Restaurant Bankruptcies

Restaurant bankruptcies have always been a topic of conversation in the industry. Very seldom can there be discussions about foodservice operators without the topic of the failure rate of restaurants coming up. That said, foodservice is actually a very resilient business. There is no question — regardless of geography — we will all continue to eat; the how and where will change so dramatically that hundreds of billions of dollars in global consumer foodservice spending will shift from incumbent brands to innovators and more convenient and profitable models.

We recently conducted a study of public restaurant companies in the U.S. to assess their risk of bankruptcy in the wake of the economic uncertainty brought on from the coronavirus pandemic. This analysis is based on a calculation called the Altman-Z” Score (a variation of the Altman-Z Score which is commonly used to calculate the credit strength of manufacturing companies), based on key financial metrics including: Current Assets, Current Liabilities, Total Liabilities, EBIT, Total Assets, Retained Earnings, and Book Value of Equity.

What Does the Altman-Z” Score Mean for Restaurant Bankruptcies?

Generally speaking, an Altman-Z” Score greater than 2.6 is deemed “safe”, between 1.1–2.6 is in the “gray area,” and lower than 1.1 is viewed in the ”distress zone.” These calculations were completed in May 2020 using Q1 2020 data for U.S. publicly traded restaurant companies, or the last available data (depending on companies’ fiscal year in the analysis set).

A total of 46 companies are included in the analysis ranging service styles (QSR, fast-casual, casual dining, etc.) and both franchisee and franchisor business models. These companies total an estimated $148b in annual U.S. system-wide sales and account for 100k locations across the country. The analysis also includes Arcos Dorados and Yum! China which operate exclusively in Latin America and China, respectively. For the purposes of classification, companies considered “highly franchised” have greater than 66% franchised units system-wide, “moderately franchised” between 33–66%, and “lightly franchised” below 33%.

Some highlights of our analysis include:

  • 6 Companies with Altman-Z” score 2.6+, 19k locations, $47b in sales
  • 8 Companies with Altman-Z” score 1.1–2.6, 9k locations, $18b in sales
  • 30 Companies with Altman-Z”score <1.1, 72k locations, $82b in sales

We’d like to not that these are not predictions nor forecasts, but rather calculations based on working capital, retained earnings, EBIT, market value, sales, and assets. Many restaurant companies operating with different models (highly franchised systems versus wholly corporate-owned systems, for instance) have naturally varied financial metrics that impact the calculations and financial performance.

It’s Not All Doom and Gloom

This period will usher in a fresh wave of consolidation through mergers and acquisitions. In many cases, recessionary M&A involves distressed and dislocated assets that can be purchased for pennies on the dollar. However, it’s not always predatory or unwelcome. In our view, this period of change will just be accelerating the transformation that was already underway and being profitably harnessed by industry leaders.

Those that are most optimistic often tend to be either those that are under-informed and bubbly optimists by nature — or, they are those that have done their homework and developed a silver-lining investment thesis. Foodservice is a multi-trillion dollar global industry that has remained as consistent as inflation and population growth for decades and spend has been irreversibly redirected in a single quarter — displacing and shifting hundreds of billions of dollars in global consumer discretionary spending. While it will be fatal for some and fortune-building for others.

Nearly Two-Thirds of Public Restaurants Are “At Risk” for Bankruptcy

We found that more than six every ten restaurant chains are in the “distress zone” when using this calculation (highly leveraged, low earnings, or a combination of both). While this is not a direct indicator of bankruptcy risk — and there are significant differences in operating models for these companies (franchisors versus more corporate-owned locations, etc.) — there are some fascinating findings.

Even with the injection of liquidity, it is not enough to cover what the losses are — with the industry down tens of billions per month right now it’s going to be very hard to get back, even once restaurants are at full capacity.

Risk Bankruptcy for Publicly Traded Restaurants

Short Runway for Many Chains Already Impacting 2020 Restaurant Bankruptcies

Restaurant bankruptcies are multiplying in 2020 and several chains filed for chapter 11 or debt protection across all segments: from quick-service restaurants Krystal Burger (declared bankruptcy back in January), to fast-casual chains Vapiano, Cosi and Le Pain Quotidien to buffet Garden Fresh Restaurant.

