raised $124 million
in November. The company used the
proceeds of the offering together with
its credit line to redeem $200 million
in 8.875% senior notes.
Fiesta was created in May 2012 as a
spin-off entity of Carrols Restaurant
Group, Burger King’s largest franchisee.
The company began trading initially at
$12.50 per share. Since the creation of
Fiesta, shareholders have been rewarded
to the tune of 417%.
Pizza Inn had the second-best restaurant
year on Wall Street. Investors took
interest in the company’s Pie Five
quick-pizza concept. Quick-serve pizza
is fast becoming a hot segment with
both Chipotle and Buffalo Wild Wings
investing in separate pizza companies.
Since opening its first unit in 2001, Pie
Five Pizza currently has 18 locations in
four states.
STOCKS THAT OUTPERFORMED EVERY INDEX KNOWN TO MAN IN 2013
Company/
Stock Symbol
Closing
Price on
12/31/13
Fiesta
Restaurant Grp
(FRGI)
$52.24
+241%
Last year’s deal of the year, a Carrols
spinoff, attracts the restaurant analysts
seeking new meat.
Pizza Inn
(PZZI)
$8.06
135%
Pie Five growth becomes the only
public option to play the emerging
quick serve pizza business.
Kona Grill
(KONA)
$18.52
+113%
15-year old chain with $4.2 million
AUV’s and 18% margins draws a new
crowd of investors.
Red Robin
(RRGB)
$73.54
+108%
The switch from red plastic baskets to
plates is obviously the reason traffic
counts were up in 2013.
Krispy Kreme
(KKD)
$19.29
+106%
Any business that served coffee in 2013
received a sugar-glazed multiple.
Buffalo Wild
Wings
(BWLD)
$147.20
+102%
Beer and wings: It’s what any 21-35
year old male dreams about when they
aren’t drinking beer or eating wings.
Noodles & Co.
(NDLS)
$35.92
+100%
This richly valued IPO becomes an
even richer one once the institutional
investors pile into the stock.
Famous Dave’s
(DAVE)
$18.30
+99%
Buyout rumors tail the company,
although at the current price, even the
most aggressive investor would pass.
Ruth’s
Hospitality
(RUTH)
$14.21
+95%
The recession is over, customers are
back, prices are higher and steak
concepts are back in vogue.
Sonic
(SONC)
$20.19
94%
Investors shake off northern climate
expansion issues and reassess the brand.
Wendy’s
(WEN)
$8.72
+86%
Nelson Peltz finally learns to keep his
mouth shut and listen to Emil Brolick.
Chipotle
(CMG)
$532.78
+79%
Big burritos: It’s what any 21-35 year
old male wants to eat when they aren’t
drinking beer or eating wings.
Jack-in-the Box
(JACK)
$50.02
+76%
Slowly and surely the creepy Jack
character expands his corny schtick
around the country.
Potbelly
(PBPB)
$24.28
+73%
Jimmy Johns and Jersey Mikes lick their
chops when they see PB’s moonshot
valuation.
Cracker Barrel
(CBRL)
$110.07
+71%
Cracker Barrel shareholders should
thank their lucky stars Sardar Biglari
bid up this turkey.
Page 6
Change
from
2012
Market Commentary
Noodles and Potbelly Debut
Despite a frothy market, there were only
two initial public offerings in 2013, on
the heels of four in 2012. But the two,
Noodles & Co. and Potbelly, were highprofile deals which were offered at high
multiples.
Noodles, which operates 310 companyowned and 58 franchised fast casual
restaurants, went public in June to
tremendous demand. Offered at $18 per
share, the stock closed the first day of
trading at $36.75, and then top-ticked
$52 on the third day, as the momentum
traders’ greed took over.
The company’s private equity owners,
Catterton Partners and Argentia Private
Investors, took advantage of the hot
market, and on December 5th, sold
4.5 million of their own shares in a
secondary offering at $39.50 per share.
Noodles closed out the year at $35.92—a
double for those lucky enough to buy
shares on the initial offering, but less
than what shareholders paid on the
secondary offering a month earlier. At
the current share price, Noodles trades
at the princely valuation of around 20x
cash flow.
Potbelly Corporation went public on
October 4th at $14 per share and traded
as high as $33 the first day. Its model,
sandwich shops in a crowded sandwich
shop market, attracted investors with its
reported 20%+ store-level margins and
targeted 25%+ cash-on-cash returns for
new locations.
Potbelly projects annual new-unit
growth in the 10% range and 20%+
a nnua l net income grow th. It is
ramping up franchise growth, too,
especially internationally where it has
12 restaurants open in United Arab
Emirates, Kuwait and Bahrain.
In its first report as a public company,
Potbelly reported 29 new restaurants
opened during the first nine months
of the year—25 company-owned and
four franchised locations. The company
also reported a respectable 1.8% same
store sales gain for the first three fiscal
quarters.
STOCKS THAT UNDERPERFORMED THE S&P 500 INDEX IN 2013
Company/
Stock Symbol
Closing
Price on
12/31/13
Change
from
2012
Crumbs
Bake Shop
(CRMB)
$.81
-74%
Shareholders get crumbs for Christmas
and should be flogged for investing in
a cupcake stock.
Star Buffet
(STRZ)
$1.18
-54%
Emerging from bankruptcy in January
2013, the company finished the year
with negative comps.
Granite City
Restaurants
(GCFB)
$1.05
-50%
A funny thing happens to your stock
price when you decide not to file public
reports anymore.
Ruby Tuesday
(RT)
$6.93
-12%
“Lord” Beall’s masterpiece is crumbling
under the weight of multi-year sales
declines and negative cash flow.
