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Unbridled Capital

Season 2 Episode 12: M&A Market Trends

Podcast

10.27.2020

Also Listen On:

We've all seen the articles regarding how 2020 has affected the restaurant industry, but where does that leave the M&A market? Rick talks with Derek Ball and Tony Petrunin from his own team about all they've learned (hint: it's a lot!) from negotiating deals through this unprecedented season.

We hope you'll take a seat at the Unbridled table as we discuss the following topics and more:

1. Current M&A market conditions
2. How have valuations changed since Covid
3. Pre and post-Covid case studies
4. Changes in the lending market

Transcript:

Welcome to The Restaurant Boiler Room, season two, episode 12. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the Boiler Room, we're going to have a great discussion on M&A market trends with Unbridled teammates Derek Ball and Tony Petrunin, and part of the discussion will include current M&A conditions, QSR sales and profit outlook post-COVID, how valuations have changed since COVID, some case studies on a pre and post-COVID basis on real-world examples of businesses we're selling, changes in the lending market, real estate financing and sale leaseback updates, timing updates with geopolitics, and near-term M&A outlook.

The Restaurant Boiler Room is a one-stop shop for multimillion-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 franchise doors on a monthly basis. Please feel free to find all of our content at Unbridled Capital's website at www.unbridledcapital.com. Now, let's enter the Boiler Room.

Welcome again for everyone who's here. This is Unbridled Capital's sixth... I think it's our seventh webinar series, and it's been a blast. And why I'm really excited today is that I'm sitting here... And of course, for those of you who've listened before, you're going to know that I have some level of knowledge personally, and our company has some level of knowledge as a company about everybody that we've interviewed. But this interview today is all of our internal guys. This is Derek and Tony. We're going to be talking about M&A, buying, selling, financing franchise restaurants. And this is the one area above all other areas where we are blessed to be the experts. We, by many measures, are probably going to have the highest deal flow and the most amount of transactions in this little area of the world that are out there, so I want you to hear these awesome guys talk about what they've been doing over the last six months and how it might apply to how your thinking resonates with regard to financing or buying and selling restaurant companies.

First, I'm going to introduce Derek Ball. Derek is, I don't know, he's the... How do I describe him? The guy without the glasses. Derek's been with Unbridled since we started in 2016, and he's been working on over $1 billion of transactions. He actually lives in the Denver, Colorado, area. I'm now down in Florida, as you know, and he's in Colorado. He's an attorney by background with a tax master's. He's excellent, great, great, knowledgeable and analytical person. And for those of you who've worked on transactions with him, you're really going to sing his praises like I do. Welcome, Derek, to the webinar.

Hey, everybody.

And then you've got Tony Petrunin, our man Tony. And Tony's fantastic. I met Tony when he was working for Pizza Hut. This was about three years ago, I'd say. He came into Louisville for a meeting and we had dinner, and then over the course of a couple of months, we had a courtship, and he ended up taking the plunge and coming to Unbridled. He's been here for a little over two years and has done a fantastic job. He's really been growing our M&A practice and really been specializing in helping our clients. He's got a great, personal feel, a lot of expertise. He worked on a lot of international transactions with the Pizza Hut system across the world, and so he brings a great breadth of expertise to our team. I'm excited to have him join the team as well, and to join this conversation. Hi, Tony.

All right. Thanks, guys. Thanks for having me.

Yeah. Well, okay, here we go. For those of you who are listening or will be listening on the podcast, what we'll be doing is talking a little bit about the current M&A market conditions, and then we're going to jump into a little bit of our view of the outlook of QSR sales and profit on a post-COVID basis. And we're going to hone in on valuations, because this is an area that I think a lot of us don't really know. If you're in this market and you're looking at what happened in March and April and May, and then you're looking at what happened, in many cases to the positive, in June, July, August, September, and October, outside of the dining room as your delivery concept, the question is, how do you value these assets these days, and what have we seen on how these assets are valued?

We're going to share with you real-life examples and case studies. Tony will give you a couple of case studies, Derek will give you a couple of case studies that are going to be fresh. They're going to be over the last couple of months. I think we're the trendsetters for the market, so we're going to be able to show you and tell you what we're seeing. We're going to chat a little bit about real estate financing and do a sale leaseback update for you, so you can get a little bit of the view from our perspective of what's happening in that marketplace, both on a 1031 basis and through the portfolio market, which is the real estate investment trusts. And then we'll talk a little bit about what's happened to the timing of deals, and we'll give you some opinions at the end of what's going to happen, from our perspective, in the next two months, three months, four months, five months, six months, and as we move into the latter half of 2021. That's the viewpoint.

Let me start with the current M&A market conditions. Guys, I feel like I've been yapping too much, so I'm just going to throw out a couple of points and let you just chime in and make this a conversation. I said it at the outset. We've got about 20 active assignments across nine brands, and six or seven new ones that have been on the market since June, and we have one assignment that is new today in the Sonic space, and we have another assignment that's going to be new, I think, in a couple of days. We see a pretty healthy breadth of transactions that we're going to be speaking from. I just largely say that we saw a really steady increase, but fairly substantial increase, in transaction activity since June. Do you guys agree? What are you seeing right now as we're sitting at the end of October?

I'll step in here. Rick, you talked about uncertainty being the enemy of M&A. Imagine where we were at in March. A lot of financing was basically put on ice. There was tons of uncertainty. Any transaction we were working on, more or less, was put to a halt. The brakes were hit. Since then, we've been, to your point, Rick, on a very nice, steady incline, and we've been constantly getting more and more deal flow. I'm sure everyone that's on this webinar has seen a lot of our deal flow since. And I would say, even up to the last three weeks or so, we continued on that same trajectory. We've seen a little bit of softening right now, but I think, again, to the main point of uncertainty, when you start thinking about the upcoming election, what that means for capital markets, those are the items that I think are driving a little bit of that softness.

Yeah. Yeah, really well said. Yeah, I think that's really well said.