Restaurant Bankruptcies Coronavirus

Smaller Chains were at Higher Risk of Bankruptcy

It’s usually the case that smaller companies are more vulnerable to economic shocks than large companies. Among U.S. public restaurants, the risk of bankruptcy increases by more than a third when comparing small-, micro-, and nano-caps to large caps. While 50% of large caps are in the distress zone according to Altman’s Z’’-score, the share of companies in the red zone increases to 69% for public restaurants with less than $2b in market cap.

The retooling that was already in motion is accelerating and the industry will look very different a few years from now.

Restaurant Bankruptcies by Size of System

Negative Working Capital Impacting Restaurant Operators’ Performance

Companies with negative working capital are most likely to face liquidity issues because they lack sufficient current assets to cover current debt. In the U.S., publicly traded restaurants have a total of $1.5b in working capital (46 companies). However, 65% of chains have negative working capital (accounting for a deficit of $6.1b).

The restaurant industry received 9% of the first Paycheck Protection Program (PPP) loan batch ($31b) and it’s not nearly enough to cover what the losses are. Greater consolidation will happen than in any of the recessions before.

Restaurants Working Capital

How Franchising Impacts Operating Margin for Restaurant Companies

There are many proof-points to demonstrate the differences in approach of top-quartile and bottom-quartile performers. When we look at Operating Margins, the differences are staggering. In moderately and lightly franchised publicly traded restaurants in the U.S., the top-quartile Operating Margin is 9x the margin for the bottom-quartile. For highly franchised restaurants, the top-quartile makes twice the profit margin of the bottom-quartile.

The top performers are also putting more toward R&D and building proprietary systems that are reinforcing the moat around their business and locking out their competition. This is a great time to make operations faster, leaner, and more agile to optimize margins and achieve top-quartile performance.

Restaurants Operating Margin

How A Solvency Crisis Factors Into the Likelihood of Restaurant Bankruptcies

The Working Capital to Total Assets ratio reveals the percentage of remaining liquid assets, once Total Current Liabilities are paid out, compared to the company’s Total Assets. As a rule of thumb, ratios lower than 15% are generally considered unsatisfactory, and negative values are considered critical. 93% of U.S. publicly restaurants are in these zones. For many restaurant chains, investors will have to step in to solve the liquidity crisis ahead of other critical initiatives focused on innovation and re-inventing the economic model.

Restaurants Working Capital to Total Assets

Restaurants Lacking the Ability to Cover Short-Term Debt with Current Assets

The higher the Current Ratio (Current Assets to Current Liabilities), the more able a company is to pay short-term debt. In the restaurant industry, the current ratio reached a median of 0.72 (FY 2019 for publicly traded companies in the U.S.) and for three-quarters of the industry, the current assets are not enough to cover all short-term debt. Some foodservice companies in the bottom quartile had current ratios lower than 0.50 (current assets covering less than half of current debt).

While liquidity pumping into the economy is buying time, many restaurants won’t be able to sustain their existing debt levels. This scenario will likely lead to plenty of distressed restaurant assets in the near future, which will spur activity as the global pause on M&A lifts as travel restrictions are loosened.

Restaurants Current Ratio FY2019

Restaurant Bankruptcy Rates Outpace Other Industries

A sobering stat: the restaurant industry has been the sector with the most bankruptcies in the last three months, with 12% of U.S. bankruptcies (more than 300) coming from this industry alone.

More consolidation will happen than in any previous recession. We think 10-15% of restaurants in America will close permanently by the end of the year (with that potentially increasing to 20% if another wave of the virus hits and without further government assistance). The bulk of that will be Casual Dining, full-service restaurants and independents.