BJ’s
Restaurants
(BJRI)
$31.06
-6%
Comp declines and tough competition
in California make casual dining a
tough proposition.
Ignite
Restaurants
(IRG)
$12.50
-4%
Maybe acquiring Macaroni Grill wasn’t
such a good idea after all.
McDonald’s
(MCD)
$97.03
10%
Ad agencies take the heat for
McDonald’s lackluster sales, yet the
stock still rises.
Carrols
Restaurant
Group (TAST)
$6.61
10%
BK’s largest franchisee targets remodels
and value positioning for 2014.
Jamba (JMBA)
$12.43
11%
Smoothie giant still can’t get consistent
positve same-store sales.
Panera Bread
(PNRA)
$176.69
11%
Slowing sales has company thinking
service and throughput sequence is the
problem.
Yum Brands
(YUM)
$75.61
14%
Taco Bell is the star performer when
KFC can’t shoot straight in China.
Thanks for the share buybacks.
Luby’s (LUB)
$7.72
15%
Growth is back on track for Luby’s and
Fuddruckers in 2014.
Tim Horton’s
(THI)
$58.38
19%
The results weren’t awful, except when
compared to Starbucks.
Einstein Noah
Restaurant
Group (BAGL)
$14.50
19%
Comp sales growth was a tall order in
2013.
Diversified
Restaurants
(BAGR)
$4.77
19%
Buffalo Wild Wings franchisee
branches out into better burger
category with Bagger Daves concept.
Page 7
Market Commentary
outlook
Continued from Page 1
The industry has grown at a 6.5% compound annual growth
rate over the decades, but over the last 10 years that CAGR
was only 4.2%. Over the last three years, the industry has
grown at just a 3.8% annual growth rate. Post recessionary
sales growth has been stuck in the mud.
“Employment growth is extremely modest compared to
what one might expect,” Riehle said. “Consumers’ cash on
hand remains constrained. It’s better, but it’s an environment
in which the consumer is deliberative about how they spend
their dollars.”
Indeed, Domino’s CEO Patrick Doyle said his biggest
concern about the economy is jobs. “People with jobs buy
more pizza than people without jobs,” he said.
But this isn’t holding back executives’ confidence. The
number of restaurant locations is expected to grow by 1%
this year, to 990,000. And employment growth in the
restaurant industry will grow at an even faster rate. The
number of restaurant industry jobs is expected to increase
by 2.8% in 2014.
By comparison, job growth for the national economy is
expected to be 1.8%. One out of 10 people working in the
U.S. works at a restaurant.
According to the NR A, fewer executives believe the
economy is a major hurdle. Two years ago, 30% of executives
thought the economy was their biggest challenge. This year
that’s down to 21%. But consumers remain concerned:
Nine out of 10 consumers are unimpressed by the economic
situation, Riehle said.
How can restaurant executives be more confident in the
economy when consumers remain so “unimpressed?”
The increase in the number of locations and the employment
growth in the industry, at a time of only modest sales and
economic growth, will mean executives will encounter
a more competitive environment in 2014, again. That
probably means more discounts and other efforts to get
customers in the door. And if you’re sick of seeing restaurant
commercials on television, you should find something else
to do, because they’re not going away.
It also could mean more closures. Already, Ruby Tuesday
plans to close 30 locations as it seeks to recover from a
seven-year string of brutal sales weakness that has some
wondering whether it has any value beyond its real estate.
F&H Acquisition Corp., owner of the Champps and Fox &
Hound chains, has filed for bankruptcy. A few other chains
are on the block, in part because their owners can’t seem to
reverse sales trends—like the Darden-owned Red Lobster.
At least from a sales standpoint, therefore, 2014 will be just
as uneven as 2013. “There are companies that are going to do
well,” Doolin said. “And there are others that aren’t. That’s
the name of the game. We will see winners. But more and
more you’re going to see companies that may not survive
the long-term.”
Technology improvements
The restaurant industry is not known for its technological
prowess. At ICR, Dunkin’ Brands CEO Nigel Travis said
joining the QSR industry after years at Papa Johns and
Blockbuster was like “going back in time.” But amid an
intense competitive environment, that industry is catching
up.
Travis and several of his fellow restaurant executives at ICR
talked about their chains’ improvements in customer-facing
technology. They include tabletop ordering systems at Chili’s
and Applebee’s, mobile ordering at several concepts and the
growing use of online ordering at pizza chains and other
restaurants. Mobile ordering is the next big thing at fast
food restaurants like Wendy’s and Panera Bread.
Guy Constant, CFO at Chili’s owner Brinker International,
even said that a combination of technology like mobile
payment and online ordering, combined with his company’s
curbside to-go business, could give the casual dining sector
a leg up on fast casual.
“We believe it’s casual dining’s opportunity to out-fast fast
casual,” he said. “It can allow you to avoid the queue you
get at fast casual restaurants.”
The brands are following the lead of the pizza sector, which
has been aggressively adding new ways for customers to order
for years. Domino’s, for instance, now gets 40% of its orders
through its website or through its mobile app.
Not everybody is on board with the idea of adding
technology, at least for now. Some chains have apparently
scrapped plans for tabletop ordering systems after tests
weren’t favorable. Others simply believe the time isn’t right.
But there is nevertheless a belief among executives that
technology is increasingly the cost of entry in the restaurant
business. After all, younger diners accustomed to technology
know this ability is out there, and they are less likely to
suffer from mistakes made by humans. In other words,
those chains that don’t have technology will lose business.
