Creating a compelling and modernized investment thesis requires superior intelligence and insights relative to understanding the landscape and how the consumer and competition are being reshaped, from the decline of casual dining to the rise of new formats.
While other sectors have seen significant increases in productivity historically, improvements in the foodservice industry have been minimal over the last 30 years. The Second Industrial Revolution benefited the industry (overall) with improvements in agricultural production. The Third Industrial Revolution, where consumer and electronics products led growth, had a very slight impact on foodservice, with the adoption of the point of sale system — most of which are really a glorified cash register.
But the sector is now in a prime position to make modernization efforts with the impacts of the Fourth Industrial Revolution and — in doing so — is becoming a more attractive target for investment.
Regardless of the future economic climate, there will be an opportunity in the foodservice space. If there’s a liquidity crisis, M&A opportunities will come through consolidation and distressed assets investment. If the economy is booming, emerging brands and markets will reveal new growth acquisition targets (38.6% of global M&A activity across all sectors features cross-border transactions already).
2019 Will Be Another Hot Year for Restaurant M&A Activity
Overall M&A activity has been growing at a 9.0% CAGR in the last five years and has topped more than $4 trillion globally, across all sectors. Restaurants account for a small piece of this activity around the world — and it’s in the tens of billions for the U.S. foodservice market. From January–October of 2018, there were 124 restaurant deals in the U.S. (versus 117 over the same period in 2017), and the increased trend is expected to continue.
The growth of M&A activity, in restaurants and across sectors, is driven by a number of factors:
- Access to capital is relatively cheap (even though interest rates are increasing in the U.S. and likely to do so in other markets), and there are record levels of leveraged loan issuance, fundraising, and increased levels of leveraged buyouts
- There’s been more money poured into private equity, and a proliferation of PE firms (now more than 8,000 globally, up from 5,000 just ten years ago) leading to increased competition between firms, and some of them seeking new sectors — particularly disruptive forces
- Opportunities for consolidation in increasingly crowded foodservice markets
- While there are plenty of advantages of being a publicly traded company (most notably, liquidity), it can also lead to greater pressures and short-term distractions with quarter-to-quarter scrutiny
- Due to higher saturation levels, cross-border transactions from developed to emerging markets are likely to pick up
- While mergers and acquisitions were formerly only used as a strategy by larger chains, smaller companies are now also looking for acquisitions (often in their same category) to grow footprint and increase efficiency
In 2018, revenue growth among publicly traded foodservice companies in the U.S. amounted to $8.1b (+7% year-over-year growth, from $122.1b to $130.3b).
Inorganic growth (from acquisitions) was responsible for 28% of the increase. In the increasingly saturated U.S. market, inorganic growth will continue to have significant impacts for both private and public companies.
What are the Motivations for Restaurant M&A Deals?
For mature brands, there’s expansion and consolidation. In the U.S., this is the case of many casual dining restaurants — 33% of 2018 deals involved targets in the full-service category. In other cases, deals are often more focused on growth companies. This strategy has been successful for the fast-casual sector in the past, and is increasingly starting to benefit the companies that have a “future of foodservice” angle to them — whether that’s technology, innovation and optimization in the front and back of the house, improved unit-economic model, or delivery companies (which have received a tremendous amount of capital investment over the last few years).
There are a variety of factors that influence mergers and acquisitions decisions, whether focused on mainly strategic or financial motivations. While these drivers for M&A are not necessarily new, understanding the evolving landscape helps to identify non-traditional value creation opportunities and a better assessment of risk.
Consolidation in sectors enables companies to gain market share which can then help from a management point of view and optimizing overhead. In other cases, investors put more of a focus on reducing costs.
Regardless, companies on the receiving end of capital find it attractive both in terms of the investment they are receiving but also with regard to strategic guidance and other capabilities provided to them through a PE firm or strategic investor.
Large Deals Grab Headlines, But Players of All Sizes are Benefitting
In 2018, restaurant valuations reached EV/EBITDA levels of 11.1x (up from an average of 10.8x in 2017) and EV/Revenue of 1.4x (up from 1.0x of 2017). Some recent transactions that have helped to increase that average have been Panera (acquired in 2017 at 18.3x EV/EBITDA) and Sonic (acquired in 2018 at close 16.1x EV/EBITDA).
Recently, some investment funds earmarked for foodservice have gotten so large that they have to find bigger deals for it to make sense. For these multimillion-dollar funds, the transaction costs and sheer amount of resources that need to be applied for a deal (including legal, financial, commercial, and operational due diligence) mean that there’s more emphasis on quality over quantity. In these cases, firms seek fewer, larger deals with greater potential upside instead of more, smaller deals.
In this ecosystem there are different sized capital providers that are each looking for specific sized deals with plans to grow companies to their internal ceiling before passing it on to somebody else. From friends and family money to angel investors to venture capital (and some corporate venture capital), to mezzanine or growth capital, and finally to larger firms that are looking to buy and combine businesses.
In the U.S., the largest foodservice deals in 2018 included:
- Nestle (based in Switerzerland) buying the rights to market Starbucks retail products from beans and capsules for $7.2b
- The $2.3b acquisition of Sonic by Inspire Brands (Roark)
- Pret A Manger (based in the UK, but operates in the U.S. as well) being acquired for $2b by JAB Holdings
- The $770m acquisition of Bojangles’ by Durational Capital Management
- Kroger acquiring Home Chef (meal kit company) for $700m
- Fogo de Chão (which made an IPO in 2015) being taken private by Rhone Capital for $560m
Cross-Border Transactions Gaining Traction
We anticipate more foreign buyers coming to the U.S., and U.S.-based investors making further investments globally. This strategy is a way to gain immediate access to a footprint, infrastructure, talent and human resources, and a regionalized know-how.
Jollibee, for instance, finalized its acquisition of Denver-based Smashburger in 2018. The company initially tried to expand to other markets and they met unforeseen challenges and struggled because customers outside of the Philippines were unfamiliar with the brand. But Jollibee does know QSR operations well, so they looked for an opportunity in the U.S. with a large enough footprint to gain scale.
Larger foodservice groups have been using cross-border transactions to grow for a while now. Growth in the U.S. for large established companies is at a point of saturation — any new units for one brand are coming at the expense of someone else. So inorganic growth and foreign expansion are the greatest opportunities.
Expect a Sea Change in Restaurant M&A, and Companies with Modernized Investment Theses Will Thrive
While we expect M&A activity to continue to pick up over the next five years, there’s going to be a significant change in strategies. There’s plenty of capital to put behind foodservice companies, and some concepts that are not even on the radar right now will jump to very large valuations in the next few years.
We’ve seen this in other sectors — technology, in particular — where there’s been a huge uptick in the number of unicorns (privately held startups valued at more than $1b). The restaurant space just saw its first unicorn in sweetgreen, and we anticipate a handful more over the next five years. Transformative technologies improving productivity in foodservice are likely to gain attention and investment as well.
When the right components are combined within a platform, the whole can be much greater than the sum of its parts (and this is reflected in valuations). If that’s something you’d be interested in, we can help. We support both with sell-side mandates and middle-market buy-side advisory for restaurant industry investments.