Yeah, and even all the deals that we're seeing, they've really been businesses that have done well through COVID, so strong drive-through-heavy businesses. I think it's no secret that the chicken concepts, pizza, and Sonic specifically as well, for obvious reasons, have done really well. We have done a few valuations recently of businesses that didn't fare so well through COVID, and our honest advice to those potential and hopeful someday clients is this probably isn't the time to sell. There are a lot of businesses that are coming out that have seen strong increases, and we just think the potential handicap on pricing for businesses that did take a bit of a bigger hit through COVID, it might not be fully back to normal right now. We think the value you would get today is probably lower than what your business should be worth. Our advice has actually been to hold your business, unless you have other reasons to want to sell, and wait for 2021, and hopefully things will get better.

Specific to one of these comments, we were getting calls in March and April asking, "When are the distress deals coming out? When are we getting 30, 40, 50% discounts on these deals?" We have yet to see that. In fact, it might be the opposite for businesses that are actually doing well right now, which we'll get into a little bit later.

All right. That's an interesting comment. I hadn't thought about this, but I think you're right. A lot of the clients, almost all the clients that are calling us that are wanting to sell their business or are wanting to continue a sales process that started pre-COVID are the ones that are up in sales and up in profits. If you are a business that is still down 10 or 15%, and I'm asking a question by making a statement here, you actually look like a shorter pygmy than before, relative to the businesses that were doing and that are on the market in relatively limited supply that are showing five to 10 and 15% sales increases. Your comparable set in the marketplace is doing a lot better than you, and that may hurt you a little more than it otherwise would. I guess that's your comment, Derek, isn't it? And I think it's right, actually.

You could sell your business. You could sell your business, but you're probably not going to get what we would believe the true value of your business should be. And if you're still down 10 to 15, we think buyers are just going to handicap that value. Keeping it, and if you believe in your business longterm and believe it'll come back to normal, we would personally advise you to hold that business, short of other reasons for wanting to sell. But yeah, I think you hit it right on, Rick.

Well, Tony, we have a supply-and-demand equation always in our world, and everything we look at, whether we know it or not, is through supply and demand.

Absolutely.

And we have a relatively low supply of transactions in the market. I have had two phone calls today from big firms asking me if there's any deal flow out there, saying, "We're looking for transactions and can't find them." We have a relatively low supply. The demand, wouldn't you say, is at least average to slightly above average. If there were 10 buyers before and two sellers before, now we might have two sellers and five buyers or one seller and five buyers. The equation is pretty similar. Fewer buyers, but a lot of buyers, and way fewer sellers potentially. I don't know if my numbers added up there. How would you map that?

Yeah. I think that's really fair. The ratio is still the same. And I think, we've seen this a little bit, too, there's been a lot of institutional money that's come in. We've always had that phenomenon where we've even seen some international buyers on a few of our bids. I think what you're seeing is an acceleration of a trend that we probably already had. Some of these guys, they were typically investing in consumer discretion on one side of an institutional portfolio, and then commercial real estate elsewhere. Now, with the Amazon effect that was already in effect pre-COVID, then pair it with the callus of what COVID's done for commercial office buildings, et cetera, doesn't leave a lot of places where you want to invest those funds that can touch on discretionary, but also commercial real estate. QSR has the embodiment of both of those. Now, not only was it recession-proof in '08, now it's proven to be pandemic-proof. With those two things married together, it makes a pretty attractive equation for buyers to be seeking to acquire in this space, so you're right on with that.

We're going to move to the next slide, but the final two points are new buyers are emerging, more aggressive than strategics. And I think that's a key point. Both of you guys, keep that in mind, and let's address that later in the presentation here. It is true that valuations have come up, and we're going to show a couple of case studies that are going to prove that and show you how the pricing has come up for these QSR brands. If you're an operator of a restaurant company, man, and over the last six months, you've seen your EBITDA up 25% year over year, you're looking at a valuation, even if your multiple's the same, you're looking at a valuation that's a heck of a lot higher. We're talk more about that in a minute.

One question that just popped up. I'll reference it. Valuations are increasing for concepts that are doing well and that are up in sales, up in EBITDA. If you're not, your valuation's not increasing. In fact, it's likely down. One of the questions was, "What if I need to sell? Should I hold?" Like I mentioned, there are a lot of reasons to have to sell. If your reason to sell is to maximize your take-home and your value, and you're down 10 to 15% in sales, now's not the time to do it. If you have another reason to sell, if you're in distress, or a lender's putting pressure on you, and you're willing to take a lower valuation, that's a different story. There is a market for businesses that are down in sales, but it's not going to be at higher valuation, and very likely lower than it was pre-COVID. The businesses that we're talking about having higher valuations and higher market to buyers are businesses that have succeeded really well, increased sales, and increased profitability. Just to be clear on that.

Well, it begs the question, Derek, and I'll throw this out there for you, what do you... It begs the question, "If my business is down 10 or 15, it was down 40, it was down 30, it was down 20, it was down 10, and now we're down five, 10%, when can I expect the market not to discount my business if I were to sell it?" What do you think about that?

My opinion is purely that. An opinion. Keep in mind, the businesses we've been marketing are businesses that have been doing really well. The feedback that I'm going to provide is feedback we've gotten from buyers generally. We haven't had a business on the market that's down 15% in sales. We simply haven't, so I don't know exactly what the offers are going to look like. This is really from just buyer commentary. We get calls all the time from buyers, and I pick their brain. "What do you think about this? What do you think about that?" If you're still down 10 to 15, we get people saying, "Well, I was down 40 back in March, April, and May. Can I get adjusted for that?" My hopeful answer would be yes.

But then you also have buyers saying, "Well, if you're still down 10 to 15, how long will that last? And should I also pro forma going forward, negative 15s for the next six months, until we start rolling over those bad periods?" The answer is I don't really know exactly, but I don't think it's good. I think it's not a positive answer. Your value's going to be exactly the same, and we can pro forma it back to 2019 levels. I just don't think there are buyers in the market that are going to be willing to do that right now. Again, that's my opinion. We haven't marketed a lot of those businesses. We have to look at Unbridled, our own time value, and taking one assignment means not taking another, so we also have to pick and choose the assignments that we think are going to be the most attractive to the market, so we have not marketed businesses that are still down 15%.

