Private equity's restaurant feeding frenzy

UK casual dining chains have proven a veritable feast for private equity firms over the last 18 months. Since July 2014 well-known brands Pizza Express, ASK Italian and Zizzi, TGI Fridays, Côte Restaurants, Las Iguanas, YO! Sushi and Gaucho have all changed hands.

The restaurant sector has always been a fruitful source of deals for the private equity industry, says Paul Hemming, a managing director in AlixPartners’ financial advisory services practice.

“The fundamentals of restaurants are good: you can buy in, you’ve got growth from rolling them out as well as the ability to have strong like-for-like sales,” he says.

As well as the sector’s strong fundamentals, in recent months it has benefited from the positive effects the drop in oil prices has had on consumer spending.

In Q4 2013 year-on-year growth in consumer spending was at 2 percent, according to Philip Shaw, chief economist at Investec. By the end of 2015 it had reached 3.1 percent as the price of Brent crude in Europe tumbled from $115 a barrel to below $27.

“You can see from the macro numbers the pace of consumer spending has been increasing over the past couple of years, and part of that is due to the decline in oil and other energy prices contributing towards higher incomes in real terms,” says Shaw.

Restaurants in the casual dining sector are perfectly placed to take advantage of consumers feeling better off.

“I think if you look at the average family, the drop in petrol price and fuel bills is the most direct link to what they have in their pockets,” says Hemming.

“These aren’t high-end restaurants, these are a price point between £14 and £20 per head as an average, and therefore it’s an affordable treat.”

However, after an 18-month boom, some chilling headwinds are likely to temper enthusiasm for the sector in 2016. In April, the National Living Wage will come into effect in the UK, raising the minimum wage for workers over the age of 25 to £7.20 per hour from £6.70 per hour. This will increase to at least £9 per hour by 2020.

A rise in the number of private equity-backed dining chains with aggressive roll-out ambitions is also making it harder – and more expensive – to find quality sites.

“Today the market’s somewhat different to the market of 18 months ago, in that there’s a lot of people with a lot of money looking for sites, and the whole industry is concerned about the ability to find sites to meet their roll-out ambitions,” Hemming says.

According to research from AlixPartners and CGA Peach there was a 6.9 percent growth in restaurant sites in the 12 months to September 2015, or a net 1,770 new restaurants opened.

“Market data show that consumer demand is lagging the rate of openings so people have to take market share, and the branded guys are taking it off the independents. All this is against a cost pressure background,” Hemming says.

While casual dining is likely to remain a vibrant and robust sector, investors may have to adjust their expectations on the amount of time needed to yield solid growth, Hemming says.

“The challenge for private equity investors is that the forecast roll outs may well take longer to deliver than originally planned, which hits the IRR but will hopefully still deliver the money multiple.”