Lending, mergers, acquisitions
Lending in the restaurant industry remains robust, and
is getting better. Anybody who attended our Restaurant
Finance & Development Conference in November saw
far more lenders than there were two or three years ago, at
least a dozen.
For the most part, the growth in lending had only been a
real benefit to bigger operators and major brands. But there
is evidence the improved environment is filtering down to
smaller operators and more brands. Doyle, for instance, said
lending is more favorable for Dominos’ smaller operators.
Page 8
“I think 2014 is going to be like 2013,” said Bob Bielinski,
managing director of the restaurant industry practice at
CIT. “The bigger companies, middle-market guys are going
to be able to borrow. Terms are going to get better. And
it sounded like smaller companies, it’s getting a little bit
better for them.”
The lending is fueling a robust environment for mergers
and acquisitions. As it is, the market for franchisee deals is
moving quickly, as older operators retire and sell to newer
operators and larger companies.
And there are already a number of brands on the block,
including the aforementioned Red Lobster and the Carlsonowned TGI Friday’s. Just as we were writing this, CEC
Entertainment announced it was being sold to Apollo Global
Management for $1.3 billion.
Indeed, Bielinski believes we could see something of an echo
boom of the M&A boom in 2010-2011. Low-cost debt has
increased the multiples buyers are willing to pay for chains,
and many owners could exit, hoping to take advantage of
those valuations while they still can. “Private equity guys
see the valuations,” Bielinski said. “If they’ve done 75% of
what they want to get done? It’s a great time to see” what
they can get on the market.
IPOs
One way private equity groups could exit their investments
this year is by going public, and several chains are believed
to be at least considering that route.
said David Maloni, a commodity consultant with the
American Restaurant Association.
A bumper corn crop is lowering feed costs, which should ease
costs for most proteins this year, other than beef—which
takes three years to follow trends because cattle take longer
to raise. SpenDifference, the Denver-based supply chain
company, estimates the cost of food products will rise 2%
this year, down from 2.6% in 2013.
Riehle expects wholesale food price inf lation to be
“manageable” this year. Compare that to 2011, when food
price inflation exceeded 8%.
That’s the good news. The bad news: Existing food prices
are still elevated. Food cost inflation has put “sustained
pressure on the pretax profit for operators,” Riehle said.
“That necessitates vigilance on the internal operating cost
structure.”
Chicken wings, considered by many to be the “canary in
the coal mine” when it comes to commodities, are expected
to be down 10% to 15% this year. Poultry prices will soon
follow, and by the second half of the year pork is expected to
be down, except for bacon. The big exception on the protein
front is beef, which lags trends by about three years. Beef is
expected to be up a little bit this year, and price relief isn’t
expected until 2015 at the earliest.
The minimum wage
Get ready to pay higher wages.
As it is, reports have said that Checkers, Focus Brands and
Papa Murphy’s are all considering an initial public offering,
and we’ve heard Bojangles’ name mentioned as a likely 2014
IPO candidate.
There is a growing push by lawmakers to raise the minimum
wage, perhaps to $10 an hour—not because protesters spent
2013 outside of fast food restaurants, but because voters
love the idea.
All of the chains would be looking for returns along the
lines of Potbelly and Noodles, both of which went public
in 2013 and doubled on their first day of trading, besting
the first-day pop by Chipotle in 2006.
Multiple polls in recent months bear this out. A Gallup
poll in November found that 76% of Americans believe
the minimum wage should be raised to $9 an hour. With
mid-term elections coming up in November, members of
Congress from both parties look at those figures and decide
something needs to be done.
Investors continue to pay massive premiums for growth
chains. Fiesta Restaurant Group’s stock, for instance, more
than tripled last year as investors realized that Pollo Tropical
was a growth concept. Private equity groups see those
returns and know when to jump in the market.
“It’s easy to make money when you can exit at 20x
EBITDA,” Bielinski said.
Food costs
The price of food has been brutal on operators for the past
few years, save for a one-year break in 2009 when nobody
was buying anything, anyway. The good news is that food
costs should moderate this year.
“We think, in general with the commodity cycle, the
inflation that began in the fall of 2006 is nearing an end,”
There is a possibility conservatives could push through a
“starter wage” to protect part-time jobs for teenagers, the
type of jobs provided by many in the restaurant business.
Some states, like Minnesota, have that type of starting
minimum wage.
But for the most part, it would be wise to prepare for a
higher minimum wage. And consumers likely will be fine
paying slightly higher prices to fund those wages. Remember
those poll numbers: They’re the ones asking for the higher
wages, after all.
— Jonathan Maze
Page 9
After a Stellar 2013, Analysts Face a Trickier 2014 When Making Stock Picks
The bullish stock market in 2013 made an awful lot of analysts
look really good. None of the analysts we spoke with last
year picked a market loser. Three analysts picked stocks that
doubled in value, thanks to the performances at Kona Grill,
Red Robin and Famous Dave’s.
Sure, you say, restaurant stocks increased by 45% on average
last year, but even by that measure the analysts did well. Their
stock picks rose on average about 59%.
Last year’s performance came despite a restaurant sales
environment that was relatively weak. Sales were lackluster
for much of the year, starting with payroll tax problems
and ending with weather issues. “I have never seen such a
divergence between fundamentals and stock prices as we’ve
seen the last 12 to 18 months in the restaurant space,” said
Raymond James Analyst Bryan Elliott.
In other words: Don’t expect a repeat performance in 2014.
Stock picking will be trickier going forward. The economy
could surge, or it could keep chugging along at its slow-growth
rate. Stocks could crash. And investors at the very least will
likely punish stocks that don’t perform to expectations.