Let me jump in and say that I think, if I were to characterize it the same kind of way, I would say... And I don't want to spend too much time on businesses that are struggling, because there are a lot of businesses, a lot people who are listening who are doing well, but I would say this. You really should be trying to comp last year. If you can show that you've comped last year for two or three periods or two or three months, depending on how you do your P&Ls, you can create a story which we can then take to the market and try to show and explain how the future-looking circumstance, how the brand is back and sales are back and the business is back, and we can fight for higher multiples and higher prices. It's very difficult to do when you are in negative sales comp territory, all the way up to the point in which we have a business for sale.

And I would say, in the last 20 years of doing this, very rarely have we actually sold a business that had sales that were 10% down. It's very, very difficult to sell a business that is showing negative 10s. It's hard to finance, so I think, directionally, Derek's right about that here. Why don't we jump into this slide? And Tony, I want you to jump in here. QSR sales and profit. Let's talk a little bit about that.

This'll tie back to this slide here, but as you mentioned, some of these businesses that have gone down 10 or 15%, I sure hope that they look like a lot of the businesses that we've seen here that have the dining room shut down, but are heavily dependent on the drive-through. Your sales might be down 10 or 15%, but I certainly hope your EBITDA is not as impacted having the dine-in shut down. What we're seeing is most businesses in QSR, my commentary's mainly on QSR, the ones with a drive-through have been able to save about 200 basis points in labor, plus or minus, and if you put a 30% flow-through on that, that offsets any declines you might have. But also, if you're having a really large uptick, you're leveraging up your P&L with a high flow-through, and your EBITDA is expanding nicely. That's something that we're seeing across the board.

Closing the dining room has actually been a blessing, obviously, in this part of the entire food space. Can't say the same for fast-casual and typical dining, which we'll talk about here in a moment. But it's a little bit nuanced. The real winners in all this has been QSR, as we all know, and I think those who are enjoying the blessings of being drive-through, some franchisees are coming to us and saying, "Gosh, can this always be like this?" And now, you have franchise orgs even rethinking some of their models and ghost kitchens and doing drive-through-only models. I think we'll see that continuing to perpetuate. Especially through this election cycle, everyone's flagging this potential for additional COVID upticks. We'll see.

Good points. All very good points. Let's jump through this slide fairly quickly. The biggest winners, QSR's biggest winners, they have been delivery concepts. You've heard that constant ring from us. Chicken and pizza have been doing really well, haven't they? They've been doing really well, just because of the delivery-based model. And chicken has been largely something that can be portable, especially with sides, and can go home and sit in someone's refrigerator and be reheated, and it's more a whole-meal replacement. Chicken has done really, really well in many cases.

Chicken has been marketed for 50 years as a take-home family meal, so it was just poised to take off during COVID.

Yeah, totally. Totally. And I'm so pleased to hear that for our KFC brethren and the people in Popeye's and some of these chicken brands who've really seen these big increases. Kudos to you guys, and keep it up.

Nominal sales increases are seen mostly in burgers. Some burger concepts, especially ones that are heavy drive-through, I was just on the phone with a guy who has a heavy drive-through burger concept that's been doing really well over the last six months. Some burgers are doing great. Other burgers, Sonic would be considered a burger, but of course, that's a contactless, drive in through a stall, a car-hop type of a situation, and that model has just been fantastic for this COVID timeframe. You've got sales that are up a lot there, but otherwise, mostly flat, maybe slightly down across some of those concepts. What are you guys seeing, and what do you see in the difference in sales by geography and location?

I think, in terms of geography, I'm not going to lie to you and say I have perfect answers here on geography. I think it comes down to state-specific laws. Anecdotally, I feel like I hear people doing better in regions that are still more shut down than others. Obviously, if you're unable to go into restaurants, that's where you're still ordering pizza or going through the drive-through and picking something up. Anecdotally, I think that's probably a decent way to start. That's what's really affecting, and we have at the bottom here, casual dining. If you're a casual dining in California or New York City, you're probably impacted a lot more than if you're a casual dining in Texas, and you've been open since July. That's going to be really, really regional. QSR, I think, is heavily just... If you have a successful operation and people know that they come to you, get quick service, and go through your drive-through, or feel safe going through your drive-through, knowing that it's a well-run operation, then I think you're probably doing pretty well. That's just my opinion.

The other point here that we haven't touched on is sports viewership, and how is that going to impact sales? Obviously, that likely somewhat impacts delivery sales, whether or not that's GrubHub, Uber Eats type of thing, or just straight pizza. Obviously, delivery pizza thrives when people are watching sports, and if sports is down, could that impact pizza sales?

Yeah, sports viewership is down.

I feel like I'm hearing that probably impacting them slightly, but pizza is still comping really positively across the country, is our understanding.

Yeah, the numbers are coming down, though, anecdotally, and I think it's because sports viewership, or one of the reasons is sports viewership is down, and it does have an impact on especially pizza. Let's watch that. Of course, we have a lot clients in all the pizza brands. It's one of our big strengths of our company, so we'll continue to watch that.

Let's jump on to the next slide. Valuation changes since COVID. Okay, this is going to be a meaty slide. What do you guys think? Tony, why don't you... I'll take the first point, and then I'll let you jump in. The first point would be, running up to middle of 2018, we were on a historic high. It's gone like this. Valuations have come up, probably 45, 40, 50% higher than what they were eight or nine years ago, and they're, in all the years I've doing this, at their historical peak. Now, if you're in a brand that's really doing poorly, you may have not seen a whole lot of multiple accretion, and you may have actually seen multiples come down.

But overall, the industry has been at or near a historic high since 2018. We started seeing it flatten towards the back half of 2018 and 2019, but still at historical highs. And then we hit COVID, and everyone was thinking, once we hit March and April and May, "Oh my goodness, the sky's going to fall, and prices are going to go to zero." Everyone grabbed their toilet paper and their guns, and all these things happened. But then we started coming out of it in June and July, and in June, July, we started having a couple more transactions happen. August, September, we started swirling a lot, and what we've noticed is that, in most cases, multiples are actually still where they were.

