Garrett Black August 12, 2014
After a long day, dinner is always a cheering prospect—at least for the diner. For those who make dinner, going out to a restaurant instead is always a tempting, albeit pricier, convenience. But now there are even more options: Why not retain home comfort by signing up for meal kit delivery? Or perhaps cut out the onerous prospect of shopping by subscribing to an online grocery delivery service?
The companies around the world seeking to provide the answers to these questions all target what can be called the convenient food sector, where subscriptions, delivery services and restaurants scramble to capture the ideal combination of quality, convenience and cost. And although VC and PE firms target very different companies, those companies may be competing more and more these days to answer the age-old question: What’s for dinner?
PE: Capturing Casual
Restaurant industry sales in the U.S. alone are expected to hit a record total of $683.4 billion in 2014, according to the National Restaurant Association. That figure is encouraging, as are slowly recovering consumer confidence levels. However, good news rarely comes without a dollop of caution, and the restaurant industry faces several trends that promise to shake up the space: consumers demanding healthier food options, legislative and regulatory issues, and technological transformation. Perhaps these shifts are giving PE firms pause, for after several years of steady recovery in restaurant deal-making, 2014 has seen a slowdown in PE investors’ appetite overall. But there’s one slice of the restaurant industry that seems to be doing just fine. Most of the restaurant deals completed so far this year (e.g., On the Border Mexican Grill & Cantina, Newk’s Eatery, Checker’s Drive-in) dwell somewhere in the fast casual dining space. Why the focus on casual?
The causes may lie at the intersection of industry trends, both in restaurant and PE.
Compared to larger companies, smaller chains in the casual dining segment can more easily take advantage of a growing demand for healthier food and transparency, as those characteristics are precisely what smaller chains are positioned to provide. With consumer confidence recovering yet still a little shaky, casual dining also offers a more affordable option than upscale establishments. Local management, regionally-derived fare and an increasing pervasion of expeditious, cost-cutting tools capitalize on economies of scale, which may be why smaller companies are enjoying higher customer satisfaction ratings and sales. Franchising offers potential for unit-growth while targeting those same trends, through careful management. And that careful management is where PE managerial expertise and capital overhang come into play.
PE firms increasingly target smaller chains poised for greater growth especially as buy-and-build grows more popular and rising deal multiples render smaller investments more attractive. Experienced PE executives can scale up fledgling, well-respected brands, sculpt local models into regional strategies, and steadily ramp up EBITDA by leveraging extant infrastructure and management. PE firms are more than happy to house a recognized consumer brand in their portfolios, even if it’s on the smaller side. Plus, strategic buyers are crowding out PE firms in the consumer space as a whole this year, especially in large M&A.
All these factors drive activity toward the lower-middle-market; the PitchBook platform reveals about 70% of PE restaurant deals came in at or below $100 million in 2013. In addition, PitchBook recently took a look at PE restaurant deals, positing that 2014’s slower PE investment pace could be due to seasonal deal-closing rates, since the bulk of PE restaurant investments closed in the latter quarters of 2012 and 2013. So if restaurant activity picks up, it seems reasonable to expect most of the action to take place in the casual dining space, at middle-market deal ranges. It’s where PE firms can find the best bang for their buck, utilizing industry experience and excess capital overhang to transform regional to national.
But there are two burgeoning trends that could affect casual dining substantially—on-demand delivery and meal/grocery subscriptions. Enter VC-backed food startups, which we will look at later. Stay tuned.