In Restaurant Glut, Strategic Buyers Keep Bankrupt Chains Afloat

(Bloomberg) -- Decreased foot traffic, competitive marketing strategies and rising debt loads have choked the restaurant industry and led to a flurry of bankruptcy filings -- but strategic buyers haven't shied away from chains in distressed situations.

Strategic buyers, usually restaurant groups that already own other brands, often get a good deal when purchasing a failing chain because they have existing operations like restaurant management to run additional locations. Private equity firms, on the other hand, often have to carry that overhead themselves, meaning the risk is higher and reasoning behind the purchase has to be stronger, said David Bagley, managing director at Carl Marks Advisors.

At one time, private equity firms including NRD Capital Management LLC, Sun Capital Partners Inc. and TriArtisan Capital Advisors LLC put a lot of capital into the restaurant space, buying brands including Ruby Tuesday, Boston Market and TGI Friday's, respectively. The level of private equity investment in restaurants, however, fell to $4.75 billion in 2019 compared to a decade high of $18.29 billion in 2017, according to data from Pitchbook.

Economic Concerns

“Private equity has a lot of money on the sidelines to put to work and restaurants seem to be the area,” said John Hamburger, president of Restaurant Finance Monitor, a restaurant finance publication. “Some of the traditional private equity funds that have played in the restaurant space are concerned about what's going on in the industry in terms of the economics.”

Private equity used to make money on restaurants by using high levels of capital to increase the number of locations, expanding brand presence and driving additional revenue, Bagley said. That old strategy doesn't make sense anymore because there's so much additional restaurant square footage while foot traffic is shrinking, he said.

One of the major struggles for restaurant brands recently has been driving customer traffic in an environment where a few chains -- those with strong investment in food innovation and marketing -- are top-of-mind for the restaurant-goers.

“If you're like Chick-fil-A and you have the wherewithal to test ideas and constantly come up with new ideas you can keep people in the door,” Hamburger said. “If restaurants don't have the financial wherewithal to compete they're going to close stores and eventually file bankruptcy.”

The pain for distressed brands isn't expected to subside any time soon, according to a recent report from Fitch Ratings. Struggling small to mid-sized casual dining and quick service restaurant chains are filing for bankruptcy more frequently, with some other names in danger of default, the report said.

For strategic buyers, distress in the industry creates opportunities for new deals. Landry's, the restaurant group owned by billionaire Tilman Fertitta, bought five distressed restaurant chains in the past year: Restaurants Unlimited, Houlihan's, Palm Steakhouse, Del Frisco's and three Cadillac Ranch locations. Fertitta has said that he sees new investment opportunity when the industry is slowing down and restaurants are controlled by weak management.

Bankruptcy Buyouts

“That's why you build liquidity and you build your balance sheet in good times and you don't have to do acquisitions in the good times,” Fertitta said in a September interview on the Bloomberg Businessweek podcast. “You eat the weak in the bad times.”

Fertitta, who also owns the Houston Rockets, has a $4.2 billion net worth, according to data compiled by Bloomberg. The Texas executive took Landry's private in 2010 for $1.4 billionbought Landry's for $1.4 billion in 2010, and has since added restaurant chains including Claim Jumper, Joe's Crab Shack and Morton's Steakhouse to the portfolio. Landry's also owns and operates Golden Nugget Inc., which controls casinos, hotels and other entertainment centers.

Other strategic buyouts in the last six months have included Huddle House's purchase of bankrupt Perkins Restaurant and Bakery for $51.5 million and The One Group Hospitality LLC's purchase of bankrupt Kona Grill for $25 million. Buying a chain out of bankruptcy allows the purchaser to get out of burdensome leases and choose the successful locations to keep running, Hamburger said.

While the restaurant industry is known for being extremely cyclical, and therefore some distress isn't uncommon, social media and digital advertising have sped up the pace of how often brands need to reinvent themselves, which they sometimes can't afford when capital structure is weak, Hamburger said.

“McDonald's, for example, has tremendous financial strength to reinvest, and they do so every 7 to 10 years,” he said. “You have to reinvest every 7 years to stay relevant -- that could be even shorter now because of the way tastes change so quickly.”

To contact the reporter on this story: Olivia Rockeman in New York at orockeman1@bloomberg.net

To contact the editors responsible for this story: Rick Green at rgreen18@bloomberg.net, Dawn McCarty, Nicole Bullock

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