Casual dining: overbooked and undercooked

Casual dining chains have been a particular favourite of UK private equity houses in recent years. Between 2014-2016 there were 24 private-equity-backed buyouts in the bars and restaurants space, according to Unquote Data, compared with 13 between 2011-2013 and just nine in the previous three-year period. While this figure includes a handful of pubs and late-night bar chains, it is primarily populated with recognisable high-street restaurant brands such as Yo! Sushi, Côte Restaurants, TGI Fridays, Byron and Pizza Express.

Yet, having enjoyed considerable backing for a sustained period, the sector has recently come across challenging times due to oversupply, as well as macroeconomic and political headwinds. Margins within the sector have been squeezed by the introduction of the national living wage; currency-related food price inflation; decreasing consumer confidence; and business rate hikes, particularly in London.

Burger chain Byron recently announced it was to close up to 20 of its 67 restaurants as part of a restructuring deal that also sees Three Hills Capital Partners buying half of Hutton Collins' stake in the company. Meanwhile, the 2017 full-year results of The Restaurant Group, the listed parent of Frankie & Benny's, revealed a like-for-like sales decrease of 3% year-on-year, further underlining the struggles faced by the segment.

People will still – and do still – eat out. It is about demand and supply catching up with each other, and that is happening very quickly" – Sam Fuller, GCA Altium

"It is a perfect storm," says Sam Fuller, managing director and head of consumer at GCA Altium. "In addition to macroeconomic headwinds, there's a lot of oversupply in the market. When London business rates went through the roof, restaurants that had been top performers within a group saw margins squeezed. Many chains adopted the same strategy of expanding into other cities and, eventually, market towns – many of which have steady or decreasing populations and a more constrained potential customer base. Supply quickly outpaced demand and areas that had been hotspots for performance quickly started tailing off."

In addition to the macro and sectoral challenges, there are concerns that immigration laws following the UK's eventual departure from the EU will lead to a labour shortage, which Fuller says will drive up labour costs further. A recent report by Deloitte found that 28% of UK restaurant staff were migrants, with the industry particularly reliant on EU nationals.

With the industry struggling, the number of deals in the space unsurprisingly dropped off dramatically in 2017, with only two notable transactions taking place: Piper Private Equity investing £10m to acquire a minority stake in steakhouse chain Flat Iron, and Spice Private Equity investing £25m to acquire a significant minority stake in Mediterranean-influenced healthy fast food chain Leon Restaurants. Nevertheless, there remain a substantial number of portfolio companies in which GPs are required to drive value and ultimately make an exit.

Smaller portions
Despite the challenges, particularly for larger-scale players looking to implement nationwide roll-out strategies, Fuller says opportunities are emerging for smaller groups. "People will still – and do still – eat out. It is about demand and supply catching up with each other, and that is happening very quickly. They might level off before the end of this calendar year. A knock-on effect of site closures is that units in good locations become available at more affordable prices. So for groups looking to add a handful of locations, they are able to cherry pick a few gems that might otherwise have been unavailable or out of their reach."

One company that is looking to implement such an expansion strategy is NorthEdge Capital-backed East Coast Concepts, which was acquired by the GP in June 2016. "To continue attracting new customers in the current market, it is essential to focus on differentiating your proposition and putting the customer at the heart of everything you do," says NorthEdge director Phil Frame. "Restaurant groups committed to adding 20 or 30 new sites face a different situation to the one we find ourselves in. It is easier to maintain discipline in your expansion and stay focused on quality when you are opening a smaller number of new sites."

To continue attracting new customers in the current market, it is essential to focus on differentiating your proposition and putting the customer at the heart of everything you do" – Phil Frame, NorthEdge Capital

As GCA Altium's Fuller highlights, private equity owners of casual dining chains are likely to have to wait out the current sectoral downturn before making divestments. In addition to a dearth of potential private equity buyers, he argues public markets are unlikely to welcome IPOs due to the disappointing performance of currently listed restaurant groups. Trade sale are also difficult in the restaurant space, as in-person interaction and the hands-on nature of the business mean synergies are challenging to find. This, says Fuller, is why "many consolidated groups have historically had to be split apart to find buyers".

"There will always be exceptions and there are assets that are bucking all these trends, which will be attractive propositions," says Fuller. "But anything performing at a fairly standard level, or below, is going to be hard to sell. A lot of investors with assets in the space will have to buckle down and wait for the tide to turn – and it will eventually turn."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Consumer
• UK / Ireland
• Investments
• Top story
• United Kingdom
• GCA Altium
• NorthEdge Capital