Private equity investors and strategic acquirers in the United States maintained a stable appetite for restaurant acquisitions in the 3rd quarter of 2015. Investment activity remained at the same level as the prior quarter with 28 announced restaurant transactions during the 3rd quarter of 2015 continuing a robust trend from the first half of the year, according to S&P Capital IQ.
In this article, Alvarez & Marsal highlights the requirement to consider the potential differences between rent expenses recorded in GAAP financial statements, and the corresponding amount and timing of rental payments required under the same lease arrangements when evaluating a restaurant transaction. We also continue our discussion on evaluating and improving underperforming units. New owners, prospective investors and other stakeholders should understand these unique accounting and operational considerations associated with restaurants.
Understanding Rent Expense: Cash versus Reported Expense
Restaurant properties are often leased rather than owned by the restaurant company. In many instances, operating leases include certain features that result in cash costs of a lease being different than what is reported as rent expense. Understanding these differences and the associated deferred rent liability is critical before closing a restaurant transaction.
Features in a lease that result in a difference between cash cost and reported rent expense include (i) escalations in rent, (ii) tenant allowances or inducements, and (iii) tenant improvements paid by the landlord. GAAP requires the impact of these features to be recorded on a straight-line basis over the life of the lease. This results in the recording of a deferred rent liability in the early life of the lease when the cash cost is less than the reported rent expense. The deferred rent liability is then wound down in the later years of the lease when the cash cost exceeds the reported rent expense.
Prospective investors should consider: (i) the historical differences between cash cost and GAAP rent expense which may affect the target’s ability to service debt, and (ii) the impact that deferred rent may have had on net working capital, particularly if there is a purchase price mechanism in place that considers net working capital. Finally, upon consummation of a transaction, the application of purchase accounting may result in a change in post-transaction reported rent expense.
A careful examination of cash versus reported rent during due diligence will prevent surprises following the completion of a restaurant transaction.
Driving Same Restaurant Store Sales – The Right Way
Today’s hyper competitive restaurant industry is a challenging environment for sales growth. However, with the right framework sales growth moves from the possible to the probable and becomes a far less daunting task.
Smart sales growth develops from thinking about the relationship between customers and revenue in three unique ways:
- Retention – how many current customers are you retaining each week, month, year? What strategies are you using to keep your customers from dining at the competition?
- Penetration – how are you getting current customers to spend more with you at each subsequent visit to increase your share of wallet? How can you get your customers to dine more frequently at your restaurant?
- Acquisition – is part of your marketing strategy dedicated to attracting new customers that have never dined with you before? Have you identified new customers you are not serving? What do you know about those customers?
Driving growth with this framework allows management to truly understand where they are gaining or losing share across these three customer groupings. Restaurant Companies who have robust analytical tools that assist them in identifying the multitude of valuable customer characteristics will consistently be at an advantage in the industry. These insights become a powerful set of tools to effectively develop meaningful relationships with customers and spend marketing dollars more efficiently. This approach is more effective than the common alternative of a blanket marketing approach where all customers are treated the same.
Restaurant M&A Activity Summary
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Source: Capital IQ. / Note: the data above excludes transactions characterized as the transfer of land, transfer of assets between individuals and other similar transactions
Summary
Strategic acquirers continued to drive momentum in restaurant transactions. During the 3rd quarter of 2015, there were 24 announced restaurant transactions involving strategic acquirers compared to four transactions involving financial sponsors. Fast/Mass casual restaurants continue to be the target of choice, although the proportion of transactions involving Fine Dining restaurants increased significantly which comprised only 4% of activity during the 2nd quarter of 2015.
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Rino Nori
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Paul Ruh
Managing Director
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Paul Aversano
Managing Director
+1 212 328 8709
Mark Roberts
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