AlixPartners: Cause for cautious optimism

In recent years, M&A activity in the UK restaurant sector has been increasingly dominated by distressed sales; looking specifically at the last 12 months, over half the deals completed have been distressed in nature. Obviously, no great surprise for the reasons behind this; a large increase in restaurant supply, coinciding with increasing costs and some softness in consumer confidence. However, once you dig in to the numbers, the rise of distressed deals really doesn’t tell the whole story as there are pockets of positivity.

Examining recent deals, what has been interesting is that trade buyers have been comfortable paying top multiples for real ‘best in class’ businesses. We saw this with The Restaurant Group (TRG) deal for Wagamama, the Coca Cola deal for Costa and JAB Holding’s acquisition of Pret. What’s also clear is that private equity, on the whole, has been somewhat absent from the market over the past 12 months. The level of private equity activity is much lower – and definitely in the mid-market space - where investors are keeping their powder dry, as seen from the recent decision by the owners of Giggling Squid not to sell. Through our experience in the market and time with private equity players, there is focus on achieving a ‘platform’ deal, from which they can follow a buy and build strategy, adding more brands in order to benefit from scale and synergies. While this has not yet happened, it may in the year ahead, so let’s watch this space.

In our experience, the four key pillars for investors/buyers when putting potential deals under the microscope are: a differentiated offering; international expansion potential; strategic plays; and ‘roll up vs roll out’ strategies.

On the first, Loungers continues to win in the all-day dining space, differentiating itself from local operators and established brands while continuing to take share away from pubs and coffee shops. We would also highlight the Ivy Collection in terms of success in targeting an older affluent demographic. There are others that have pivoted and successfully transformed their revenue streams by entering new categories, for example Brasserie Bar Co with its White Brasserie pub group.

The next key theme is the opportunity for international expansion. Pret and Costa are standout examples here of what’s possible when there is real potential to grow international sales and build on proven success. The UK is very competitive from an eating-out perspective; European penetration of brand operations is much lower. At the same time, the strongest UK brands resonate in overseas markets. Being able to take advantage of these new territories is of growing importance for would-be investors. We also see franchising becoming much more of a focus in taking advantage of the overseas opportunity. Of course, the key here is picking the right franchise partner and the right territory. But if you get it right, it’s a valuable income stream and offers the ability to test new markets with a lower risk strategy.

The presence of a strategic imperative can also drive premium valuations. The best example of this is perhaps the £556m acquisition of Wagamama by TRG. In one stroke, TRG changed the positioning of its business by adding to its portfolio undoubtedly the standout performer in the market. It also enabled management to drive a range of synergies to improve the economics of the deal for its shareholders.

Another strategy coming to the fore has been that of ‘roll-up’ rather than ‘roll-out’. By that we mean acquiring other businesses already in your market and either rebranding or changing the operations to improve the economics. In these scenarios, you’re not having to take local market share in order to make the deal successful - you’re buying a business already established but improving its profitability. We’ve seen this strategy with Azzurri through Coco di Mama acquiring Pod, Pret acquiring Eat and the acquisition strategy of Coffeesmiths Collective.

Boiling all that down, we see the opportunities to secure good valuations on a sale as being very much built around strategic fit to a purchaser and the growth story that’s inherent within a business. Each of the deals I have highlighted exhibit one or both of these traits. One of the key aspects, and this is something again which Loungers has consistently achieved, is a business’ track record for return on capital. How do you build the confidence of investors in your business to drive growth? It’s through your track record, the return on investment when opening and refurbishing sites - so being able to develop and articulate that story is important to drive value. A key element of this is the nature of the deals available from landlords. The market has gone through a period of rapid expansion where landlords have been demanding higher and higher rents along with more competitive premiums to get into sites. To a certain degree, that’s changed now and the deals landlords are willing to do is enabling investors to achieve better returns with new openings. While it’s clear that the market is in a contraction phase, with operators not investing as much in openings or refurbishment programmes across their estates, what it does mean is for those with the cash to invest and grow, they will be the newest kid on the block for longer and the ability to take advantage of that investment should run for longer.

Looking at exit options, a few years ago it was pretty easy; you could engage with a few private equity investors, get a bit of an auction going and get a top price by simply talking to one investor group. Now it’s a much broader field of play, whether it’s domestic or international trade buyers, private equity or international investment funds. The UK remains an incredibly attractive market and, for overseas investors, it’s cheap in dollar terms. So, in conclusion, whilst it’s been a tough time for the restaurant sector, there are definite themes which are driving premium valuations and give cause for optimism as we head into the end of the year.

• Graeme Smith is Managing Director and head of Corporate Finance at AlixPartners