SUN CAPITAL PARTNERS HAS HAD ENOUGH WITH THE RESTAURANT INDUSTRY – WHAT CAN WE LEARN?

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SUN CAPITAL PARTNERS HAS HAD ENOUGH WITH THE RESTAURANT INDUSTRY – WHAT CAN WE LEARN?

It is 17 years since Sun Capital Partners, a multi-billion dollar private equity firm made their first investment, buying Bruegger’s Bagels, within the restaurant industry. Seventeen years can be viewed as pretty much a complete cycle in terms of up and downs. With only one material restaurant chain left in their portfolio, they have announced their departure from our favorite industry. We’re here to learn, so we spent an unexpectedly long time reconstructing the important elements of thirteen transactions. We stand to be corrected if we’ve missed anything material, but we’re not the library of congress (for $100 annually) and we do our best. At the end of this piece, we will summarize the bottom line.

Bought – Company

2003 – Bruegger’s

2005 – Souper Salad

2005 – Garden Fresh

2006 – Real Mex Restaurants

2006 – Fazoli’s

2007 – Restaurants Unlimited

2007 – Friendly’s Ice Cream

2007 – Boston Market

2008 – Smokey Bones

2008 – Timothy’s Coffee

2010 – Captain D’s

2010 – Bar Louie’s

2013 – Johnny Rocket’s

Let’s look at these deals in chronological order from the time they were initiated.

BRUEGGER’S

Bruegger’s Bagels, founded by our friend Nord Brue and originally based in Burlington, VT was acquired by Sun Capital in 2003 when sales and profits were declining. In the course of the next eight years management, led by CEO, Jim Greco, reduced the Company’s cost base, remodeled nearly all locations, introduced new product lines, and increased store count through the opening of new Company–operated and franchised units as well as  add–on acquisitions. Separately, Sun Capital had bought Canadian based Timothy’s Coffee in March, 2008 (with 106 franchised Timothy’s, 47 mmmuffins, 13 Michel’s Baguette’s) for a reported $100M. In November, 2009, Sun sold Timothy’s to Green Mountain Coffee for $167MM but, immediately prior to that sale, Sun sold the franchised operations of Timothy’s to Bruegger’s. Between the purchase of Bruegger’s in 2003 and 2011, when Bruegger’s and the franchised locations of Timothy’s were sold to Group Le Duff SA, a French company, sales were reported to have grown by 76% from 2003 while EBITDA more than doubled.

Bruegger’s was a very successful investment by Sun Capital, making a reported 13x their investment for a 35 percent annualized internal rate of return. We don’t know whether the reported gain on Timothy’s was included in this calculation, but Bruegger’s/Timothy’s was all very good news.

Postscript: In 2017 Group Le Duff sold Bruegger’s to Caribou Coffee, owned by JAB Holding Co., owner of Panera Bread, Einstein Noah Bagels, Peet’s Coffee, and others including Green Mountain Coffee, which had bought Timothy’s from Bruegger’s in 2009.

SOUPER SALAD

In 1978, the first Souper Salad (SS) was opened by Ray Barshick in Houston, Texas. It was acquired, with about 91 locations, by Sun Capital in 2005. In 2007 Souper Salad added  Grandy’s (with one company store, 4 franchised stores managed by the company and 67 franchised locations, bought out of Spectrum Restaurant Group’s bankruptcy). By the middle of 2008 SS had grown to 151 stores in 17 states. In 2009, the company began selling franchises. However, coming out of the 2008-09 recession, the SS chain had shrunk to 80 units by the end of 2010. In 2011, the parent company filed Chapter 11 bankruptcy and 25 more locations were sold. LNC Ventures, owned by Dan and Jackie Hernandez, bought SS out of bankruptcy in 2012. In the course of 2011, Souper Salad had also disposed of the 65 unit Grandy’s chain, selling to Sun portfolio company, Captain D’s.

Postscript: By late 2013, the SS chain was down to 45 locations. In 2014, SS, with 37 locations, was sold by LNC to Brix Holdings, LLC., based in Dallas.[5][6] After the acquisition, Dan Hernandez remained president of Souper Salad until 2016. [7] Grandy’s, still a sister concept to Captain D’s, has not helped anyone in a long time, shrinking from 72 units in 2007 to 38 locations in 2019 and only 27 units by August, 2020.