Now, there're two factors when it comes to pricing a company if you don't have any real estate, and one's going to be... The two main factors, let's say. There's many factors. One's going to be the multiple, and one's going to be the EBITDA itself, and those are the two things that are moving this equation. What do you think about the comments there, Tony? What do you think?

Yeah, no, I think you hit the nail on the head. Multiples are just one piece of the valuation puzzle. The other is EBITDA expansion. We've actually been lucky enough to only work on, really, businesses that have had that latter expansion. EBITDA expansion has been happening. I will say that, in those brands that we worked on, you're right. The multiple is relatively unchanged and slightly down, but to offset that, we've seen EBITDA expansion. And we'll talk about this in some of our case studies, but we've seen an overall price increase.

The other thing I would say is a little bit of a nuance to add onto this is financing is absolutely essential as you think about these businesses. What we've seen with a lot of the lenders on the deals that we've worked on is that, one, lenders are willing to take market share and looking at some of these opportunities to beat up some of their peers that have been heavier in fast-casual and casual dining. When they see a business that has EBITDA expansion, they're thinking, "Okay, great. This is actually a good, safe investment for our committee. It's COVID-proof, it has potential." That's been a big thrust of what we're seeing on the businesses that we've been able to consummate through COVID. It's one thing to have just expansion of your EBITDA, but the lending community is really supportive, and a lot of folks are looking at it as a chance to grab market share.

Yeah. That's good. What happens when [crosstalk 00:23:21]-

I have a few responses to that specifically. I think Tony was right on. I would argue that multiples are even slightly down, but valuations are way up. And the reason, there's two pieces to this. When we talk about where multiples are and where valuations are, know that we're not talking about the average buyer in the market, the person who's going to, out of 10 offers, come in fourth or fifth. We're talking about the offer that comes in first.

When we talk about what the market is, it's the market that is winning the deals, and there are buyers that are willing to pay for a lot of the expansion that we've seen this year. I would argue that most aren't, but a lot are, and those are the buyers that are winning these deals. And keep in mind it's not been on any of the deals we've done, one buyer running away with it. They've been competitive in those one, two, three, top three places in LOIs. But just remember that it's not the average buyer. There're a lot of buyers out there that are going to take the average of the last three years and the LTM, and that's what they're going to pay on. But that's not what's going to win a deal.

Additionally, I think the reason the buyers are currently willing to pay similar multiples as to what they would've pre-COVID, even with the massive EBITDA lift, because a lot of them expect the EBITDA lift to continue, at least until we start rolling over in March and April. That's critical. My personal opinion is that when we get to May and we're marketing businesses on LTM April 2021, my personal opinion is multiples will crash. I think valuations will still be strong, but the actual multiple will go down. People aren't going to want to pay that same multiple on what will likely be historically high EBITDA.

I think a lot of people view, once you start rolling over that EBITDA, if you've been up 20% in sales, let's just say, expect to potentially continue your plus-20s through March, and then maybe you're going to get negative 10s after that. Most buyers we talk to do believe that the new normal will be better than year in 2019, but the peak will be LTM April 2021 for people, and where in the middle will it land? And I think a lot of buyers, and the reason we're seeing the prices where they are, is buyers see that as LTM August, LTM September 2020. They'll continue to get upside through the next six months, and then a little bit of downside from there. I think, if we're getting a five-and-a-half-times multiple today, it might look like a four-times multiple LTM April 2021. That's the dynamic, at least in my personal opinion, of why this is happening.

We also just got a question. Mike, good to see you on. Won't say your last name, but good to see you on. Seller notes. We're hearing it discussed. We've yet to do a deal with it. Sellers just don't often like to do those, to be perfectly honest. They would rather keep their business and take the risk of them operating it, getting it. And then you talk about earn-outs, and sellers don't trust buyers and how they operate. How do you calculate the earn-out? We do have one deal where we actually are doing an earn-out, and it's going to be based on sales levels in 2021, not based on EBITDA. But it's just something you don't see very often. Sellers are often not very comfortable with it and would almost rather hold their business. Historically, we haven't needed seller notes or earn-outs, because the market's strong. The only reason sellers will take that is they do want to get out, and the price that they could get over the next couple years is significantly better than what they could get now.

And the comment, I think, too, is I've seen in my career here a lot of seller financing and earn-outs, Mike. Those are going to be probably a little bit more in tune with deals that they haven't recovered or are in distress. We're largely not doing those types of deals right now, but if we were, if we were representing a bunch of casual dining brands, there would be a ton of that seller financing, earn-out, alternate financing structuring. That's part of an arm of our company that we have a lot of expertise and time involved in. If you need alternate financing for a restaurant business, or if you're looking to buy a restaurant business or sell a restaurant business, we have those resources for you.

I would make a comment, though, about March and April 2021. I do think, from talking with lots of clients now, that if you're an operator and you're listening to this, you probably have a slightly overinflated view of what the future of your sales is going to look like. Too many of the people I talk with who are operators say, "Hey, we're going to keep a lot of these sales increases forever." If they're not saying it that way, they're at least presenting themselves that way.

And we're in a business that's really grown one or 2% each year for the last 500,000 years. It's not a high-growth industry. It is true that the competition is coming down with a lot of store closures, so there is a case to be made that you're going to win longtime customers. But the thought that you're up 40% year over year now, and that next year, at the same time, you're going to be comping or even negative five or negative 10, it's probably not going to happen. That's a comment.

Let's move on, though, to Tony. I think this is going to be a really neat section, because Tony's going to give us, and then Derek will, a little bit of some actual case studies on some recent deals. Go for it, Tony.

Yeah, sure. What better way to bring real-world scenarios and talk about what we've seen, right? We actually had a series of KFC transactions that I would say we went to market late last year, going up into COVID. And we took those same businesses, monitored them through COVID. Obviously, almost everybody in this business had a March slump. April recovered, and these hockey-stick from there. We took those same businesses, relaunched them. We got a nice comp set here, at least in KFC, to tell you what we saw.

