Welcome to The Restaurant Boiler Room Episode 20. I’m your host, Rick Ormsby, Managing Director at Unbridled Capital.
Today, in the Boiler Room:
June Restaurant Sales and Transactions Update
Low Treasury Bills Mean Higher Real Estate Prices
Boston Market Closes 10% of Locations
Franchise Lending Platforms Close Down
Unbridled Has Historic Closing Percentage019
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 www.unbridledcapital.com
Now, let’s enter the Boiler Room:
A. June Restaurant Sales and Transactions Update
Background: TDn2K reports that June comp sales were down (0.01%) while traffic worsened at (3.14%). Both figures were significantly worse than in May, at 1.1% and negative (2.2%), respectively.
Comments: TDn2K also reports that the Rolling 3-month trend is 0.19% in comp sales and an alarmingly negative (2.88%) in comp traffic. The trends are worsening. Flat sales tell me that restaurants don’t feel like they can take more pricing because of competitive pressures. We’ve been saying this for quite some time – you can’t keep raising your prices forever and expect customers to keep coming. It’s like having 3 lemonade stands at a corner in a neighborhood. If you raise your price from $1 to $1.25, and the other 2 stands are at $1, your business is going to tank unless your lemonade is amazing, your speed of service is fantastic, and your physical location is convenient. Prices might need to go lower – choke choke choke – to stimulate traffic, which seemingly continues to get worse as each month passes. Granted, I have always thought that low prices – in a vacuum – are not the best way to sell your product.
Effects on M&A: In a recent episode, I said that EBITDA dollars are dropping at the franchisee level in most brands right now. Well, this probably continues to be the case. Lower EBITDA means lower valuations.
New England was the strongest region, while Texas was surprisingly the weakest.
They summarize the month with several key comments: 1. The Key to solving the problem lies with traffic, 2. The economy is still growing slowly with modest consumer demand expected, 3. Restaurants are dependent on-to-go offerings to grow sales, and 4. The workforce dilemma remains unchanged, with staffing still a top concern.
B. Lower Treasury Bills Mean Higher Real Estate Prices
Background: The 10-year US treasury has taken a major slide in the past 90 days, from a high of about 2.6%, all the way down to about 1.95% in early July. We are currently sitting at 2.12% as of July 16th, which is historically low overall measurable time periods.
Comments: This trend might be turning around, but who really knows? As of July 16, Treasury has had the biggest weekly climb since April. This is mainly due to better-than-expected inflation data as the US consumer price index rose more than expected in June, with the core CPI posting its biggest gain in 18 months. As you likely know, inflation expectations are a key determinant in the Federal Reserve’s decision to raise or lower rates. Many experts are predicting a lowering of rates soon because inflation has been persistently low, affecting economic expansion. Bankers generally like to see inflation hovering around the 2% range. Who knows for sure where the economic data will take us in the next few months or quarters?
Effects on M&A: For now, a retreating 10-year to 2.1% means that cap rates are becoming more favorable. We are starting to see this trickle down into the real estate markets, where valuations and pricing have gotten incrementally more favorable for real estate sellers over the past few months. Several of our real estate partners, REITs, and brokers are commenting on near-term trends of slight appreciation of their real estate assets when monetized in a sale or disposition. I don’t think many of us saw this happening at the end of 2018 when the 10-year was near 3.25% in December. Maybe the trend is short-lived, maybe not – I’ve been wrong in predicting these trends more than a few times over the past 7 years. However, for now, the drop will enable sellers to continue to attract higher prices. Whether it is for an acquisition or as part of an existing franchise portfolio, declining rates are always a time to revisit your financing structure to see if you can relieve any cash flow constriction through financing alternatives.
C. Boston Market Closes 10% of Locations
Background: Jonathan Maze recently reported that Boston Market has closed 45 locations, citing that this represents 10% of its stores amid sales challenges and a multi-faceted transformation. Boston Market is owned by Sun Capital Partners and has over 400 locations nationwide.
Comments: Boston Market was started in 1984 in Massachusetts, and it had an incredible growth trajectory into the mid-1990s. Its rotisserie chicken platform with fresh sides and inviting dining rooms were a welcome change to fried food, and there were plenty of franchisees – at KFC in particular – who were worried about a formidable competitor in the chicken segment. In recent years, however, Boston Market has struggled. Maze cites that sales are down 9% since 2014 while shifting consumer preferences and rising costs have created difficulties for the brand. This has led to attempted rent relief negotiations, store closures, and varying hours of operations to reduce expenses – all things you would expect from a restaurant company operating on the edge.
