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Unbridled Capital

What is the 2020 Outlook for Restaurant M&A?

Video

01.27.2020

Valuations have been enjoying a booming cycle over the past seven to eight years. Let me give you a simple example to illustrate. Take a theoretical franchisee and a brand over this time period that has enjoyed a 2% annual same-store sales growth, 200 basis points of margin improvement, a 1.5 times accretion in EBITDA multiples, and has completed 50% of its mandatory remodeling. Each of these individual improvements results in 10 to 30% increase in valuations, but collectively there is a massive effect of multiplication.

Shockingly, in this example, the value of this franchisee's business has likely skyrocketed by 150 to 250% over this time. Which, on the high end, has outpaced the total return of Dow Jones. Wow. But everything in life runs in cycles, and restaurant valuations and M&A activity can't stay strong forever. Most M&A advisors, like myself, think that we are slightly past the peak. And some data is beginning to show that restaurant franchise valuations have declined by a few percentage points in the past six months.

Why? Here are a few key factors, number one, declining same-store sales and shocking traffic declines. TDn2K recently reported that September 2019, rolling three months sales from a same-store basis, were down 0.42%, while traffic was down 3.53%. Number two, bifurcation of results across various brands, with many regional and legacy brands struggling. Number three, overdevelopment of new restaurants is putting increased pressure on sales growth, real estate costs, and ability to hire and retain good employees.

Number four, about half of the states have enacted minimum wage increases, leading to sometimes horrific near-term consequences to restaurant P&Ls and rapid store closures in some states. Number five, several restaurant lenders have stopped making loans or have laid off their franchise lending groups in recent months. While there's still plenty of liquidity, this trend is worth following. Number six, other lenders I know are carefully watching the compression of margins in the past year, noting that restaurant margins are down by 100 to 200 basis points.

Number seven, some lenders are anticipating a reduction in lease-adjusted leverage by 25 to 50 basis points across the franchise lending system in the next six to nine months. This would effectively reduce the total amount of debt that can be borrowed for acquisitions, inevitably leading to lower valuations for would-be sellers. Number eight, macroeconomic uncertainty seems to be increasing as threats of trade wars and negative growth internationally seem to be larger concerns for the domestic U.S. economy. And number nine, another rate cut in October 2019 seems encouraging at the surface, but at some point, lenders no longer liked the risk/reward profile of making aggressive franchise loans.

Overall, my take is that the current trend of very gradual worsening will continue for valuations. I don't see a very good reason why near-term restaurant traffic will increase. Higher minimum wage will continue to intensify, that is certain. Sales trends could strengthen from here, but I'm unsure that they can overcome the cost pressures from an EBITDA perspective. Macroeconomic and political risks are indeed increasing. Lenders are leerier than they've been in past years. Let's certainly hope I'm wrong about valuation declines. I would never have predicted this many years of expansion back in 2012. None of us has a crystal ball, unfortunately.

Thanks for your time. Feel free to check out Unbridled Capital's website at www.unbridledcapital.com for more videos, podcasts, white papers, and a list of our transactions. Please feel free to give us a call if you'd like to talk about the sale or financing of your franchise business. With a success rate approaching 93% over the past two years and over 1000 restaurants sold or in diligence, we are honored to be the franchise M&A leader in the industry.