In those businesses, we saw sales increases of about 10 to 20%. When you actually look at how that transposed down, the EBITDA's up 25%, so that just tells you what we were seeing on the previous slide about profitability expansion, even with the dine-in being closed. Just so much volume is getting pushed through at a very efficient drive-through window, which is fabulous. This, again, exemplifies what we were talking about earlier about pricing being relatively up. EBITDA was higher, but multiples softening, but net-net pricing expanded by 25%, based on what we generated at the end of last year.

Which is enormous. Which is enormous. Bang, 25%.

And all of our lenders, too, on each of these transactions were bullish. We came off of a few fast-casual concepts where it was night-and-day difference. Then you speak to another lender, and they say, "We're all in on QSR. We're happy to finance this transaction." It was a really nice breath of fresh air when we started turning the corner there in June.

And then from a qualitative standpoint, we had about a similar subset of buyers, five to seven on each of these packages. And to Derek's point, there were a couple within that subset that were stronger than the others and really sharpening their pencils, but what we saw was interesting. It's not a deterioration in that group. The same folks showed up then that then showed up again in the second round. And we were even pricing the business up higher, because not only was it 2008-proof with the last recession, now it was proven to be COVID-proof. We saw a big uptick there in terms of the quality of bids that we were receiving.

And then more importantly, the dynamic was a little bit different, the makeup. In one of those cases, we had a pretty strong outside buyer, and people who were coming from outside the system that normally don't bid on these packages, they're looking to diversify. We're seeing that trend continue now as well, even on some of the deals we're launching currently.

And then last thing I would say is, this is a bit anecdotal, because the sample size on these two cases was smaller, but things moved very quickly with the franchise, or quicker than we would normally expect. But I think it's because of the lack of supply and lack of transaction moving through those systems. But again, that's nuanced, and I'll caveat that that can change on any given transaction, but we did see a little bit of a hastening of that process.

Yeah. Thanks, Tony. I would say a couple things to note here. Number one, I just go berserk again about the pricing. The overall pricing is up 25% over 2019 in these cases. That doesn't mean, if you're sitting here listening and you're in some sort of a burger brand in the Midwest or wherever you're operating, that you're going to achieve the same results. It's very much a specific case-by-case analysis. But the fact that we're telling you, the 25% increase in valuations over 2019 is unbelievable. If you have a $20 million business, what is that? Is your business now 24, $25 million? It's a huge increase in valuation. That's number one.

The second thing is the uptick in outside buyers. This is something that I've noticed quite a bit. If you're a mid-level franchisee in the brand that's for sale, those kinds of people aren't making offers, and when they make offers, they're not competitive. If you're a large franchisee in the brand, you're really not... Our limited data set, unless it's a Taco Bell deal, you're not really making exciting offers, in many cases, too. A lot of the people who are making these offers are people who are outside the system, who are smaller family-office and private-equity groups, or operators in other brands who want to jump into a new brand for growth. That's my viewpoint from a few examples. Good job, Tony.

That's fair. I think that's fair. The other thing I would add on it, those outside buyers are willing to pay that premium so that they can get the seat at the table, whereas some of the folks who are already in the system or already large multi-unit operators, they're not as... I shouldn't say motivated, but they're not willing to dial up that premium to get the deal, as maybe someone else would.

I think that's really well said. Really well said. And I know this isn't just for KFC. You've had other transactions you've been working on. I think you probably got eight or nine transactions you're working on for us, so I know that's just a general view. But thank you for the example. Let me jump over to Derek. Derek, why don't you give it a swing, buddy? Swing for the fence. What do you think? Derek's opinion's always a little more measured. He's the grouchy attorney guy, so he's going to deliver the nasty news in a delicate way. Go for it.

Commenting on the outside buyers question, my personal experience hasn't really changed much since pre-COVID. We do have new people that want to come into the QSR industry because it's doing so well, but are they actually willing to pay the prices? I haven't personally had a ton of meaningful conversations with groups that weren't previously interested in QSR in some capacity that are now coming in. I'm not sure if Rick and Tony have, but I haven't.

And if we are talking about them, is it something longterm that they actually want to do, and are they still going to be here in two months, or is this just the thing of the moment? I don't know. Most of the outside buyers that I've talked to are usually buyers that are in different brands that an internal franchisee would consider outside the system, but in QSR and interested in QSR, and COVID making them more interested in QSR. I haven't seen as many people just flat-out coming to QSR yet. I can see that happening. I personally don't hear that experience.

Some of my deals in terms of pricing, like we've already said, pretty much every deal we're working on, sales have been up, EBITDA has been up, multiples are arguably slightly down on current EBITDA, the valuations are still up. It's very dependent. If you've got five million in EBITDA and you're only up $100,000, don't assume your valuation's going to be up 25%. It's going to be at least where it was before.

But the up 25% are the groups like Sonic. If you're experiencing 30 to 35% in sales slips and strong flow-through, it may sound crazy, but I can guarantee you, the valuation is up about that much. We already have certain comps to show it. It is there. Not every buyer is willing to pay it, but there are buyers willing to pay it for the same reason of what I talked about earlier. They still think there's upside, and maybe now is where we end up meeting once it's all said and done. Once other restaurants are closed, maybe this is where the QSR industry settles, and they're willing to take the risk of paying what would be a really strong price to take that gamble.

My experience has been in several different brands. For obvious reasons, Pizza Hut is doing really well. Pizza Hut franchisees, we aren't really doing a ton of marketing right now on any Pizza Hut deals. There's obviously a lot of news in the market about what's going on in Pizza Hut, and I think a lot of those franchisees, they've taken a lot of hits over the last three or four years, and think they're excited to ride this out and see where it goes. New leadership changes and COVID, so I don't know if we'll see any big Pizza Hut deals at least this year. Just franchisees looking to ride out the wave, really.

The other brands that are just seeing strong labor improvement, like Tony said earlier, and there're some buyers that are willing to pay for a little more than other buyers that are more fearful of what happens when breakfast and late-night and dining room come back open. That's a big fear for a lot of buyers, and rightfully so. You're taking a bit of a gamble, and you're really believing in the future in the longterm if you pay up for that right now.