Restaurant Bankruptcy Rates

Estimating as Many as 10–20% of Restaurants Closing Permanently by End of 2020

In the U.S., 4.4 million restaurant jobs have been lost (comparing 2019 with the average employment for April–June 2020), and though there are no official figures for closings, we estimate between 198,000–231,000 restaurants will close in 2020. This will be the first year the number of establishments doesn’t climb in at least 20 years (even during the 2008/2009 recession the number of restaurants continued to grow). 

U.S. restaurant closures due to coronavirus

Highlights of this analysis were featured in Bloomberg News.

A Timeline of Recent Restaurant Bankruptcies

The following restaurant chains have gone bankrupt or are in a bankruptcy process as of mid-2020. Many will have to liquidate their assets or be subject to massive reorganizations.

  • Krystal Burger is one of the chains that filed for bankruptcy before the COVID-19 crisis (in January 2020). In declaring bankruptcy, the quick-service restaurant chain indicated debts of between $50–$100 million. Insolvency will affect around 30 unsecured creditors and restructuring is taking place.
  • Bar Louie is a chain of pubs that filed for bankruptcy protection in January 2020. Three letters of intent were submitted for the acquisition and the company lenders also submitted a stalking horse bid to bankruptcy court for an undisclosed valuation.
  • American Blue Ribbon Holdings (parent to the Village Inn and Bakers Square Brands) arranged for debtor-in-possession financing for $20 million. Therefore, the company is continuing operations, is able to restructure and may access debt consolidation, and eventually pay off its debts.
  • SD Holdings was on the border of being insolvent and filed for bankruptcy protection in Federal court in February 2020. SD Holdings franchises 73 Sonic-Drive-In restaurants, 14 MOD Pizza stores, and 3 Fuzzy’s Taco Shop locations. Filing for bankruptcy was part of a strategy to sell its locations. Liquidation of assets wouldn’t be enough to pay a secured debt of more than $22 million.
  • NPC International declared chapter 11. We indicated that the Pizza Hut and Wendy’s franchisee was considering bankruptcy earlier in 2020. The company had missed interest payments had seen its debt downgraded. The company was able to avoid bankruptcy late in 2019 but had defaulted on debt financial covenants. As of June 2020, NPC declared bankruptcy citing “challenges magnified by COVID-19” and is expected to go through a re-organization process.
  • Cosi had to file for bankruptcy for the second time since 2016. The principal of the company’s majority shareholder passed away in 2018 and funding was interrupted. From there, the fast-casual chain was unable to find debt relief, leading to bankruptcy.
  • Craftworks (parent to Logan’s, Rock Bottom Restaurant & Brewery, and Old Chicago) was another restaurant chain to file for bankruptcy. Proceedings started with an auction of assets with a stalking horse bid made by a company lender (Fortress Credit).
  • Vapiano is a fast-casual chain founded in Germany and with 6 units in the U.S. Due to the coronavirus lockdowns, the company faced insolvency and started proceedings in Germany.  A consortium of bidders — including the Van der Valk family (one of the major hospitality dynasties in the Netherlands and an initial Vapiano franchise partner), Henry McGovern (Founder and former Chief Emotional Officer of AmRest), and Sinclair Beecham (Founder of Pret a Manger) — are expected to complete a transaction in June 2020 to help re-start the brand.
  • Food First Global Restaurants (parent of Brio Tuscan Grille and Bravo Cucina Italiana) filed for Chapter 11 Bankruptcy in April 2020.
  • Toojay’s Management LLC also went bankrupt. The QSR deli chain explicitly mentioned the coronavirus crisis as the cause for its bankruptcy in the filing (despite having received a loan from the Paycheck Protection Program).
  • Garden Fresh Restaurants (parent of Souplantation and Sweet Tomatoes) is another of the chains that have gone bankrupt due to the coronavirus crisis. The 97 salad bar restaurants are buffet-style and would struggle to see guests back even after restrictions are lifted. Chapter 7 bankruptcy protection was attained in May.
  • Sustainable Restaurant Holdings filed for bankruptcy in May 2020 and also cited the coronavirus crisis as the reason. The company’s brands, Bamboo Sushi and QuickFish, are seeking a buyer.
  • CFRA Holdings (a franchisee for IHOP operating restaurants in four states) also filed for Chapter 11 in May. The franchise agreements with Dine Brands Global had been terminated in April.
  • Le Pain Quotidien also filed for bankruptcy and is looking for an acquisition for $3 million to Aurify Brands for 35 of its restaurants.
  • BarFly Ventures (HopCat brewery and pub) filed for Chapter 11 in early June, also citing the pandemic as the reason.
  • CEC Entertainment — parent of Chuck E Cheese’s and Peter Piper Pizza — filed for chapter 11 bankruptcy in June 2020. The family eatertainment segment has been among the hardest-hit by the coronavirus pandemic. The company was highly leveraged, listing $1 billion in debt. The owner of CEC, Apollo Management, plans to restructure the company.
  • Twisted Root Burger declared bankruptcy on three corporate stores. The fast-casual “better burger” chain is keeping six corporate stores running for off-premise sales. Assets and liabilities were indicated in the $500k–$1 million range.
  • Luxury Dining Group, the parent company of Fig & Olive (a 10-unit, upscale Mediterranean concept operating in five markets including New York and Washington, D.C.) filed for Chapter 11 bankruptcy protection as all locations were closed and 700 employees laid off as a result of the pandemic.
  • Maines Paper & Food Service filed for bankruptcy (chapter 11) in June 2020. The foodservice distributor supplied QSR chains (including Burger King, Tim Hortons, Wendy’s, Applebees, IHOP, and Chilli’s) and also handled logistics for Darden.
  • California Pizza Kitchen filed for chapter 11 bankruptcy as of July 30th, 2020 due to the Coronavirus crisis. The company is expected to go through restructuring with a $30 million bridge loan and to transform long-term debt into equity. Locations will be closed (the company had 200 locations in the U.S. and sales for $635 million in 2019).
  • Matchbox Food Group filled for bankruptcy (Chapter 11) in early August, citing the pandemic as the cause. The casual dining chain will go through restructuring and already has an investor that could buy it.

