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Unbridled Capital

Macroeconomic Update 2018

Video

04.02.2019

After the go-go years of 2015 and 2016, 2017 was a mixed year for the Franchise M&A community. I'm glad to give you some of my opinions on key trends and commentary for 2018 and beyond. First, many franchisees experience sales and or traffic declines in 2017. Deals were correspondingly more difficult to close, with the average time to completion up quite a bit over last year. Commodity costs hurt the restaurant industry in 2017. 2018 expects a moderation in food cost inflation, which should help stem the re-trading seen by buyers and banks in 2017. There were a surprising number of deals for sale in places like California, Seattle, Colorado, Minneapolis, and other high labor markets. Expect to see a rash of sellers in these markets in 2018 and beyond as franchisees look to sell after stomaching big labor increases in their P&Ls.

Consequently, Midwest and Southeast franchisees are selling their businesses for huge premium. Most buyers and investors want to run away from the coast and from the high labor markets. Expect this premium to continue. Also expect 2018 to be a big year for Franchise M&A. There are several reasons, moderating seller expectations, hopeful stability in sales and margins, favorability from tax policy changes, a reduction in corporate refranchising markets, and continued lending favorability for M&A transactions. There are a bunch of 30-something year old financial types getting into the franchise space. They want 10 to 30 unit acquisitions for their first time at it, and some want 50 to a hundred. I've never seen such a pronounced trend in such a short period of time.

We have seen an unusual amount of pizza businesses for sale. Hardly a week goes by without a large franchisee or franchise owner of a pizza brand asking for our help to sell their stores. Despite Pizza Hut sales challenges for the brand specifically, we've brought over a dozen new interested groups to the brand in recent months. Pizza Hut businesses are now receiving double digit offers, largely because their unit counts are large, there's faith in yum to turn around the brand, and Pizza Hut deals are trading at lower prices than other brands.

The days of eight plus times of EBITDA offers might be gradually going away. We are seeing some slight pricing degradation in the highest price brands. At the same time, we expect pricing upside on moderately priced brands. Buyers are increasingly looking for scalable five to six times EBITDA investments in tier two and tier three brands. If you're an owner of 20 or more units and several successful brands comprised mostly of smaller franchisees, you can expect a big premium if you decide to sell. This includes brands like KFC, Arby's and Popeyes, among others.

In 2018 and beyond, expect several continued rate hikes, resulting in slightly higher borrowing costs and higher cap rates. Franchise lending though should continue to be strong, absent a macro event in our country. However, I've noticed an increased reticence in lending to brands with struggling comps, traffic declines, or margin erosion. Keep watching the restaurant automation trend. I've been saying this for a while now. Maybe I'll be wrong, but I think Little Caesars's automated robot pizza machines could be a game changer.

Here's a wild opinion. I think restaurant real estate will be much less important 10 years from now than it is today. While everyone is currently fighting for the best real estate for new development, perhaps we should be looking for ways to make it less important. Take notice of the growing trend of food trucks throughout our country. Casual dining has struggled mightily. We might be nearing the point of no return for many brands and franchisees in this segment. No one wants to pay a tip anymore. Fast casual brands are getting hammered by pricing from their QSR competitors, their high labor model and the finicky customers that they have are worrisome. Expect many fast casual companies to make massive changes soon or many of their franchisees could be in financial trouble.

I said this before, too, but there are way too many restaurants, way too many. There's a burger chain or a sandwich shop on every street corner, and some of them won't make it. So therefore, don't overdevelop. One bad store kills six good ones. Push back against your franchisor when they pressure you to overbuild. Don't sign unrealistic development agreements.

Finally, as a customer, I will no longer pay 12 to $14 for lunch from a restaurant chain. I just won't do it. And I bet I'm not the only one. I don't care how much minimum wage is, or it will be. At Unbridled Capital, we are here to help you. Knowing these trends translates to the expertise, needed to fight for better outcomes and higher prices for our clients. Trust us when it comes to the sale or financing of your business.