It should be no surprise to anyone following restaurant deals that the market is decidedly different than it was prior to the pandemic. Though restaurant valuations are healthy, and the mergers and acquisitions market has picked up, deal behavior has changed.
As Ashish Seth, founder and managing director of Harrington Park Advisors, described, “It’s no longer a gold rush.”
“Ten years ago, you could have two units and a dream and get bought out for $60 million to $100 million. Those days are gone,” he said Monday during the opening keynote of the Investment Summit at the annual CREATE event in Rancho Palos Verdes, California. “Investors have a much higher bar. Today it’s about fully understanding the business, not about wishing and hoping you become a billion-dollar company.”
Seth provided a historic arc illustrating the deal environment, noting that everything changed with the advent of Amazon, followed by the creation of Chipotle. Amazon disrupted the entire retail sector, while Chipotle did the same for food, he said.
“Chipotle provided a brand-new way to connect with guests, serve food, provide quality food, hospitality, connection. Nobody else was doing it the way Chipotle was doing it,” Seth said. “If Chipotle can do this in Mexican, what else is out there that will fundamentally change the restaurant business?”
Those fundamental changes ignited the gold rush. Investors were pouring capital into all kinds of brands trying to find the next Chipotle that could be worth billions in a matter of a decade. Then the market became saturated.
“The restaurant business, as (longtime industry consultant) Malcolm Knapp would say, is simple but not easy,” Seth said. “(Finding the next Chipotle) is a meaningful dream to chase, but reality set in and we realized simple is hard, we realized fast casual is a capital-intensive model. Because of the capital that got plowed into the space, the sector got overbuilt.”
Then COVID hit, and rising food costs triggered rising menu prices that consumers couldn’t keep up with. That has brought us to a new restaurant valuation environment, in which casual dining is trading at 5 to 10x EBITDA, or earnings before interest, taxes, depreciation, and amortization. Fast casual is trading from 8 to 13x, and QSR is trading from 10 to 20x, all much lower than 10 years ago.
“As I present these valuations, I’m very scared because I think sometimes people forget averages are averages for a reason. We (once) sold fast-casual restaurants for 23 times EBITDA,” Seth said.
What is driving valuation includes base factors like concept, cuisine, and brand, the type of food you’re selling, whether your business model is company-owned or franchised, and which segment you operate in. Investors also consider store-level trends, like average unit volumes and traffic.
“Then you’ve got to talk about portability. Does your business actually work in other markets? Not just going from LA to San Diego. Does it work from LA to Phoenix? Does it work from LA to Salt Lake City and Dallas?” Seth said. “Are you actually a growth brand? You can’t tell people you’re a growth brand if you’ve not been growing.”
Finally, what are your capital needs, your infrastructure, your people, systems, and processes?
“Every company is a little bit different when it comes to these things,” Seth said. “Unit growth is very important. If you want a growth valuation, you’re going to have to demonstrate that you’re a growing brand. Deal structures matter significantly. The deal is not done until the paper is signed and you have cash in your account, and a lot can be decided between those times.”
The deal environment today, he added, is about fundamental analysis, not just wishing and hoping you become a billion-dollar company. That said, you should be optimistic about your business.
“Every day is going to bring a challenge, and you have to be optimistic when you’re selling your business. You’re trying to grow your business, you’ve got to be aggressive,” Seth said. “But don’t be unrealistic. Expectation is a part of deal-making, but it’s not the whole deal.”
Also, the expectation has to be practical.
“We are in the ‘show me’ not a ‘believe me’ market. If you’re telling me customers love you, show me repeat business,” he said. “If you’re telling me your brand has real equity, show me that equity in your numbers and store-level financials. You have to prepare for and demonstrate the results you seek.”
Contact Alicia Kelso at [email protected]
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