Restaurants are ready for a wave of dealmaking as pandemic underscores need for diversification

Published Mon, Nov 23 20203:47 PM EST

Key Points

Inspire Brands is taking Dunkin' private for $11.3 billion, signaling a restart to dealmaking that could drive growth for restaurant companies.
But investors can take a while to value an acquisition fully and can harshly punish companies for the laggards in their portfolios.
Buyers right now are looking for diversification and opportunities in the fast-food segment, given its quick recovery during the crisis.

Inspire Brands' $11.3 billion purchase of Dunkin' in late October was the biggest deal in the restaurant industry in more than six years, signaling a broader restart to dealmaking after the disruption of the coronavirus pandemic . The purchase of the coffee chain is Inspire's fourth acquisition in as many years, further driving speculation that the company's aggressive buying strategy is part of a plan to take Yum Brands' crown as the world's largest restaurant company by number of locations. With the inclusion of Dunkin, the Arby's owner will have more than 31,000 restaurants worldwide, but Yum's footprint of 50,000 locations still dwarfs that of the upstart. The coronavirus pandemic gives portfolio companies like Yum and Restaurant Brands International the chance to add even more restaurants to their rosters before they risk being outrun by Inspire and other upstarts in the industry. The health crisis has turned it into a buyer's market, with restaurant valuations falling about 13% below the 10-year average, according to Aaron Allen & Associates. The success of past deals shows that companies can reap the rewards after acquiring another chain, allowing them to broaden their international footprint, rake in more revenue and receive investor plaudits. "Restaurants have been largely a kind of 'wait and see,' but now you see a light at the end of the tunnel, in terms of the vaccine, and there's going to be a race to getting these deals," said Aaron Allen, CEO of the eponymous restaurant consulting firm. What buyers are looking for Private equity firms and mid-sized restaurant groups backed by investors are among the potential buyers looking for deals right now, according to Dave Bagley, managing director of Carl Marks Advisors, an investment bank that offers advisory services. Allen said that inquiries about deals have resumed after the presidential election was over. Mergers and acquisitions within the industry were down about 40% during the first nine months of the year, according to the firm's data. Pent-up enthusiasm for deals will likely continue into next year, and the big restaurant companies are looking to exit the crisis even bigger. "There's trillions of dollars in capital sitting on the sidelines," Allen said. Buyers right now are looking for diversification during today's uncertainty, according to Bagley. "A lot of people are looking for that diversification," he said. "They were entrenched into one group, one segment, and now they see there's a variety of reasons why that might not be the right strategy." The parent companies of casual-dining restaurants, such as Applebee's owner Dine Brands , may be looking for a chain with drive-thru lanes to replace the dine-in customers that have deserted them during the pandemic. Dine Brands, which has a market value of $1 billion, had $278.5 million in cash and cash equivalents on hand, as of June 30. On the other hand, a company like Restaurant Brands may be looking to add a sandwich chain or pizza company — one of the rare winners during the crisis — to its roster. The Burger King parent, which has a market value of $27.1 billion, had $1.92 billion in cash and cash equivalents on hand, as of Sept. 30. Buyers are primarily interested in limited-service restaurants, according to Josh Benn, global head of consumer, retail, food and restaurants at Duff & Phelps, a financial consultancy. Benn said that nearly all of the deals for healthy restaurant companies during this time have involved fast-food chains. "We believe M & A reports at potentially appealing valuations are likely to provide excitement for other [small- and mid-cap], domestic focused quick service restaurants, including Jack in the Box and Papa John's ," wrote Cowen analyst Andrew Charles on Oct. 25 after Dunkin' confirmed the sales talks with Inspire. Papa John's has been in the middle of a turnaround since its founder was fired from the company in 2018 in the wake of a scandal and public backlash. Its comeback got an extra boost last year through a $200 million strategic investment from the hedge fund Starboard Value, which retooled Olive Garden years earlier. With a market value of $2.61 billion, Papa John's is significantly smaller than Domino's Pizza or Pizza Hut-parent Yum, but it has likewise benefitted from the consumer shift to pizza, boosting shares by 25% so far this year. Jack in the Box, which has been the subject of sale rumors for several years, is also making its own turnaround after years of declining sales. In its latest quarter, same-store sales rose 12.2%. The stock, which has a market value of $2.05 billion, is up 15% so far this year. Bagley noted the attractiveness of the "eatertainment" segment, which includes chains like Dave & Buster's , Punch Bowl Social and Topgolf. Before the pandemic, the category was beloved by investors, who saw it as a way to win over millennial consumers who placed more value on experiences. The crisis has scared away those customers, as well as driving down the valuation of those businesses, but consumers will eventually return. Dave & Buster's same-store sales plummeted 62% in September. The stock, which has a market value of $1.15 billion, has fallen nearly 40% so far this year. On the other hand, restaurants that rely on mall traffic to drive sales will be more unattractive, given the bearish outlook on the future of those shopping centers. For example, the Cheesecake Factory 's real estate footprint has heavy exposure to malls. The pandemic isn't completely upending what buyers are looking for in a sale, but instead underlining the importance of a strong restaurant footprint and branding strategy. "As long as consumers have trust in the brand, they like the brand, that's what ultimately in five years will drive value," Bagley said. "These short-term issues, yeah they're critical, but as long as you make it through, long term you have to be situated for success." The success of past acquisitions Before the pandemic, taking well-known restaurant chains private or buying