​A welcome success story for the coffee and cake market

Last week, Caffé Nero acquired a significant stake in Coffee#1, a premium coffee shop operator with 92 stores across Wales, the Midlands and southern England. SA Brain, which acquired the business in 2011, will continue to retain a significant minority shareholding in the business – a clear sign of its belief in the success of the concept and future potential of Coffee#1.

Turning the clock back eight years, many in the industry questioned the logic behind Wales’ largest pub and brewing company buying a small, artisanal coffee chain, however, to SA Brain the strategic rationale was strong. First of all, the coffee market was (and is) in strong growth. Secondly, coffee shops could serve as a natural hedge to pubs both in terms of an alternative social hub and when the weather is more inclement. Finally, coffee shops benefit from much swifter planning approval compared to pubs, allowing a faster pace of growth. Combined with Brains’ deep understanding of Coffee#1’s heartland (South Wales and South West England) and the compelling financial metrics (high margin / return on capital employed), the strategic logic was clear.

During Brains’ ownership, the Coffee#1 estate grew more than six-fold. As the fastest-growing premium coffee shop operator in the UK, Coffee#1 had reached a scale where it required its own infrastructure and Brains’ decided to seek a partner to facilitate the continued expansion of the brand. We approached private equity investors with a track record of leisure roll-outs and strategic partners, with considerable interest in the business expressed by each of these buyer groups. Ultimately, the sale of a majority stake to Caffé Nero provided clear operational and strategic benefits and allowed Brains to retain a stake in a successful, fast-growing business.

What makes Coffee#1 a success?

Prior to being awarded the mandate by SA Brain, we visited 47 Coffee#1 shops - 67% of the retail estate at that time. From our first visit, it was clear that Coffee#1 offered something special and different. Perhaps that is because we were used to London coffee shops focusing on either “craft” coffee in a cramped environment (high London rents) or larger branded chains where speed of service is the key priority.

The environment is spacious (low regional rents) with plenty of available seats and clean tables. Comfy sofas, armchairs and bookcases all contribute to a relaxed atmosphere, while the friendly staff behind the counter offer table service.

This atmosphere has been a key tenet to Coffee#1’s appeal and brand identity, with a focus on “selling time and space” in a comfortable environment, as well as coffee and cake. Combined with deliberately larger stores, this has encouraged longer dwell time amongst affluent customer groups. Time-rich, older guests can extend their visit without feeling rushed. Parents with small children and prams have the opportunity to meet in spacious surroundings. Tourists are also attracted to Coffee#1 given the high-quality fit-outs often in character buildings, which are tailored to each locality.

These attributes allow Coffee#1 to charge a premium price for its coffee versus branded competitors. Other premium-price coffee shop operators tend to be single site artisan operators with a city centre focus. Importantly, whilst Coffee#1 is perceived by its customers as artisanal and offering a premium experience, it has been careful to ensure it benefits from a mainstream appeal. This is not easy to achieve and there are few examples of operators being able to take a premium concept to a mainstream audience. One such example is Meantime Brewery Company, which Sapient Corporate Finance, sold to SABMiller in 2015. Meantime was at the forefront of the modern craft beer movement in the UK with award-winning lagers and ales such as London Pale Ale and London Lager. Research demonstrated that Meantime was regarded by consumers as a “craft” product but highly accessible to both genders and different types of consumers. This wide appeal is similar to what Coffee#1 has achieved in a different part of the drinks market (and a different geography).

Does Coffee#1 have national roll-out potential?

We think so.

As advisers to the pub and broader leisure sector, we regularly see fantastic new concepts. In London there are some great cocktail bars that prepare wonderful cocktails. These bars have developed a cult following and perform very well. However, could the concept be rolled out nationally? In most cases there may be a market for a dozen or so of such bars but not the potential to scale the concept nationwide. Be At One is an exception and, similarly to Coffee#1, it focuses on the experience rather than just the product. This enabled the successful roll-out of 33 Be At One bars, attracting the attention of Stonegate, which acquired the business last year to scale the concept nationally. Similar parallels can be drawn with Coffee#1. Other artisanal coffee shops are seemingly occupying smaller and smaller spaces. But, will this format work across the UK? That much is unclear. Those with broader, differentiated and / or more regional offers such as Boston Tea Party, Caravan and 200 Degrees are far more likely to succeed.

Coffee#1 has developed a format that is eminently scalable – premium, high-quality offering, in a relaxed, spacious environment with an unwavering focus on the customer, cleanliness and the coffee. Since Brains acquired the brand in 2011 when it comprised 15 units, it has grown to 92 stores and preserved its independent feel. This is despite Coffee#1 being the next largest branded operator after the “Big 3” coffee shop chains, which together account for over 50% of the branded coffee chain market.

Coffee#1 has been able to expand from its heartland in Wales and the South West, primarily in affluent, regional market towns. The focus on regional and premium locations has enabled Coffee#1 to fulfil a need for high-quality coffee in these towns and present an alternative to more ubiquitous offers. This strategy has kept competition from premium and artisanal coffee retailers to a minimum where operators are less prevalent and focus on city-centre locations.

In a UK market where coffee has been in constant growth, Coffee#1 is ideally positioned. Coffee culture is firmly established in the UK, driven by an increasing frequency of consumption. Even during the 2009 recession, the coffee shop market (and indeed Coffee#1) witnessed growth. That said, coffee penetration in the UK remains low compared to many European countries. For Caffé Nero, the leading premium operator in the UK, Coffee#1 adds a new concept to its family of brands, opening up growth in smaller, regional towns where customers typically have more income and more time.

In the coffee and cake market where the woes of one particular operator have dominated the headlines in recent months, the acquisition of Coffee#1 by Caffé Nero and its exciting future growth prospects, provides a welcome respite.

Fraser Anderson is a partner at Sapient Corporate Finance, an advisory specialist to the leisure sector