“We’re at peak valuations now,” said Jefferies Analyst Andy
Barish. “It seems to leave a lot less room for issues, or misses.
That’s what we’re trying to stay away from.”
Despite those worries, analysts went ahead and picked stocks,
anyway. And they picked a wide range of restaurant companies,
from each major sector. And somewhat surprisingly, they
weren’t afraid to take a few risks. Like this one:
Carrols Restaurant Group
Elliott gets bonus points for this one. Carrols is a franchisee,
and franchisees are not exactly glamour stocks on Wall Street.
But the company is still integrating the restaurants it bought
from Burger King more than a year ago. Its investments in
those stores, and in its existing restaurants, could bear fruit
soon.
And that, Elliott believes, could open the way up for
more acquisitions, which would help the company’s value
considerably. “Carrols can see some significant profit
improvement at restaurants they acquire from Burger King,”
Elliott said. “Late in the year, they could look to refinance
their high-yield notes, lower their interest expense, and could
possibly be in the market to buy more Burger King assets.”
“They’re clearly very good operators,” he added. “That’s a stock
that could work so long as we don’t have a real significant
demand contraction.” Or, he said, the Burger King brand
“doesn’t lay an egg.”
Bloomin’ Brands
Jefferies analyst Andy Barish admitted that casual dining “isn’t
the greatest place to be,” but that didn’t stop him from picking
Bloomin’ Brands, owner of Outback, Boneheads and others.
Analyst
Stock Pick
Bryan Elliott, Raymond
James
Andy Barish, Jefferies
Mark Smith, Feltl & Co.
Carrols Restaurant Group
Paul Westra, Stifel
Howard Penney, Hedgeye
Nicole Miller Regan, Piper
Jaffray
Lynne Collier, Sterne Agee
Greg Badishkanian, Citi
Investment Research
Bob Derrington,
Wunderlich Securities
Sara Senatore, Bernstein
Research
Bloomin’ Brands
Diversified Restaurant
Holdings
Del Frisco’s Restaurant
Group
Yum Brands
Starbucks, Cheesecake
Factory
Cheesecake Factory,
Chipotle
Starbucks
Panera Bread
Panera Bread
To Barish, Bloomin’ Brands was an early adopter of many
strategies casual diners are using to get customers to come in
the door. The company’s leading Outback brand remodeled
restaurants and used marketing to its benefit.
“They stand above some of their peers,” Barish said. “A lot
of companies have implemented a lot of the things that
Outback implemented a while back. They’ve used incremental
innovation, marketing and remodel programs that other
brands are just now doing, and it’s still driving incremental
benefit.”
Diversified Restaurant Holdings
Here’s another bold pick, this one from Feltl & Company
analyst Mark Smith, who picked Diversified, a franchisee of
Buffalo Wild Wings that is also developing a casual dining
burger chain called Bagger Dave’s.
Low chicken wing prices should help Diversified’s Buffalo
Wild Wings units, providing a nice tail wind for the company’s
profitability.
But Smith finds far more potential in Bagger Dave’s, the
16-unit casual dining burger chain in the Midwest. Smith
believes that Bagger provides an interesting entry among the
burger players.
“These guys are making an interesting argument for what
they’re calling ultra casual,” Smith said of Bagger Dave’s. “They
have full service, a full bar, a lower ticket price and a relaxed
atmosphere. It’s unique. It has life, and I think it could work.”
Del Frisco’s Restaurant Group
Among the 2012 class of restaurant IPOs, Del Frisco’s was
Page 10
somewhat forgotten, at least early on, even though it had
no debt and despite consumers’ recent rediscovery of steak
restaurants.
But investors discovered the company last year, and Stifel
analyst Paul Westra sees more growth. “We see DFRG as the
industry’s cheapest growth stock,” he said, “delivering doubledigit capacity growth at the highest returns-on-capital within
the full-service restaurant sector—all being executed by one
of the best operating teams in the industry.”
Cheesecake Factory
Miller Regan also picked Cheesecake Factory, providing us yet
another opportunity to remind people of the risks in choosing
a casual dining name.
But Miller Regan believes the industry is in a positive cycle,
and Cheesecake is expected to outperform the casual dining
sector on the sales front. And like Starbucks, Miller Regan
likes Cheesecake’s “shareholder-friendly” approach to capital
allocation—thanks to its dividend and its share repurchases.
Westra likes the company’s Del Frisco’s Grille concept, which
has more than 100 potential future sites and is “the most
exciting concept within the upscale polished-casual dining
space.” The company also said recently that the Grille concept
helps it test out new markets for its upscale steakhouse.
Lynne Collier, analyst at Sterne Agee, also likes Cheesecake
Factory, in part because the company delivers better brand
value, and has more pricing power than its competitors.
She also said consumers are rushing toward quality, and
Cheesecake’s quality perception will bring diners in the doors.
Yum Brands
Louisville-based Yum Brands didn’t participate in the stock
party in 2013, at least to the extent other stocks did, largely
because of the company’s extreme weakness in China. But that
weakness is past and the comparisons get easier. That could
lead to a pretty good 2014 for the company, at least according
to Hedgeye Risk Management’s Howard Penney.
Chipotle
We have questioned Chipotle’s inflated stock price for a while
now, and then watched it soar past $300, then $400, and then
$500. So if anything, the Denver-based burrito chain is a safe
pick, and thus Collier’s second choice makes plenty of sense.
Penney said Yum’s strong Taco Bell brand should benefit in
the U.S. thanks in large part to weakness at McDonald’s.
