Altium’s Sam Fuller explains why a slowdown in M&A was always going to be a possibility in the casual-dining market, and shows where the light at the end of the tunnel can be found
After a busy few years of M&A in the casual-dining sector there was inevitably going to be something of a lull, as assets settled down under new ownership and built the scale, in terms of both units and profits, their new owners need to generate their desired return on investment. Consequently, if you were to draw up a list of assets that look likely to trade in 2017-18, it would probably be the shortest for a number of years.
The question now is whether the increasing uncertainty around the UK consumer economy, coupled with the well-documented sector headwinds that operators are facing, will result in a fall in investor demand to match the scarcity of supply. Cost headwinds, be they FX-led (via increased supply costs), rent and rates hikes, or legislation induced (such as national living wage and apprenticeships) are manageable from an M&A perspective – they hit profits and go to value. A slowdown in trading makes life tougher. Declining like-for-likes (LFLs)can all too easily spook investors into a double hit on valuation, with lower profits being compounded by a lower multiple.
There are signs that the banks are getting more wary of the UK consumer. Our experience post-Brexit vote is that international debt funds are starting to avoid the UK. The good news is that UK banks remain largely supportive, though clearly this could change if their consumer portfolios endure a prolonged period of pressure. If the debt market tightens then private equity and trade buyers could struggle to raise finance, at least in the quantum required for large cap M&A.
Meanwhile, the listed restaurant sector is not in the rudest health. The Restaurant Group, Tasty, and most recently Comptoir and Richoux, have all announced that they are experiencing challenging times. Public announcements talk of strategic reviews, the sale of weak sites, slowed rollouts, a renewed focus on cost savings and efficiencies, etc. Privately owned assets are, of course, under no such disclosure requirements and it is very rare to hear of negative LFLs as a result. Despite what the various trackers would have us believe, common sense would suggest these trends are not afflicting just the PLCs. Against this backdrop, a sector IPO has rarely looked less likely and, perhaps with this in mind, plans to float Wagamama appear to have been shelved again.
So, if big ticket M&A and IPOs are potentially going to be constrained, what is the likelihood of merging assets? The suspicion remains that it is challenging to drive meaningful synergies from putting restaurant chains together. There should be some back-office savings, in finance and marketing for example, and maybe some benefits in buying, but cutting front-line staff, area and general managers and anything else that could have a remotely detrimental effect on quality of service and offer, is not a sound investment thesis. For mergers to add up, there probably needs to be a step change (down, for the avoidance of doubt) from recent valuation metrics.
So does all this mean that M&A bankers like me should hang up our boots and do something else? (Just how hard can opening a restaurant be?) Thankfully not. We just might have to work a little harder for our money. On the plus side, tougher times make it easier for investors to pick winners. The struggles of one operator can lead to increased availability of sites, staff and, ultimately, customers for another. In particular, this feels like a good time to be building the next wave of 20-unit-plus assets. Flat Iron and Caravan have both traded in the past few months at cracking valuations, and with strong interest for both assets and frustrated investors who lost out. If you are an investor, taking a chain from 10 to 30 sites is probably less frightening than taking 100 sites to 200-plus right now, particularly with all the market towns that level of rollout would involve!
While I am sceptical, at least in the short term, on big mergers, I know that a number of the larger groups are keen to bolt on growth brands. Since the last downturn, the sector has been far less aggressive when it comes to debt and, as a result, even if LFLs are under pressure, slowed rollouts should lead to greater cash generation, hopefully without any covenant issues. Hence there should be money to buy and then grow sister brands. This is where the scale of the bigger operators is a distinct advantage.
They have the platform in place, be it property pipeline, opening teams, greater procurement, HR for staff sourcing, etc. to instantly boost smaller operations. Azzurri moved decisively for Coco di Mama and immediately put down the accelerator on rolling it out.
Diversification away from the core group offer is key, hence moving into the fast-casual lunch space, coffee sector or, top of the list (judging by my recent conversations), pubs with food, could all be on the cards. This strategy then opens up new exit options, as we saw with Gaucho-Cau, the theme of a steady cash generator coupled with a fast-growing brand attracts investors.
Finally, we should remember that even if we are due some tougher times in the sector, a sense of perspective is important.
Restaurant assets have always delivered some of the strongest returns on capital in the leisure and, indeed, wider consumer sector. Cinema’s, coffee shops, five-a-side football and pubs all struggle to get close to the returns many restaurant chains target as standard. As a result, there will always be demand for assets.
Transactions might be a little more self-selecting but I have no doubt these pages will continue to announce M&A over the next 12 months.
■ Sam Fuller is managing director, London and consumer team, at GCA Altium