With the worst quarter in years, restaurant bankruptcy cases are likely to increase in the third quarter of 2020.

Advice for Operators in Precarious Situations

We’d recommend looking for buyers and strategic alternatives before it gets worse. The liquidity crisis will soon turn into a solvency crisis. We’d give it about 60 days. That’s when travel restrictions will lift, runway and cash burn will run out for many struggling businesses, and restaurant M&A will resume to a white-hot level. There is more private capital sitting on the sidelines than the government has put into rescue plans.

It’s hard to get deals done without the ability to meet face-to-face. The timing of going back from pause-to-play will coincide smoothly with the solvency crisis. In some ways, you could look at this situation and point to vultures circling in the sky with smiles while the prey enters their death-throws; but — depending on perspective — what happens next could also be characterized as looking up into the sky and seeing a caped superhero coming in to rescue a struggling enterprise.

About Aaron Allen & Associates

We are a global strategy firm focused exclusively on the foodservice and hospitality industry helping middle-market companies and investors with both buy- and sell-side M&A advisory services. Our clients include restaurant chains, foodservice technology providers, and alternative foodservice formats. We also specialize in multi-national, multi-brand portfolios, and cross-border transactions.

Our restaurant and foodservice industry M&A advisory services include:

  • Investment Thesis Ideation
  • Market Landscape Scanning
  • M&A Readiness Assessment
  • Investor Presentation Development
  • Deal Sourcing and Target Identification
  • Commercial Due Diligence
  • Operational Due Diligence
  • Value Creation Strategies
  • Post-Acquisition Integration
  • Board and Management Installation
  • Growth and Expansion Planning
  • Go-to-Market Strategy
  • Performance Optimization
  • Portfolio Planning and Rationalization
  • Operating Partnerships
  • Board Participation and Advisory

Going beyond the three financial statement models to identify and unlock trapped potential and value-accretive opportunities by building a perspective from the most granular-level data to the big picture of a global market place, we apply a data-driven, analytical process combined with deep and specialized foodservice industry experience and expertise.