But mostly, he focused on China, where Yum has staked its
fortunes and where it relies heavily for profits.
The company’s sales had plunged in 2013, but are starting
to recover. In addition, Penney said, the management team
there is strong. “I would not bet against this management
team,” he said.
Starbucks
Remember when everybody was writing off Starbucks? Now
it’s one of the most consistent performers among restaurants
on Wall Street.
Don’t expect that to change this year, at least according to Citi
Investment Research analyst Greg Badishkanian, who believes
that Starbucks will benefit from a resilient high-end consumer.
He also likes the chain’s international growth, such as its
development in China. That international growth and
“channel development” will continue to provide margin upside
for the chain, which should therefore help its stock.
Piper Jaffray analyst Nicole Miller Regan also likes the Seattlebased coffee giant. She likes the chain’s consumer packaged
goods platform, and cites the company’s “commitment to a
shareholder-friendly approach to capital allocation” and an
“impressive brand equity,” Miller Regan said.
The brand equity has yielded consistently strong same-store
sales. Miller Regan also said the recently settled dispute
with Kraft over packaged goods opens up that business to
the company, and “represents one of the deepest and most
promising opportunities for sales and margin upside.”
Like Cheesecake, the company delivers better value—it has a
high-quality perception for a generally reasonable price—and
still has pricing power as a result. Collier also mentioned the
rush to quality.
“We believe consumers will continue to demand higher-quality
ingredients and information about where their food has come
from,,” Collier wrote. “Chipotle has become a leader in food
education, and we will see many other operators follow in its
footsteps.”
Panera Bread
The St. Louis-based bakery/cafe chain didn’t have a great
year in 2013, but the company also has been among the most
innovative chains in finding ways to fix its problems. That
includes increased labor hours and new technology designed
to improve the throughput at its restaurants—which company
executives believe has been hurting the company’s sales
numbers recently.
This should bear fruit as the year goes on, according to
Bob Derrington, analyst at Wunderlich Securities. “They’re
initiating new programs that we think will make a difference
in 2014,” he said. Derrington expects comps to accelerate as
the year goes on and be in the mid-single digits by the end
of the year.
Bernstein Research analyst Sara Senatore agreed with
Derrington that Panera’s labor and technology focus should
improve traffic at the company’s restaurants this year. She,
like the company, is betting that service is the main issue
behind the company’s recent struggles. “That’s the crux of
the issue,” Senatore said. “Is it really the service issue, or is
it about something else? That will dictate the performance.”
— Jonathan Maze
Page 11
What We Learned From 2013 Deals: Proceeds Are Still King
By Dennis L. Monroe
The year 2013 was a busy year for restaurant deals that
ended with a flurry of transactions in the public and private
markets and the entire franchise industry. The year also
included a significant number of consolidation transactions.
Small operators were swallowed up by the larger operators,
particularly among the chain restaurants, and large operators
were acquired by even larger companies.
This past year saw early franchisees (particularly in the
Applebee’s system and QSR segments) selling to newer and
larger companies, many of which were private equity or private
equity-sponsored companies. We even saw a financial company
(normally a sponsor) become an operator. In summary, the
big guys got bigger.
What did these acquisitions teach us about legal structure and
tax issues? A number of issues stood out for us this year as
we represented a number of sellers. Hopefully, the following
reflections will be helpful to people and companies who are
looking to sell or acquire in the restaurant space in 2014.
1. Understand your structure and where the various assets
are owned. The assets to be sold are often in a number of
different entities. It is important to have a clear understanding
of the balance sheets and particularly which entities hold
intellectual property and goodwill. All of these entities should
be part of the seller group. When assets are in several different
entities, the way the purchase price is allocated among the
entities needs to be guided by a real understanding of tax
implications based on such issues as basis, unused losses, state
tax and unused credits.
2. A seller needs to understand the scope of its liabilities.
What do you have to pay off at closing? What are potential
prepayment penalties? What are the expenses of the sale?
What are the contingent liabilities such as gift cards, lawsuits,
employment matters, vendor contracts (particularly vendor
contracts)? It is important these liabilities be provided for
separately, especially if they are related to prepayment penalties
and buyouts of contract obligations. It is very likely some of
these payments may be deducted as ordinary expenses instead
of offsetting capital gains.
3. Allocation of purchase price among the various asset
classes can be more of an art than a science. Different
types of buyers have different allocation needs. It has been my
experience that financial buyers are not as concerned about
the allocation of the purchase price among the classes of assets
as are operators who want faster depreciation. It is important
the allocations be detailed by restaurant and entity. Look at
each type of asset and how you can maximize tax savings and
avoid ordinary income. Parties sometimes overlook allocating
to leasehold interests or franchise rights as opposed to goodwill
or other intangibles. Also, if real estate is sold, sellers must
understand some of the depreciation is recaptured at a higher
rate than capital gains. The purchase price allocation should
be addressed early on in the selling process.
4. A new tax wrinkle in deals is the new 3.8% tax imposed
on high-income taxpayers on certain passive income. This
may definitely have an effect on the selling price process,
particularly if the real estate is not sold and is leased to the
buyer. This 3.8% tax is imposed on rental income on real estate
retained by a seller and leased to the buyer.
5. Besides not negotiating an effective allocation of
purchase price, ignoring the effect of state taxes can be
costly. If units are in multiple states, transaction terms may
have different consequences in different states. For example,
the State of Florida imposes sales tax on rental income; some
states have income tax while other states impose high state
income tax rates. Appropriate allocation of purchase price to
states with lower tax rates can be a meaningful opportunity.
More states also are trying to force or trace taxable income
to individuals that have changed residences. Consider these
factors in your structure.
