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January 16, 2018 - Source: Debtwire Middle Market Memo

Samantha Gleit comments on market dynamics for casual restaurant owners


Casual dining restaurant owners will be hard-pressed to see any recovery in 2018 if industry trends continue, said multiple market participants.

Mid-sized chains like the now-bankrupt Romano’s Macaroni Grill and the struggling Bravo Brio continue to get caught between quick service restaurants (QSR) such as McDonald’s and fast-casual chains like Panda Express, added the sources.

Average same-store sales declined 1.6% over the first nine months of the year and though total sales have grown during the same period, more than 70% of all the money spent in chain restaurants have gone to QSR or fast casual brands mainly at the expense of casual dining, according to data collected by a restaurant industry analytics website TDn2K.com.

“There’s a shakeout going on for a while now. If you are a restaurant, especially a casual dining chain, your concerns aren’t done,” said Dan Collins, principal at Colorado-based restaurant banking firm The Cypress Group.

As part of the shakeout, casual dining chains like Macaroni Grill and Ignite Restaurant Group have filed for Chapter 11 protection, while Bertucci’s and Granite City Food & Brewery have hired advisors as they struggle with ongoing covenant issues and consider financial and strategic alternatives.

A lot of casual dining concepts were established when there wasn’t competition from fast casual restaurants which resulted in their expansion, and now they are stuck with a large footprint and high fixed lease costs meanwhile consumer preference is moving away from these concepts, according to industry banker.

“In casual dining, it’s not only the lending community but owners and operators that are reconsidering their development strategies right now. The capital is available but it is being more cautious as the market sorts out who the winners and losers are in casual dining,” said Armando Pedroza, head of restaurant Finance at Citizens Bank. “Naturally, it’s easier for concepts that are the winners, but difficult for concepts that are struggling.”

Unlike QSR and fast casual, casual dining is slightly more expensive with a longer menu and higher labor costs. And if people are going out to eat, they are mainly either going out to a higher end place or fast casual where they can pay half the price, said three sources.

“I think we are going to continue seeing pressure on casual dining.Though I expect many of them to survive, it takes a while for something to turn around,” said the industry banker.

“The situation in the industry is similar to what’s happening in retail sector and since a lot of casual restaurants tend to be near malls, with mall traffic down, they are being hurt. And a lot of them aren’t enough of a destination that people will leave the house for it,” added David Berliner, restructuring and turnaround partner at BDO.

To be a franchisee or not to be?

The prevailing downturn in the industry is present across all operating models as well, be it a franchisee model or company-owned and operated.

With a franchisee model, the capital expenditure is borne by the franchisee creating less volatility and better return on assets for the franchisor. And while the franchisee is running the business, the company can focus on building the brand and understanding changing consumer trends like TGI Friday’s has done.

Meanwhile, a company owned and operated model provides more flexibility, but also a higher cost structure as it assumes leases and labor costs.

“A lot of public brands like the franchisor/franchisee model because they have to put in less capital. Whereas private companies are leaning away from that because it allows them more flexibility -- for instance, they make changes to menu, store design whenever they want,” added the industry banker.

While each model has its benefits, merger and acquisition activity in the franchisee world has been ongoing since buyers like the asset-light nature of the business and the attractiveness of popular brands, especially in the QSR segment, said Samantha Gleit, associate at King & Spalding LLP.

“Franchisees, continue to be attractive for bidders due to the decreased operating risk associated with the asset-light model, the opportunity for growth, and since some restaurant brands can be counter-cyclical, like McDonald’s with its dollar menu, and are more likely to withstand headwinds in the economy,” she said.

by Tanvi Acharya