For my particular deals, I would say the franchisors are moving a little bit faster. I think part of all of those, though, is a lot of the deals we're working on right now, the clients really want to get it done this year.

By year end. Yeah.

As I said earlier, it's the uncertainty. They want to get it done this year if capital gains does go up next year and doubles. People just want to get out. I think that's part of it, is there's also more pressure on the franchisor to get it done this year so they don't risk having their franchisees paying millions and millions of extra dollars in taxes next year, and then it potentially coming back on them for being too slow. I think that's potentially part of it. I don't know. Maybe there's just not a lot of deals at corporate right now that allows them to move faster. I'd say, overall, we probably are moving a little bit faster.

You've had a couple of deals, too, that aren't M&A assignments, that are financing assignments, where we would go, a client would hire us, and we would go refinance their debt for them and take it to a national market. You probably have a perspective there. What do you think?

Overall, you're probably going to get less term sheets and less banks overall interested this year, but the rates and the terms are still extremely competitive. You've got banks out there that are, I guess, hunkering down a little bit, focusing on their current franchisees or current geography and not really expanding their holdings, but then you've got other lenders looking at taking market shares. You've got really, really aggressive lenders in certain circumstances. Who really cares if you got 10 term sheets last year and five this year, as long as they're still competitive, which they are? It's stilly a really, really strong financing market. If your business is doing well, I would encourage you to potentially look at calling your lender and looking at refinancing it.

Give us a couple of examples from two Taco Bell assignments that you've worked on. Recent refinancings, just general, high-level, fixed-rate financing, sub-3%, no personal guarantees, low origination fees, if any. What are you seeing?

Generally speaking, what you said is pretty accurate. The top of the market has ended up being on those. Yeah, those are really strong Taco Bell businesses, by the way. Obviously, as some of the lenders that I know are on the call can say, that's not going to be attributable to every business out there. Those are very strong, high-volume, well-respected operators as well. You have a business like that and you don't currently have a strong financing arrangement, it might be the time to give your lender a call and see what they can do for you.

A little more choosy, but if you have a business that had nice increases, and it is true that while there are less lenders and less term sheets in the market, and there are a cadre of lenders who are quietly stepping out of the restaurant space, probably the lending space altogether, there is enough of a market for really strong financing. And if you can get the financing, the rates are incredibly low, too. The cream has risen to the top, like it always does, so if you're in the handful of brands with awesome performance, I bet, if you're on this call, you're getting bunches of lender calls that you weren't getting back in March, April, and May. Any other comments here? We want to-

[crosstalk 00:39:48] just a couple quick questions. Someone said, "I've heard some buyers wanting to erase 2020 from any valuation calculation." There are a lot of buyers that are doing that, and they're not winning deals, to put it simply. I would say at least half the buyers that you talk to are going to argue that, and I don't necessarily say they're wrong or not, but that's not the market. If you want to win deals, you just can't do it, really. Same argument could be made, "Well, what if your business is down 30%? Can we just erase 2020 and go back to 2019 levels?" We're just not seeing that.

Another question. "Where do you see rates going in the next few months?" To be perfectly honest, I have no clue. I'm sorry. What we've heard is they're going to stay aggressive and stay similar to where they are right now, but I don't wake up in the morning and read that every day, so I don't have a better answer.

I'd say the best answer is probably either A, we don't know, or B, status quo. We have enough national headlines from the federal reserve banks telling us that they're going to keep interest rates at these levels for a long time, so we wouldn't expect a massive change. But anything can happen from a geopolitical perspective. If we enter into recession, if there's headwinds there. I think that's probably a good comment.

To go back one, the first question was about... What was the first question again, Derek? I was going to let Tony answer that, too, because he was nodding his head, man. He was eager. He's ready to take it.

No, we got another question from Mike, and it was basically saying, "Are buyers solely focusing on year-end 29 EBITDA as the normal, and are they applying higher multiples there?" My perspective is, as we're on this financing slide, is a lot of the lenders I've spoken to and the categories that are doing well that we are transacting in, chicken, pizza, burgers, in particular Sonic, and especially in Sonic, I would say a lot of the lenders are looking at it and saying, "Well, we know if we solely finance on '19, one of our competitors are going to go ahead and take this deal away from us and finance the buyer's place in the bid." What they've actually been doing is going somewhere in between '19 and LTM numbers, is what I've been seeing, and they'll try to maximize how much they can lend in that position, and then our aggressive buyers are filling in the gap with additional equity. That's what I've seen in deals.

The people who are really getting after it, they're saying, "Okay, let me get an aggressive, realistic lender," who will basically go to the investment committee and say, "Hey, look at this brand. It's been doing well through COVID," get the sign-off that they need, still get pretty realistic, strong terms, but then they know they're going to have to open up their equity checkbook a little bit more to consummate the deal. As Derek noted, all it takes is one or two of these type of buyers to come into our transactions to shine really well in the process. I do think there's a lot of people who are pricing off '19 solely, but to Derek's point there, they're not winning the deals.

That's good. Let me jump now, guys. We're going to be having to move a little faster here, because we got to get through some slides here. I'll just take this slide. If you have something, jump in. You can say it. But just as a quick real estate financing and sale leaseback update, we would give the broad commentary to our clients. The cap rates are really attractive right now for the same reasons that EBITDA multiples are. The interest rates are low and people are looking to do 1031s, and there's timing considerations here where people are wanting to avoid tax increases and the possibility that 1031s could go away under a change in administration if things go to heck in a hand basket. There's all kinds of reasons why the pace of real estate transactions has really picked back up.

We think, historically, though, interest rates and just the interest in QSR as a stable post-COVID business model are really helping. The 1031 market was a little wobbly before. Pardon. The rate market was a little wobbly before, but we're hearing some anecdotal comments from both clients and real estate folks that that market has come back pretty strongly in some recent comps and transactions. We're watching that, and we think the portfolio market, the rate market is back on the table, whereas maybe it was largely off the table back in May, June, and July, maybe even August. Largely, I think the real estate financing and sale leaseback market is strong at the moment if you have a brand, again, that's comping and showing positive results, especially in the QSR space.