6. Another idea is the use of tax deferred like-kind
exchanges and not just for real estate. Franchise rights,
furniture, fixtures and equipment all can be rolled over to
utilize the advantage of a like-kind exchange. So if you are
selling three QSR burger stores and you wish to get into a
pizza concept (which seems to be the trend), if you are careful
and you properly allocate, you can accomplish a tax-deferred
like-kind exchange along the way.
7. Allocation of payments to employees on a sale is often
overlooked. These should be carefully thought out and treated
in such way as to create an ordinary deduction for severance
or deferred compensation. One of things I like to see is giving
employees a profits interest early on and, if the sale price of the
assets exceeds a certain specified amount, allowing employees
to collect a share of that price.
8. Liquidate the entity. This is often overlooked once a
transaction has been completed and distributions are made
to shareholders. In some situations, the entity liquidation is
needed to generate a capital loss, and this should be done
in the same year in order for capital losses to be matched to
capital gains.
2013 was a great year for deals and deal makers, and we learned
a lot. But after-tax proceeds from a sale are still king.
** Rick Gibson, partner, contributed to this article.
Dennis L. Monroe is a shareholder and Chairman of Monroe
Moxness Berg PA, a law firm specializing in multi-unit franchise
finance, mergers and acquisitions, and taxation. You can reach
him at (952) 885-5999. Or by email at dmonroe@mmblawfirm.
com.
Page 12
Valuations: A Bubble in the Making?
In November’s Monitor, I asked Castle Harlan Managing
Director David Pittaway for his thoughts on current restaurant
valuations as they applied to fast-casual brands. “I look at these
concepts and think, ‘Geez, valuations are crazy,’” he declared.
Later, when I’d inquired whether Castle Harlan had made a
mistake by not buying polished-casual Yard House, he flatly
announced: “Absolutely not. That went for 12x cash flow!”
So I began wondering whether a bubble had begun developing
regarding the frothy prices that private equity firms have been
willing to bid and pay for a new or legacy restaurant property.
To find out, I invited several of the industry’s key financial
people and posed the following questions via email: Can one
make a credible argument that a “bubble” is developing in
the prices being paid by private equity firms for restaurants
(emerging brands or otherwise)? If so, what’s the strongest
evidence, and will payout terms to management be negatively
affected at exit?
Three (including one who asked for anonymity) provided
in-depth answers, which have been slightly edited for length
and clarity.
Anonymous investor and advisor
Bubble? I would think “Yes,” and the basis for the argument is
that higher multiples are being paid currently, in addition to
giving brands credit for forward growth. This is particularly
true in emerging brands. The thesis on the investor side is you
will grow into a reasonable multiple over time.
However, if over time, leverage becomes more costly and/or
capital becomes less available, prices/multiples will moderate.
So if as an investor you paid 9x to get in the deal and you get
7x on the way out, you will need additional growth and/or
margin improvement to get the same return in equity as if the
multiples remained constant.
Payout? Not really. Management should be incented through
sharing on absolute incremental value that is created going
forward. And they should have participated in the higher
values being paid now. The managers who get squeezed a little
are the guys and gals who come in with the investor and have
high-incentive valuations as a starting point. Of course, if
the multiples are high on exit, they would avoid that squeeze.
Kevin Burke, investment banker (Trinity Capital):
Bubble? I think when you look for evidence of the bubble, you
have to look at the restaurant world in two segments: The first
segment is composed of restaurants that are relevant to the
consumer, consistently drive traffic and same-store sales, have
good curb appeal, a good promotional scheme (including social
media), are market share defensible with respect to competition
and have good pricing and product development.
The other segment contains restaurants which struggle to
produce good traffic and same-store sales, has spotty curb
appeal, has limited or flawed promotion and perhaps an
insufficient budget to adequately promote, may have little or
no social media presence, cannot defend their demographic
and trades margin for price in order to drive sales. I don’t
want to condemn any brands by throwing them in the lesser
of these buckets, but I think you clearly grasp the difference.
The more attractive bucket is populated by Chipotle, Taco
Bell, Panera, Buffalo Wild Wings and the like. These concepts
have good margins, lots of new store development, defensible
customer bases and are growing both gross units and samestore sales. Directionally, they are all improving transaction
count over time though this will vary from quarter to quarter.
Payout? If a management team is part of a private equity
buyout that basically overpays for an asset, the likelihood of the
management team ever realizing their deferred compensation,
(bonuses, stock options or equity) is diminished. A
management team can be caught in the middle between the
buyer and the seller and perhaps given a carrot “too far out
on the stick.”
The dilemma, of course, is that management teams have a
fiduciary duty to their owners (who are the sellers) and as
they try to achieve the highest possible price they are working
in opposition towards the probability of their attaining
meaningful financial upside in their new role!
Mark Saltzgaber, investor and advisor:
Bubble? Looking back more than 30 years, there has been
clear cyclicality in the restaurant financing market. The peaks
include the early ‘80s, with the first wave of casual dining
IPOs; the early-to-mid ‘90’s, with the biggest wave of venture
and public market activity; the mid-2000s, with the debt
and buyout boom; and today, which includes all stages and
financing sources. Thus, history would say that peak-to-peak
cycles occur every 10 years or so.
Is the current environment a bubble? I can’t say that, but what
I will say is I don’t see it getting any better. If it does, then I
will move to using the “bubble” term. The bottom line for me:
Valuations are clearly higher today than historical norms and,
if offered an even money bet, I would certainly bet valuations
will be worse in five years than they are today. And then I
would then double-down that another peak is on its way.
