Is casual dining on the menu for PE investors?

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Joe Bedford (pictured), corporate partner at law firm Stevens & Bolton who advised the management team of TGI UK on its recent acquisition by Electra Partners, looks at how the casual dining sector is attracting interest from private equity investors…

Looking at trends over recent months and years, together with current market rumours of further activity, it is clear that private equity has been showing significant interest in the casual dining sector. 2014 ended with the acquisition of TGI UK by Electra but that was only the latest in a long line of casual dining deals, including Hawksmoor (Graphite Capital); Cote (Close Brothers Private Equity); Byron (Hutton Collins Partners); Pizza Express (Hony Capital); ASK and Zizzi (Bridgepoint); Strada (Sun Capital Partners); Prezzo (TPG); Turtle Bay (Piper Private Equity); Red Hot World Buffet (Risk Capital Partners); Gusto Restaurants (Palatine Private Equity) Laine Pub Company (previously named InnBrighton) (Risk Capital Partners); and Benito’s Hat (Calculus Capital).

Well managed and well branded casual dining has proved itself to be relatively resilient through tough economic periods, which is a reason in itself for the P/E spotlight to have turned on it in the post financial crisis years. As economic conditions have begun to improve, a number of factors have played into the hands of casual dining businesses. Greater levels of disposable income, or at least increased consumer spending confidence, drives upward trends in eating out. Lower interest rates together with a renewed mortgage rate race to the bottom helps perpetuate that trend. 

And the relentless march of virtual shopping, with ever increasing availability, sophistication and convenience, continues to challenge the viability for retailers of a physical presence in the high street, or even town satellite areas, meaning more sites becoming available for casual dining usage. All of these, plus of course numerous other variables are incorporated into a P/E commercial and financial modelling exercise. But it is the reference to sites which gives a clue to what is likely to be one of the traits of casual dining businesses which is seen by P/E simultaneously as both a major attraction and a material challenge in owning and operating them.

Scalability has always been one of the key boxes which P/E investment committees would like to have ticked before signing off on an investment. If the business is sustainably scalable and otherwise sound, then it has clear potential for profitable growth towards a realistic expectation of an exit at a level which delivers reasonable multiple returns to investors. If the business is scalable based upon a known winning formula, repeatable time and again on a template basis then in theory there should be greater certainty of profitable growth and so, by definition, proportionately lower risk of an unsuccessful investment. Good casual dining businesses, at almost any stage of their life-cycle, should be capable of being viewed as having potential to be scaled up materially. 

The rhetorical question then follows – by what method do you scale up a casual dining business. Answer? Expand the number of sites in the portfolio. But, despite the assisting factors mentioned above, that is not as simple as walking into an unoccupied prime site and planting the brand’s flag. Ignoring the challenges of identifying sites of the right square footage and cost in the right part of the right area populated by the correct demographic, there is also the small matter of competition for those sites. Existing players with similar real estate demands are also likely to be on the expansion trail as the race for profitable scale and general market share continues. New players, rooted domestically or elsewhere, are now appearing on a regular basis – many models don’t succeed but inevitably some do stick. As well as the competition for sites and competition between casual dining businesses, the market faces challenges from other quarters. Changes in beer tie rules are driving the pub operators further toward food sales and the traditional fast food operations are attempting to eat away at restaurant market share. In its top 10 predictions for 2015, BDO’s December 2014 Restaurants and Bars Report lists a “Big Year for the Pub” and the rise of “US Smokehouse and Barbeque” formats (2014 having seen the ‘rise of the burger’) but casual dining dominance is not on the list.

But evidence to date indicates that the successful brands in the casual dining market know exactly what they are doing, and that there is still plenty of room for multiple brand co-existence plus a strong appetite within the UK population for the style of eating out offered by these businesses. It is also likely that the management teams of these businesses are live to all of the above challenges and are seeking to develop coping strategies which will allow them to continue to expand, potentially at an accelerated rate given current economic conditions. So the scalability box should remain firmly ticked for now, and given the capacity for casual dining businesses to meet P/E investment criteria it would seem likely that good management teams will soon be receiving approaches from P/E, if they have not been approached already.

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