Let's see. Timing updates. You guys want to take a swing at some of this broad macroeconomic stuff? This is Tony's bailiwick. He's licking his lips down there. Tony's in Texas, by the way. All Texans have got a political view, I've found over the years. No, I'm teasing. What do you think? What do you guys think about some of these items here? Presidential elections, vaccines, stimulus package, and unemployment, GDP growth.

Well, there's no doubt that all these things create uncertainty for buyers and sellers in capital markets. Here we are, call it two weeks away from a presidential election. A lot can happen after that day in November comes and goes.

The other thing that was a little bit interesting, I think, as were preparing for this, there's news that was coming out about Johnson & Johnson and some of these other developers of the vaccine that are having negative consequences and not hitting milestones that they previously committed to, or that they estimated they could hit. I think, for anyone who's in QSR, that's a hell of a tailwind. I hate to say it, but if a vaccine gets pushed out, it means more people are going through the drive-through.

Of course, everyone wants this thing to go away as quickly as possible, but certainly, the vaccine that was supposed to be this bullet solution seems to be not as clearcut as we originally thought. Johnson & Johnson, AstraZeneca were the top five, and two of them, earlier this week or last week, announced that they had major issues. That could be an interesting narrative to see how that plays out. And then you got Fauci coming out saying that further lockdowns might be happening. We're going into a flu season as well. It could actually be a good time for QSR, but I think the biggest item on this list, if I could prioritize in terms of uncertainty, would be the election and what happens there.

Yeah.

My opinion is this. I'll share it. I don't think the average person-

Careful, careful, careful.

I don't think the average person cares about a vaccine. I think the world will eventually open up. I think people will be in too much pain longterm, and restaurants will start defying orders, to be perfectly honest, in states that are continuing to shut them down and saying, "Come get me." And I think we're already seeing that anecdotally in the news. My personal opinion is I'm not real focused on a vaccine. Half the country's already said that they won't take it anyway. That's my own personal opinion on a vaccine.

Presidential election is definitely a massive question. If Biden or Harris takes office, you can almost rest assured that capital gains will go up. They have to probably take the Senate, too. I'm not political. I don't predict the future necessarily, but it seems like it's not an unlikely scenario. And capital gains, they've already made it very clear, will go up for people, I think, over a million bucks. Obviously, most of the people that we're talking to here on this call, that applies to labor considerations.

I don't think it's any secret that they want $15 national minimum wage. What that's going to do overall is an unknown. Can you react accordingly and keep EBITDA the same? It probably depends a little bit on your business, but we've seen franchisees and certain QSR brands that are in massive labor areas actually improve EBITDA. Their labor percentage might go up overall, but I've actually seen franchisees improve EBITDA in minimum wage increases for their respective states. If you take price and other considerations accordingly, I'm not going to say that that's necessarily what's going to happen across the country, but it's not crazy to say that.

In terms of the stimulus package, I guess if the whole country had 1,200 bucks in their pocket, it probably works out for everybody on this call, but what will happen down the road in terms of taxes? Unemployment and GDP growth, I'm not qualified to answer that. I don't know.

I'll jump in here. Thank you, Derek. I'll just say this. From all the study over the years, my general reaction to this is, when oil prices are high, QSR sales are down. Unemployment and GDP growth don't affect restaurant same-store sales a ton. They do a little bit, but not a ton, because you have to eat, and they're at the lower end of the food chain. I think what's going to happen is the vaccine stuff, and we're going to get more COVID cases as it gets cold, and it's going to benefit QSR, and it's going to hurt casual dining. And I think you're going to see sales increase over the next three to six months in those QSR concepts, I think, and you're going to see more restaurants shut down and more bankruptcies.

And then I think the first half of 2021 is going to have a lot of M&A activity, a lot of people wanting to sell. But I think, like Derek said, if we get a Biden or Harris presidency, I think we're looking at second half of 2021 and beyond being potentially... I could be wrong. This is going to be taped, so I could be way wrong, and people are going to laugh at me. But I think we could be in a massively bad situation. I think we would definitely be in a situation where, if you make over $1 million, your capital gains taxes are going from 23.8% to 39.6, to 40 to 42%, in that range, potentially. That's massively important for people selling at big numbers, and the labor piece is going to crush people's P&Ls, I think, too, if there's change.

If you're a restaurant operator, and I know I'm a sales guy, I have been for 20 years. I've been wrong about some of this stuff in the past, so I don't want to be a fear-monger, but I don't see a really bright future past the first half of 2021. If you're in the next three to five years considering a sale of your business, I think you'd be crazy not to advance that forward to now or the next few months. I think you'd be crazy. I might be wrong, okay?

That's caveated with a full blue sweep, right? Senate flips [crosstalk 00:49:46].

Unfortunately, yes. Yes, it is. I don't want to be a prognosticator, but it's looking more likely, isn't it?

Yeah. It's pretty much obvious now that-

And someone asked [crosstalk 00:49:58].

Oh, go ahead.

Capital gains increase is going to impact valuations. It's a consideration. It has to be a consideration [crosstalk 00:50:05].

No doubt. No doubt.

I don't know what the impact will be, but it has to be a consideration.

Yeah. Yeah. We got a couple more minutes. That's absolutely right. Capital gains taxes go up, sellers don't sell. Right? In one way, it may create less supply, so there may be more demand. But then-

Eventually, there'll be a new normal. It might take two years for a seller to get around the mindset that, "Okay, I'm just going to have to pay 40% capital gains tax, and there's no other way around it." It might just really depress M&A for a year, year and a half until sellers essentially get... There's always a normal. It's the big change from, "Well, last year, I could've sold at 20%, and now it's 40. I'm not doing that." But two years from now, and they say, "You know what? I'm out. I'll deal with it."