technology firms was the trend. Outside of Inspire's deal activity, Auntie Anne's owner Focus Brands took Jamba Juice private in 2018. Focus and Inspire are both backed by private equity firm Roark Capital. McDonald's bought Dynamic Yield and Apprente, two technology firms that use artificial intelligence to improve sales at its drive-thru lanes. The purchase of Dynamic was McDonald's largest deal in two decades. The Covid crisis is not expected to reverse those trends, but it has introduced new opportunities for publicly traded restaurant companies, who have had success in the past buying up restaurant chains. Take, for example, Restaurant Brands' $1.8 billion acquisition of Popeyes, which occurred nearly four years ago. At the time, the fried chicken chain was seeing sales growth slow following several years of expansion. The Burger King owner planned to help Popeyes gain a foothold in international markets, which fueled the growth of rival KFC. Since then, Popeyes has become the jewel of the company's portfolio. The blockbuster success of its chicken sandwich has introduced new customers to the brand and driven double-digit quarterly same-stores growth for more than a year since its release. It's also helping accelerate Popeyes' expansion, as more Restaurant Brands' franchisees want to join in on the action. Analyst Mark Kalinowski, CEO of Kalinowski Equity Research, estimates that Popeyes has added at least 20% to Restaurant Brands' stock value since the acquisition was announced. But this type of deal, isn't without drawbacks. "One public market phenomenon is that investors overly punish the umbrella company valuation for the 'problem child' brand," Evercore analysts said in a recent note to clients. For Restaurant Brands, the problem child is Tim Hortons. The Canadian coffee chain accounts for more than half of its annual revenue, but it has struggled to draw in new customers as it reaches maturity in its home market. In 2019, the chain's annual same-store sales fell 1.5% as both Burger King and Popeyes reported positive same-store sales growth. The 2014 merger between Burger King and Tim Hortons created the portfolio company. It carried an $11.4 billion price tag, only narrowly beating Inspire's purchase price for Dunkin'. The enduring popularity of the Massachusetts-based coffee chain and its rival Starbucks has left little room for Tims' expansion into the U.S. market, one of Restaurant Brands' original aims for the chain. Deals also need time before investors fully value their impact on the company. For example, Yum bought Habit Burger Grill for $375 million in January, shortly before the pandemic upended the U.S. restaurant industry. The deal was its first acquisition in more than eight years, when it bought the Chinese hot pot chain Little Sheep. Yum CEO David Gibbs named Habit's growth potential, both in the U.S. and internationally, as one of the top reasons for acquiring the fast-casual burger chain. Domestically, restaurant closures of KFC and Pizza Hut restaurants have weighed on Yum's overall restaurant count in recent years, despite Taco Bell's success. Although Habit Burger reported an operating loss in the third quarter due to the coronavirus pandemic, its revenue was nearly half of Pizza Hut's. It also opened five new restaurants in China and the U.S. Still, Yum's stock has risen only 2% since the deal was announced. The pandemic has in part dragged down shares, although its same-store sales declined just 2% in its latest quarter. Gibbs told investors in late October that Yum is in no rush to do another acquisition but signaled that it could pursue deals on a similar scale to Habit Burger. "We want to digest Habit, get that established, get the right partners around the world and get the growth going there," he said. "And if we continue to see the kinds of results that we think we're going to see and that we have seen from them, that would be obviously a positive data point as we think about other similar type acquisitions down the road." At the end of September, Yum had $1.11 billion in cash and cash equivalents, included the $206 million it received for offloading its investment in Grubhub . Yum might not be the only public restaurant company that doesn't take advantage of M & A opportunities as a result of the crisis. RBC Capital Markets analyst Christopher Carril wrote in a note to clients in mid November that some portfolio companies, like Darden Restaurants and Restaurant Brands, could have other priorities. Their current leverage might lead them to prioritize reducing their debt over mergers and acquisitions. Restaurant Brands, for example, has net leverage of 5.5 times its earnings before interest, taxes, depreciation and amortization over the last twelve months. The leverage ratio shows how long it would take Restaurant Brands to pay off its net debt as long as its borrowings and earnings remain constant. Additionally, their attention might be better deployed on their existing brands. Some chains, like Tim Hortons, are looking for growth, and the pandemic's devastation of the restaurant industry could mean those brands have the chance to gain significant market share. "You can start to project what 2021 is going to look like, which should give those multi-brand operators ... a little more convinction about longer-term growth and trying to take advantage of the situation, rather than just worrying about survival," Benn said.

People walk past a Dunkin' store on October 26, 2020 in New York City.

Michael M. Santiago | Getty Images

The purchase of the coffee chain is Inspire's fourth acquisition in as many years, further driving speculation that the company's aggressive buying strategy is part of a plan to take Yum Brands' crown as the world's largest restaurant company by number of locations. With the inclusion of Dunkin, the Arby's owner will have more than 31,000 restaurants worldwide, but Yum's footprint of 50,000 locations still dwarfs that of the upstart.

The coronavirus pandemic gives portfolio companies like Yum and Restaurant Brands International the chance to add even more restaurants to their rosters before they risk being outrun by Inspire and other upstarts in the industry. The health crisis has turned it into a buyer's market, with restaurant valuations falling about 13% below the 10-year average, according to Aaron Allen & Associates. The success of past deals shows that companies can reap the rewards after acquiring another chain, allowing them to broaden their international footprint, rake in more revenue and receive investor plaudits.