Reports of high profile backers looking to exit their investments in the sector, or at least limit their exposure to it, are sadly becoming more frequent. However, Mike Hinchliffe, of law firm Addleshaw Goddard, says there is still plenty of cause for optimism that private equity will continue to support the sector in various ways. He also points to lessons the industry can learn from the experiences of the retail sector in 2008.
“Headwinds” seems to be the word of the moment for the restaurants, bars and pubs sector. Search any trade magazines during 2017 and it will not take long to find it (usually on the front page), and it is similarly visible in sector newsletters and e-bulletins circulated by corporate financiers, accounting firms and commercial due diligence providers.
It might, therefore, be presumed that private equity firms have “shut up shop” on this particular sector for the time being. A cocktail made up of rising costs, pressures on consumer spending, future challenges on availability of labour in light of Brexit, and an uncertain wider economic and political climate, hardly presents itself as an attractive investment opportunity. Private equity investors have been prominent in the roll-out of casual dining formats, in particular in recent years, but amidst profit warnings from those who have had to publicise their performance during the year already, and much speculation as to what the reality is for those who have not, it is unsurprising that many investors are saying that the sector (as well as other consumer facing sectors in general) will be a difficult one for investment and M&A activity over the coming months.
That said, whilst there is little doubt that deal volumes are relatively subdued compared to preceding years (a trend that we would expect to continue), there is cause for optimism that private equity will continue to support the sector in various ways. With apologies to Ian Dury, here are 5 (rather than 3) reasons to be cheerful:
1 Private equity investors are backed to invest in what they know. The institutions that give PE firms money to invest look for differentiation and focus based on the strength and experience of the PE firm’s investment team. Many of the leading investors in the UK (across the full spectrum of deal sizes/life cycle) have built up significant experience in the sector in recent years, with senior team members who look at little to nothing else. Even though they may now find themselves preoccupied with supporting the investments that they have already made, they are unlikely to switch off their radar to new deal opportunities in the meantime.
2 The sector continues to have an excellent reputation for innovation and entrepreneurism - characteristics which invariably attract PE investment. This is particularly true of those investors who back new concepts through the relatively early stages of business expansion - see for example the recent investments in Flat Iron and Mowgli Street Food.
3 Whilst there will be challenges to maintain consumer demand, there are trends in the sector that continue to be encouraging for investment opportunities. Consumer habits have continued to evolve, and the trend is towards branded offerings which can successfully integrate their dine in, delivery, social media presence and use of customer data. Private equity investors are attracted to markets where leaders can be identified who will emerge from a more challenging environment. Businesses that can adapt their format to different consumer groups through the day will also catch the eye.
4 There is a lot of money out there. The private equity market in the UK is mature and competitive, with significant funds already committed. In contrast to the environment immediately following the 2008 financial crisis, there is also significant debt available via debt funds, as well as banks. Lending multiples may be down, but there is still strong competition for financing for the right businesses at sensible levels.
5 To risk stating the obvious, investors are attracted to investment opportunities where they can invest at a lower EBITDA multiple and sell at a higher one. It follows that some will have found investing in the sector very difficult in 2016, but are now again open for business - so long as the value expectations of vendors/management are realistic, and they can find their own angle.
Learning the lessons of retail in 2008
Taking a step back, there is a possible analogy here with the wider retail sector in 2008. In the 4-5 years immediately prior to the financial crisis, there had been a significant amount of UK private equity activity in retail on the UK high street, particularly by mid-market investors supporting expansion or roll-out. The buoyant economic climate and wider consumer trends that had prevailed during that period had made such investment opportunities appear relatively easy, but had arguably disguised the fact that a number of retail offerings were becoming tired. In an increasingly dynamic and changing retail environment, they had failed to keep up with evolving consumer trends (in particular, towards shopping as a leisure experience), and to successfully integrate their physical and online presence to provide a true omnichannel offering.
During the period that immediately followed the credit crunch the real skill in retail - a.k.a. giving customers what they want - came to the fore. The better businesses not only weathered the storm, but emerged with a stronger market position; and whilst some older brands were lost, others were reinvigorated; with new brands and formats establishing themselves as a dominant force.
Whilst the continued increase in pure online retail during that period undermines this analogy a little, there are still a number of parallels. Consumers have become more discerning - in that they will look for value for money (and reject mediocre offerings), and also seek out new experiences. As one investor put it to me recently: “We will definitely do a deal in casual dining, but probably only one, and we will be looking really hard to make sure it’s the right one”. Whatever the shape and size of the opportunity, those businesses that focus on the fundamentals should continue to attract strong interest from both investors and corporate acquirers.”
Mike Hinchliffe is a partner at law firm Addleshaw Goddard LLP specialising in private equity fundraisings and M&A transactions, and with particular experience of deals in the restaurants and hospitality sect