Effects on M&A: The casual dining industry has taken a battering over the past 5 years. Competition from fast-casual and QSR has given more options to customers – who don’t see the value in tipping for table service as much as previously. An increased palate for ethnic and spicy foods has driven customers to specialty casual dining establishments and independents. I certainly hope to see Boston Market effectuate a successful turnaround plan, but this is a challenging time for many restaurant concepts. Don’t be surprised if the difficulties continue.
D. Franchise Lending Platforms Close Down
Background: Over the past month or so, several franchise lending platforms have either closed, eliminated departments, or severely restricted making new loans.
Comments: Over the past 5 years, there has been a proliferation of franchise lenders newly entering the industry. A simple stroll down the convention floor at a Taco Bell convention will result in a count of 15-20 of them. Many entered the space because of attractive unit economics and new development possibilities. Rates got pushed lower, credit was generally easy, and covenants became lite – as the competition started to increase dramatically among banks in the past few years. Fast forward, and the past 12-18 months have shown some chinks in the armor. Huge labor pressures, rising costs, and stagnant sales have begun to affect lenders’ balance sheets. Most franchise lenders now have several – if not more – borrowers who are not meeting covenants. All the while, the near-term outlook for sales and EBITDA does not look very rosy. As lender portfolios worsen, their credit teams and risk officers begin to raise a flag of caution and internally ask – ‘Is it worth it anymore to lend to the franchise space given the big headwinds and a large amount of competition?’ It is a bit surprising to me to see several lenders make these decisions so quickly over a short period of time, but much like restaurants themselves, sometimes closures are needed to separate the wheat from the chaff.
Effects on M&A: It is somewhat alarming to see these lender closures and slowdowns. Right now, there are still plenty of options for financing and fresh capital – few potential buyers will notice any difference. However, this might be part of a larger trend. And if we see more franchise lending platforms go away or shy away from new loans, eventually it will mean that operators won’t have enough outlets for the capital they need to run their businesses and meet their often-egregious development obligations. In my opinion, if I am considering a near-term sale of my business, this type of news accelerates my decision and worries me. Any trend of tightening credit will almost certainly reduce valuations by 5-15% or more – it can be that precarious and represents a huge amount of money for the valuation of many franchisee’s businesses.
E. Unbridled Has Historic Closing Percentage
Background: Here are some cool stats – Steph Curry’s lifetime free throw percentage is 90.5%. Alabama football’s winning percentage is 90.2% in the past 10 years. Unbridled Capital has closed 89.6% of our sell-side M&A assignments in the past 18 months.
Comments: We are in good company here for sure! Humbly speaking, our closing rate is probably double or triple the industry average. The franchise M&A industry is littered with different characters, personalities, and styles. On one end, you have semi-retired brokers who play golf 5 times a week and want to do a handshake deal every few months. Firms like this typically have very little critical thought behind what they do, and their analytical ability, modeling, legal understanding, and due diligence work is almost non-existent, instead favoring a heavy-laden sales message. These types of firms typically over-promise in terms of higher valuations to clients. They likely won’t take a ton of assignments. Their closing percentage gets hurt because they don’t work the details of the deal once a buyer is found – often 50%-75% of the work in closing a successful transaction occurs after the buyer is determined. Another type of broker is a website consolidator – they slap hundreds of listings up on a website, hoping that some of them will sell. These types of firms are also likely to have poor analytical abilities and little interest in spending hundreds of hours of due diligence with their clients. This type of firm relies on a high volume of transactions and is generally fine with a low closing rate if they have enough listings. On the far other side, there are sophisticated M&A firms that have very little personality. Their sales ability is questionable, their personalities are caustic, they are too busy to pick up the phone when you call, they make you feel unimportant and they don’t focus on business development well – increasing the pipeline of buyers, for example, instead of working with existing relationships they have. It is very, very rare to find an M&A advisory firm that has very strong analytical abilities and great sales and business development skills. For most reputable M&A firms, sales skills are poor, and clients get suboptimal results and have difficult personalities. Finally, in all these examples, integrity and trust are always a concern. Many advisors or brokers will cut corners to get paid and will use questionable ethics when no one watches.
Effects on M&A: At Unbridled, our huge closure rate can be attributed to quietly doing the right thing, over and over. We honestly assess a client’s business. We treat our clients like family. We seek the very best outcomes for them – with integrity, responsiveness, critical thinking, and excellence. In my humble opinion, we have the best-in-class blend of salesmanship and analytical expertise. I often say that we have strong Midwestern roots – we aren’t necessarily flashy, but we are hard-working, honest, and care deeply for our clients. I have worked very hard to set up the company this way so that our clients get a world-class M&A experience. A special thanks to Derek Ball and the entire Unbridled Capital team for helping our clients reach their goals!
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Disclaimer: Please note that neither Rick Ormsby nor Unbridled Capital LLC gives 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.