Season 1 Episode 17: Over-saturation of Fast-Casual Restaurants



Also Listen On:

1. Higher Valuations Seen in Tier 2 & 3 Brands
2. Competition from C-Stores for Restaurant Customers
3. Whataburger is Possibly Selling a Stake
4. Over-saturation of Fast-Casual Restaurants
5. Sales Momentum and Menu Innovation

Welcome to The Restaurant Boiler Room Episode 17. I’m your host, Rick Ormsby, Managing Director at Unbridled Capital.

Today, in the Boiler Room:

Higher Valuations Seen in Tier 2 & 3 Brands

Growing Competition from C-Stores for Restaurant Customers

Whataburger is Possibly Selling a Stake

Over-saturation of Fast-Casual Restaurants

Sales Momentum and Menu Innovation

Tag Line: The Restaurant Boiler Room is a one-stop-shop for multi-million dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk – delivered to the front door of franchisees, private equity firms, family offices, large investors and franchisors on an every-other-week basis. Feel free to find our content at Unbridled Capital’s website at

Now, let’s enter the Boiler Room:

A. Higher Valuations Seen in Tier 2 & 3 Brands

Background: Over the past few years, many of the larger, Tier 1 brands (defined as brands with at least 4,000 units domestically) have had a substantial wave of M&A deals, both among the franchisees and, in many cases, from Corporate re-franchising. While the pace of sell-side M&A in these brands continues to be strong, the absolute number of sellers is dropping rapidly as consolidation has played a huge factor. A new wave of deals is starting to happen within Tier 2 brands (defined as 1,000 – 4,000 units domestically) and Tier 3 brands (less than 1,000 units domestically) as the M&A market continues to seek out opportunities for acquisitions.
Comments: At Unbridled, we are starting to see the M&A environment change somewhat. Some sellers are now mid-sized to large franchisees in Tier 2 brands specifically. They have been seeing the wave of M&A activity among their larger-brand peers, but since there hasn’t been as much buying and selling in these mid-sized brands, a platform acquisition will likely result in great opportunities to consolidate through tack-on acquisitions at lower valuation ranges. This same trend is happening among the franchisors – most Tier 1 franchisors have sold their company stores in the past few years, and most of them now have an asset-lite model of 5% or less corporate ownership. But for many Tier 2 and Tier 3 brands, they still own sizable amounts of corporate stores and are considering re-franchising.
Effects on M&A: Personally, I think this is a great situation for franchisees in these smaller brands. Finally, mid-sized brands are starting to have access to a more robust M&A environment. Larger franchisees in these brands are sophisticated in many cases, and as capital flows into these brands, they will see large EBITDA multiple accretion, in my opinion, over the next year. It is also a great situation for buyers, assuming they can find the debt-financing to do these deals. Prices are slightly lower, the larger franchisees in these brands are often great operators, many of these brands are newer and have better growth prospects, and smaller franchisees can be bought at 1-2 turns of EBITDA lower than an initial platform acquisition – unlike smaller franchise deals in the Tier 1 brand space. All in all, expect to see this trend continue in 2019 and 2020 as deal flow continues to move down-market.

Growing Competition from C-Stores for Restaurant Customers

Background: Peter Romeo recently published an article pointing out three new ways that C- Stores are challenging restaurants. His examples are as follows: 7 Eleven adds beer delivery, Wawa adds catering and Circle-K is focusing on fresh snacks.
Comments: This article caught my attention because I am personally seeing this competition all over my city in Louisville, Kentucky. Here, you can go to many C-Stores and get a semi-gourmet lunch or dinner. You can also get about every kind of coffee or trendy drink that you want. Fountain drink options are also improving. Product quality is improving, portability is strong and there are plenty of choices. Most importantly, convenience is super, and the price point is way-lower than most restaurants.
Effects on M&A: I am a firm believe that restaurants better be wary of C-Stores. Any negative impact is somewhat unnoticeable right now, but as we’ve seen in the past 12 months, restaurant traffic has been universally lower across the country on a comparable basis. When a family can go to a C-Store and get a hot dog, sandwich or sub, along with a bag of chips and a drink – for 30% less than the cost of a QSR restaurant and while not having to wait in a line – this is compelling. Remember that many customers like this don’t mind trading down a bit on quality in exchange for speed, convenience, and price. The playbook for restaurants continues to be the same – great operations, friendly service, clean restaurants, great speed, good products, and menu innovation – these offer the competitive advantages needed to stay ahead and protect your EBITDA. However, if you are a QSR who relies on hot dog sales or trendy drinks, your operations and speed better be awesome, or your business is slowly at-risk.