And I'm really proud of our company, because we don't just buy and sell. We give counsel to people that I think is really mature, and one of the things that we're going to be looking at, if Biden or Harris becomes president, is we're going to be looking at ways to think about sitting in our clients' shoes and thinking about how to increase their inheritances, to try to keep their take-home as high as possible under the new legislation and laws. We'll be spending a lot of time and a lot of money and a lot of effort in figuring this out. I can imagine if 1031s will continue to happen, if you own real estate and you do transactions, you're going to keep real estate, or you're going to do 1031s if it's still available in the market. There's going to be all kinds of different structuring that we'll have to think about, depending on what the legislation shows us.

But just to go through the near-term M&A outlook, EBITDA increases probably keep coming through March, April of 2021, just because they're going to be rolling over the negative numbers, especially on the QSR side. We're going to be rolling over flat numbers with big increases. Supply and demand, I think you're going to see an increase in supply in January, February, March. I really do. I think it'll start. It always hits around February, and I think it's going to be quite a bit. I think you'll see quite a bit of it. You guys, I'll let you jump in with any comments on this. We just have a couple minutes.

We expect Q1 and Q2 to be busy. People are already saying, including me, as I think up at night and think about... I've got a couple pieces of residential real estate I might be selling. I'm thinking to myself, "If I can't get it closed by the end of the year, what's the likelihood that if it closes January 31st of 2021? Then I'm going to be hit with increased capital gains taxes." Most of the experts we talk to say that it's very unlikely that they're going to make tax changes retroactive to January 1st if there's a change in the presidency. And then, even so, it has to get through the Senate. But nonetheless, if you can get a transaction done by the end of the year, do it. If you can't, do it as soon as you can if you're fearful that taxes might go up.

A lot of people with expertise tell us that we're talking about the March and maybe April and May timeframe is probably when legislation would probably be enacted, so you'd probably still have a window. We don't know for sure, but you'd probably still have a window in Q1 to get a transaction closed. And if that's the case, our average transaction takes six months. You got to be calling us now. You know what I mean? Or within the next two or three weeks if you want to try to have something happen by April. That's just the way the timing's going to work on it.

You may have less sellers. Probably going to have more distress deals. I can't imagine casual dining and fast-casual can continue to hold on, even at negative 10s and 15s through the winter. It's been a rough road. The PPP money has helped, but I got to think, and we watched some of the bankruptcy proceedings, and they've been increasing. They're at historical highs already, and they're going to increase, we think, for sure. And then uncertainty, as we've talked about before, is never a seller's friend. We would encourage anyone who has any sort of a near-term window, at this point, you may wait and watch and see what happens in the presidential election, but you shouldn't last much beyond that if you have a near-term window of selling or doing a financing activity or finding a financial partner for your business. Any comments, finally, from you guys?

All the stuff that we just talked about is largely negative outlook on the future, and it depends, really, what happens in November, is our honest opinion. There's always going to be an M&A market. There just will be. And there's always going to be buying and selling. The buyers that we sell to aren't looking to hold it two years and sell. Most of those buyers are looking to hold it 20 years or more. If you're looking longterm in the restaurant industry, I would assume that you're in good hands being in QSR. If you're wanting to buy something now and sell it in 30 years, might not be the best thing to do. But I think, for the longterm, QSR is going to hold, it's going to do well. It's shown to be resilient. They're pretty much everything. I wouldn't have too many longterm fears about the QSR industry. There're just little short hiccups that you get used to, and you get used to the new normal. It's just making sure you have a path in and a path out appropriately.

That's great. Thank you all so much. I think it's an excellent comment. Tony, do you want to make a last comment before I wrap up? Here's the guys' contact information if you want to reach out to any of us. I think you know us, probably, but feel free to write it down. The one thing I love about our entire team is that we have different perspectives, we come from different places, and we have different opinions. That's what makes a healthy team. We have different strengths and opinions that we can bring to the table.

One thing I would say, it looks like there's a couple of questions. Do you guys want to jump in on any final questions before we end up? Do you guys see any questions that haven't been answered?

One here. Just looking at the first one that popped up to me. "What's allowed struggling companies to avoid forced workouts from banks, bankruptcy? Seems like deep distress has been avoided." I don't have a lending background. I'd be interested to hear some lender's perspective on that. I guess the option would be let's force all of these guys out, and then what's the lender holding at the end of the day? And is that actually a better option than to potentially help them over the next six months and have a company that hopefully, once COVID is done, is healthy again? Or would you rather just say, "No, we're calling it now. Go to bankruptcy, and we'll figure out who can buy it"?

I don't think most lenders probably view that as a good option. Struggle with the client and the customer for the next six months, and then help them out of the situation, and now you have a client that's still going to be paying their debt hopefully six months from now when the world reopens. That would be my personal guess. I'd love to hear if a lender is hearing that response. Give me a call, and we can chat. That would be my personal guess.

Yeah, I think that's right. I think that's right. Landlords are willing to be gracious right now more than any other time. You got PPP funds still in people's hands that are buying them some time, and with the stimulus deal around the corner, I could see a lot of lenders saying, "Hey, maybe we do give this another six months and see what happens." But I think the question was targeted around music venues, bars. We probably don't traffic in those very often, but to Derek's point, that would be my hunch as well, is that there's probably more flexibility now than there has been, and that's been putting a lot of time on the clock than if it had been a typical recession.

Thank you guys so much for listening. I want to just give a shout-out again to everybody who's watching, who will watch, and all the podcast listeners from The Restaurant Boiler Room. Thank you to Derek and Tony for you guys' great perspectives, man. It's great to hear them. You guys, I'm proud of you. I'm proud of what you guys are doing for Unbridled Capital. Thank you for everyone. Reach out to our website, and you can link up with us, connect with us any way over social media. You can see our email and phone numbers. We'd be glad to answer any questions anecdotally for you, talk about the value of your business, help you find financing, whatever it might be. Keep in mind, too, that we're going to come back in early December when we know the presidential outcome and do something related to taxation and the future of M&A as it relates to possible changes in tax legislation. Stay tuned for that. That'll be in early December. Thank you so much, everyone. Thanks for your time.

Thanks, everybody.

Thanks, everybody.

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