Payout? If management equity is junior to the buyers’
investment, higher valuations definitely make their upside a
riskier proposition.
—David Farkas
Page 13
CHAIN INSIDER
The Big King might have led to Steve Wiborg’s departure
at Burger King. The former franchisee turned company
executive left in October, after exercising an unusual out clause
in his contract that allowed him to leave if he was unhappy
with his new responsibilities. We’ve heard that Wiborg’s
decision was due in part to differences between him and other
executives in Miami over some of the company’s products,
including the Big King. Wiborg apparently pushed to keep
the middle bun out of the sandwich, and therefore cheaper
for franchisees. His request was denied. That and other lost
battles apparently contributed to his decision to resign. His
decision, by the way, remains a major prickly point for many
franchisees who had viewed Wiborg as their main backer at
company headquarters.
Speaking of Burger K ing, big franchisee Carrols
Restaurant Group has exercised its right to first refusal in the
Burger King system. Carrols, which bought that right more
than a year ago, decided to pull the trigger on a four-unit
deal in which the purchase multiple was a scant 2x EBITDA,
which is what you’d call an opportunistic deal. Suffice it to
say, it’s widely expected Carrols will start exercising that right
frequently as soon as it has integrated company-owned Burger
Kings into its system.
John Cywinski saw the writing on the wall, apparently.
After Yum Brands reorganized, combining its US and
international divisions under a single KFC CEO, Micky
Pant, Cywinski resigned as president of KFC in the U.S.,
effective April 1. In a letter to franchisees, Cywinski said
the restructuring made it “unlikely that I’ll accomplish my
personal goal of becoming CEO in the near-term.” KFC has
struggled in the US, and has lost market share to chains like
Popeyes and Bojangles. It also suffered from operations issues,
particularly last year during the boneless chicken introduction.
But, for what it’s worth Cywinski said that KFC is “well
positioned” for 2014 and that “our strategy is right.”
Want to sell healthy items? Have your wait staff tell
customers about them on Monday, but not on Saturday.
Apparently, consumers dining out on Saturday are looking to
have a good time and don’t want to know about healthy items,
at least according to Cracker Barrel executives at ICR. But
they are more willing to hear about them on Monday when,
apparently, they’re recovering from their weekend of binging.
A few fast casual chains presented at the ICR XChange
conference, and some noted that competition for top sites has
grown increasingly competitive. Restaurant industry growth
at the moment appears concentrated among fast casual chains
that prefer leased sites in retail strip malls and lifestyle centers,
but it’s not like those sites are growing on trees. There is a
belief that this competition could drive up prices and hamper
growth for many of these concepts in the future.
Big is going for the “golden sombrero.” Sardar Biglari, the
activist investor who really wants to get something out of his
investment in Cracker Barrel, is now pushing for a sale of the
company and even agreed to submit a bid himself to get the
bidding going. The company said no, and now Big is calling
for a special meeting, but it seems unlikely this effort will be
any more successful than Big’s three failed efforts to get on
the board. This prompted a baseball reference from Raymond
James analyst Bryan Elliott: “Biglari is going for the ‘Golden
Sombrero,’” he said. “He’s already struck out three times. Now
he’s going to strike out four times.”
Big restaurant chains Applebee’s and Chili’s have received
a lot of ink recently with their decisions to install tabletop
tablets at their restaurants nationwide. But some chains have
tested these tablets and decided against installing them. That
includes TGI Friday’s, which apparently spent $80,000 testing
out one tablet before opting against the idea. Another chain,
Boneheads, tried a version that required servers to carry devices
with them. The servers rejected the technology. Nevertheless,
casual dining executives believe these tablets will likely be the
price of entry in the coming years.
Atlanta-based Krispy Kreme hopes that some renegotiations
of franchise contracts will increase its income in the coming
years. The doughnut chain has a lot of franchise agreements
that give operators what it calls “sweetheart” royalty deals. The
company wants those royalties increased when the deals are
renewed. Interestingly, the franchise believes operators will
sign on for the higher payments, because those operators want
to renew their deals. So the company has said negotiations on
that issue are coming along fine.
Page 14
analyst reports
BJ’s Restaurants
BJRI-NASDAQ
(Neutral)
Recent Price: $29.00
BJ’s Restaurants Inc. is the owner and operator of a chain of casual dining
restaurants. The chain includes 146 BJ’s Restaurant and Brewery locations. The
company was founded in 1991 and is based in Huntington Beach, California.
Domino’s Pizza
DPZ-NYSE
(Perform)
Recent Price: $71.65
Domino’s Pizza operates the biggest pizza delivery chain in the US. The company
is mostly franchised, and has about 10,300 stores in the US. and 70 additional
markets. Founded in 1960, the company is based in Ann Arbor, Michigan.
CEC Entertainment
CEC-NYSE
(Neutral)
Recent Price: $54.75
CEC Entertainment is the operator of the Chuck E. Cheese chain of pizza and
gaming restaurants. The company targets families with its combination of pizza
and video games. The chain has 571 locations, mostly in the US. It was founded
in 1980 and is based in Irving, Texas.
BJ’s Restaurants announced soft fourth quarter results, including a 2.7% decline
in same-store sales during the quarter, well below a predicted decline of 0.8%.
A number of analysts lowered their price targets for the chain, including Baird
Equity Research analyst David Tarantino. “While we continue to believe the
company has significant long-term growth potential,” he said, “we believe visibility
into BJRI’s ability to drive better operating momentum in 2014 remains low at this
stage.” Traffic also fell 2.3%. The company used discounting to get customers in
the door. This led to “substantial pressure” on the company’s operating margins.
