The dam has broken on M&A activity in the sector and the next 12 months could see an unprecedented number of businesses changing hands and securing new investment, but has the market learnt its lesson from the downturn when it comes to debt?
Before the end of this year, we should know for certain the new owners of nearly 600 restaurants, thanks to successful conclusions to sales processes concerning TGI Friday’s, ASK/Zizzi and Prezzo. By Thursday, Greene King’s interim update should also help cross the t’s and dot the i’s on the group’s proposed acquisition of Spirit and any supposed uncertainty generated by vote against the tie. This all sets up nicely for 2015, when the trickle of deals should become more like a river, with large and small groups looking to secure new ownership/funding.
Surely the start of the year will provide news on Bill’s, the Richard Caring-backed juggernaught with the impressive pipeline. Some have suggested that the group may take a year to bed in its new sites before coming to the market. I, for one, am amazed that feelers weren’t put out to the market earlier this summer, when it was in the middle of doubling its estate size in one year. Its pipeline of openings remains impressive and whole swathes of the country is untouched, while its management team has had another year to bed in and make its mark out of the shadow of Andy Bassadone and Chris Benians.
I can’t see the brand going another six months, even three months, without making its move, especially with second half of the year already mooted for the phoney wars set to stop over YO! Sushi, Ed’s Easy Diner and Las Iguanas and proper processes set to begin. On the smaller ticket side, it will be an interesting 12 months for highly rated businesses such as MeatLiquor, Honest Burgers, Bistrot Pierre and Banana Tree in terms of next stage funding. With Honest Burgers already being the attention of a number of approaches.
However, before we get ahead of ourselves, and there are plenty more companies that could be speculated about aside from the ones mentioned above, a sobering thought on debt. One of the great lessons learnt over the last eight year, particularly in this sector, is that high levels of debt and leasehold businesses do not go well together.
Ian Edward, the corporate adviser to the eating and drinking-out market, says: “It is very sad to see with some of the auctions being played out at the moment that you are seeing levels of debt of 4.5 and 5x EBITDA coming in again. I think it will end in tears as it did before. One of the things that is very clear is that if you are an overleveraged and underinvested business in this sector trying to compete day to day it is almost impossible.”
Edward points to the former Barracuda Pub Company business (latterly Bramwell Pub Company) as an example of what can go wrong.
He says: “Mark McQuater, a great operator, built up the business to be worth £260m when he sold it to Charterhouse, but nine years later it was in a horrible state, over leveraged, under invested and all the good people had left. He lost his way and energy. He has come back into sector as chief executive of Inventive and I saw him the other day and he has reenergised the business and himself, and its profits are up to £12m-£14m. But Barracuda is a real object lesson in how overleveraged businesses are really going to struggle.”
As everyone knows, the sector has become more and more competitive and this trend isn’t going to reverse anytime soon. However, despite this and the warning above, Edward still believes the sector provides a fantastic opportunity for investors.
He says: “I have been in this game for a long time, but I believe this is the greatest time to invest in the sector. More exciting things are happening for consumers, yes they are fickle, yes they change their minds about where they want to go out, but if you are good and have good management in your business it is a good time to make money.
“It may be that we move from an environment where people were making 40% returns on capital to a market where we make 20-25% returns on capital. If that’s where it ends up it is still a fantastic business to be in. If you look at the pub sector long term, it looks for 12% on a freehold and about 18% to 20% as a target on a leasehold. In the fullness of time we may end up there, but in the meantime, if you are good you can make 30-40% returns on capital which creates businesses that have a flexibility to open in all sorts of places, make a lot of money and build large estates which can be sold to private equity or to trade.”
While private equity will still be the main mover in the market, the trade buyer angle is set to become more interesting.
“The pub companies will buy restaurant businesses, there is no question about it, the convergence is happening,” Edward points out. “It has already happened the other way, with TRG acquiring Brunning & Price, but it is now going to go more the other way.”
Ralph Findlay, Marston’s chief executive, talked at M&C’s recent Pub Retail Summit, about finding small embryonic brands in the restaurant sector that he could put into his pub business. Edward says: “The simple reason for this is that pub businesses, which are generally freehold based and been built up over a long time, in places were the customers are not. The thing that makes leasehold assets attractive is that generally speaking you get a guarantee of a large amount of customers.”