Whataburger is Possibly Selling a Stake

Background: Jonathan Maze recently reported that Whataburger is reportedly looking to sell a stake in its business, possibly to speed up growth. He reports that the chain’s system-wide sales are up by 52% over the past 5 years, unit count is up 9%, AUVs are a whopping $2.9MM, same store sales were 5.7% last year, and Whataburger has 800 units with $2.4 billion in overall sales, making it the 6th largest burger chain and 31st largest restaurant chain nationally.
Comments: Whataburger is a closely-held family company, and it has had a fantastic regional reputation for many years – almost a cult following in Texas, where almost 85% of the units are located. I really like this chain – what’s not to like about $2.9MM AUVs? This is a text-book case of a restaurant company that would attract a massive number of investors. Plenty of people will see that the unit growth possibilities within this brand are potentially gigantic, though thoughtful consideration must be given to how to expand to new markets where customers do not know the Whataburger brand name so readily.

c. Effects on M&A: Most of the family office and private equity investors I know are looking for big growth in a potential acquisition, whether it be on the franchisee or franchisor side. Investing in franchisors certainly commands a much higher price, where control over the entire brand and potential for expanding through franchising make the economics much more attractive. If a stake in Whataburger is sold, it will be interesting to see how much, what price, and what type of investor. While there are certainly risks to expanding a regional brand, Whataburger seems to have a compelling story when it comes to growing its company.

D. Over-saturationofFast-CasualRestaurants

Background: In a recent article, Kevin Hardy poses the question – ‘Are There Too Many Fast- Casual Restaurants?’ He cites growing competition, slowing sales and traffic, and a need to differentiate as challenges facing the segment.
Comments: I certainly agree with this article. Fast casual was a darling just several years ago. Three types of franchisees started developing units in this segment – 1. Large QSR franchisees who were looking for a second brand investment in their existing footprints, 2. Real estate developers, who were building strip centers and looking for a tenant, so they decided to become franchisees, and 3. Smaller mom-and-pop operators, many of whom are younger and undercapitalized. While there are several fast-casual concepts that are really doing well, and other spotty examples of so-so brands that perform great on a store-by-store basis, the overall outcome here has generally been challenging for all three types of investors. Real estate costs have risen, and labor and food costs are higher at fast-casual since the overall appeal to customers is a better experience than fast food. Most of these concepts do not have drive-thru’s, which is becoming an increasing differentiator as delivery, take-out and digital ordering are becoming more prevalent. Lastly, many fast casuals have a daypart problem and can’t drive high enough revenue to compensate for the added operational and real estate costs – they over-index lunch, for example, and do not appeal to customers at dinner, or vice versa.
Effects on M&A: Fast casual will have to fine-tune its model, I believe, in order to continue to grow. I don’t know if it is menu innovation as much as it is a better labor model, a lower price point, and value offerings. From an M&A standpoint, there are several fast-casual brands that are darlings while there are others who just aren’t very profitable. And since most franchisees have outlaid a large and recent amount of capital for new unit builds, selling or refinancing these businesses is difficult in many cases because their embedded equity is low or even non-existent. In the next downturn, I expect many fast-casual units will close if they can’t figure out how to increase sales and improve profitability. And for landlords, you’ll likely be looking at major rent concessions if a downturn happens, and you hold a fast-casual lease.

E. Sales Momentum and Menu Innovation

a. Background: Nick Upton at Franchise Times recently published an article that grabbed my attention – entitled “Data Dive Shows What LTOs Actually Drive Metrics.” LTOs are defined as Limited-Time Offers, a product introduced at a restaurant for a short promotional window, intended to create news and new customer visits. Nick cites three findings – 1. It’s hard to stand out in a crowded market, 2. Discounts and free items work, kind of and 3. Momentum matters.

Comments: LTOs are a tricky one for sure. Many times, LTOs come at an attractive price point, whether it is a new product introduction or not. In a market saturated with QSR value offerings, customers are looking for low prices, so the risk of a low-priced LTO is that few new customers come in the door, and instead, existing customers trade-down to try the LTO, lowering the guest check. The bottom line on low-priced LTOs is that they better drive incremental traffic gains and new customers, or they will really hurt an operator’s bottom line. Nick also mentioned Taco Bell, Chick-Fila-A, Burger King, and Chipotle as examples of standout LTOs in 2018 along with the comment that momentum matters.
Effects on M&A: I have been talking about momentum in the franchising industry for years. Momentum is a funny thing – it is difficult to get an even more elusive to keep. But momentum is incredibly powerful. If customers like a brand’s overall experience, they will be loyal, come back more frequently, and spend more money when new products are introduced. So, in this sense, LTOs can be wildly successful and build an enormous competitive advantage if a brand has innovation ingrained in its culture and not part of a short-term, gimmicky mindset. As I alluded to in the previous podcast, a long-time industry expert recently told me the importance of always being innovative. This is actually one of the cornerstone principles of Unbridled Capital, and it is a crucial part of a great franchise company. People are attracted by new ideas and fresh perspectives, and when you bring customers into your story, they will respond. The outcome is the elusive momentum that everyone is searching for in a crowded and oversaturated market of franchises and restaurants.

Closing: Thanks so much for entering the Boiler Room today. You can find our podcasts on iTunes, Google Play, Stitcher, TuneIn, and Spotify. If you like these podcasts, please listen, rate and review! I also encourage you to visit our website at for the best franchise M&A and financial resources in the industry. Our website includes podcasts, videos, white papers, and a list of our M&A transactions.

Disclaimer: Please note that neither Rick Ormsby nor Unbridled Capital LLC give legal, financial or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information, errors therein, or omissions therefrom.