The company now plans to use new brand messaging in March, along with an
upgraded menu, and is working to increase unit-level efficiencies to strengthen
its operating model. Tarantino has a new price target of $28.
“Top notch execution over the past five years has pushed” Domino’s unit economics
to all-time highs, according to Oppenheimer Equity Research analyst Brian
Bittner. But management expects healthy domestic comps of 2-4% over the longterm, thanks to technology advances, new products and share gains from small
competitors. Still, with the stock trading at a 26x P/E ratio, “we believe material
earnings upside is required for compelling stock appreciation in ’14. But we see
no slack anywhere in the model for such an event and reiterate perform rating.”
Domino’s management did announce plans to reimage the domestic system by
2017 that could cost an average of $40,000 to $55,000. While the plan seems
“counterintuitive” for a delivery company, “we agree with the strategy.” The store
base is 20 years old on average and carry-outs account for 40% of orders.
Apollo Global Management agreed to buy CEC Entertainment at $54 a share.
Sterne Agee analyst Lynne Collier said that the offer is in line with her published
base case valuation estimate of $54.79. “We believe this to be a reasonable offer
given CEC’s historical trading range of 5.5x-6.5x EBITDA,” she said. Apollo is
one of the world’s largest private equity firms. The offer was an 11.5% premium
over the previous day’s closing price and a 24.6% premium before word leaked
that the company was seeking a buyer. The company has the ability to solicit
higher bids until the end of January. “While additional suitors are possible, we
believe that any interest is more likely to come from private equity rather than
strategic buyers,” she said.
Page 15
ANSWER MAN
Not So Bold 2014 Predictions
What are the major themes you are following for 2014?
What else should operators concern themselves with?
The big theme this year is improving restaurant-level
performance and maximizing through-put during peak meal
periods. Let’s face it. New business is hard to come by. QSR
needs to put more people through at lunch, while casual dining
has to “make hay” on the weekends. And, fast casual needs
to speed up the lines. Operators can’t afford to turn anyone
away. As the great Landry’s CEO Tilman Ferttita says: “There
are no spare customers.”
I’m interested in the gradual shift from store-level retail sales to
online sales and how it impacts future real estate site decisions
for restaurant owners. The weakness of big retailers this holiday
season was at least partially due to a gradual transition from
shopping at retail to buying online. What are the ramifications
for restaurant real estate if sales keep moving from bricks-andmortar retailers to online merchants?
Panera CEO Ron Shaich, the modern-day Frederick Taylor
(the father of scientific management), is zeroing in on process
and execution. Too many of his customers, he says, walk out of
Panera during lunch because it is too crowded. Shaich wants to
add labor hours to existing schedules to cut the wait time. He’s
rolling out a new kitchen display system, and rejiggering the
menu to eliminate complexity. He’s also creating a catering hub
system, as busy managers find they can’t drive both catering
and the retail business at the same time.
What do you make of Darden’s announced spinoff of Red
Lobster?
The Maharaja of the restaurant business, Chipotle’s Steve
Els, is also into process improvement. Chipotle is tracking
customer transactions per hour in an effort to speed up the
long lunch lines, which at times resembles the Post Office
during Christmas.
Chipotle’s CEO Marty Moran told an audience at the recent
ICR Exchange that Chipotle is so serious about throughput
that it promotes the “Four Pillars of Throughput.” The pillars
include an expediter to bag burritos and get drinks, a so-called
“linebacker” that works behind the front line crew and makes
sure the bins are full, someone to set up the store before lunch
to make sure everything is in its place, and finally, making sure
the best performers are in position during the lunch rush. “It is
staggering the difference you will see in the speed of service,”
promises Moran. I sure hope so.
The second major theme of the year is technology. Mobile
transactions are the wave of the future. Olo, a restaurant
mobile ordering service that counts Five Guys and Noodles as
customers, reports four million users, double that of a year ago.
Restaurants using the service report higher check averages and
increased order frequency. This begs the question: If customers
already have a smartphone in their pocket and the technology
is proven to build restaurant sales, why are restaurant owners
installing more POS, table-top devices and kiosks? Why not
use the customer’s smartphone and save the big IT dough?
Darden has dug itself into a big hole. Red Lobster and Olive
Garden have stalled in the general casual dining malaise. They
leveraged up to buy Yard House in 2012, and now have $2.5
billion in debt, the majority of which was downgraded in
October by Fitch. Instead of paying the debt off, they raised
the annual dividend from $1.00 in 2010 to $2.20 to appease
a few mouthy shareholders.
Now, CEO Clarence Otis, is promoting a tax-free spinoff of
Red Lobster to try and satisfy two competing activist investor
groups. The two activists, Barrington Capital Management
and Starboard Value, want Darden to “monetize” its real
estate with a large sale-leaseback. Of the approximate 2,200
restaurants Darden operates, it owns the real estate on about
half of the locations.
What would you do?
I’d forget about the big sale-leaseback. These MBA jerks
pushing big sale-leasebacks as a business transformation
strategy are never around when the rent has to be paid. I’d
completely revamp the Red Lobster business model. In a sitdown environment, customers want the personal touch of an
owner-operator, not the mandatory chain-manager-visits-thetable exercise. Mr. Otis might want to study the Chick-fil-A
model and get an owner-operator in each Red Lobster. Darden
could charge rent, collect a royalty and take full advantage of
their supply chain.
Should they close on Sundays, too?
No. That would devastate all the grandmas in America.
The last time Answer Man ate at Red Lobster he was 20 pounds
lighter and still had a full head of hair.
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