There doesn’t seem to be any obvious way that Sun Capital could have made any money on this investment.

GARDEN FRESH

Garden Fresh, founded in 1978 in San Diego, CA, amounted to 97 company operated soup and salad restaurants operated as Souplantation and Sweet Tomatoes when purchased for $198M by Sun Capital in 2005. By 2012, when top management was changed, there were a larger total of 118 locations. In October, 2016, now with 123 locations, Garden Fresh declared bankruptcy. It was purchased out of bankruptcy by Cerberus Capital Management in January, 2017.

We have no knowledge of the operational results or balance sheet changes at Garden Fresh while under the ownership of Sun Capital, so dividends paid out of recapitalizations or cash flow from operations, as well as annual fees could have mitigated the losses on this situation, but it was likely not a great investment success.

REAL MEX  RESTAURANTS

Sun Capital bough Real Mex from Bruckmann, Rosser, Sherrill & Co., reportedly for $359M, in August 21, 2006. There were 200 company-owned restaurants operating in more than a dozen States. The primary concepts were: El Torito, El Torito Grill, Chevys Fresh Mex and Acapulco. However, as the economy weakened by late ’08, Sun Capital’s leverage required them to swap majority control for a reduction in the debt burden. My mid-2010, however, Sun Capital was once again majority owner (70%), of the restaurant portfolio, by way of a debt for equity swap, with Real Mex consisting of 183 operated locations plus 26 Chevy’s franchised units.

The situation obviously deteriorated quickly from mid-2010 to late-2011, when Real Mex entered bankruptcy.  A group of noteholders had the winning bid to acquire the assets in the bankruptcy auction.

There does not seem to be any obvious way that Sun Capital succeeded with this investment.

FAZOLI’S

Fazoli’s, with 319 locations, 179 of which were franchised, was bought by Sun Capital in 2006. The plan was to revitalize the menu, improve the food quality and variety, upgrade the décor, refine the marketing and reduce costs. The Company was sold in 2015 to Sentinel Capital Partners (owner of Checkers, Rally’s, Newks, and TGI Friday’s), at which point the Fazoli’s system consisted of 213 locations, 89 of which were franchised.

Since Fazoli’s shrunk by a third in size while owned by Sun, it would be logical to assume that they didn’t do well with it. However, reports are that Sun Capital made three times their investment over nine years of ownership. This was a function of Fazoli’s  poor management prior to Sun’s purchase, therefore a modest purchase price, cash flow improvements while owned by Sun Capital and a more full valuation at sale.

RESTAURANTS UNLIMITED

Sun Capital purchased Restaurants Unlimited (RU) in March, 2007. RU, based in Boca Raton, FL, founded by Rich Komen, operated 29 restaurants in total when acquired under names including Palisade, Cutters Bayhouse, Scott’s, Ryan’s Grill and Fondi Pizzeria. Only months later, in July 2007, Sun added Pacific Coast Restaurants (PCR), operating 27 restaurants under the names of Stanford’s, Newport Bay, Manzana, Newport Seafood Grill and others. In July, 2019, Restaurants Unlimited, at that point down to 35 restaurants in six states, filed for bankruptcy. Landry’s bought RU out of bankruptcy for a reported $37M. Multi-brande, multi-unit restaurant, geographically dispersed chains are difficult to manage.

There is no apparent way that Sun Capital could have done well with this investment.

FRIENDLY’S ICE CREAM

In August, 2007, Sun Capital purchased the publicly held Friendly’s Ice Cream Corporation (FIC) for $337M of equity plus $175M of long term debt. At that point there were a total of 515 locations systemwide, plus a distribution system of over 4,000 supermarkets and retail locations. Just four years later, in 2011, FIC filed for bankruptcy protection, at the time with $297M in debt and announcing plans to close 63 of its just under 500 locations and indicating over 7,000 retail points of distribution. It came out of bankruptcy with Sun Capital maintaining ownership while erasing a $75M loan. In 2016, Dean Foods bought FIC’s manufacturing and retail distribution business for $155M. In December 2018, Sun Capital bought back a dozen FIC locations across Massachusetts. Early in 2020, with only 138 locations remaining, FIC filed for bankruptcy once more. FIC has now sold it’s assets for $2M to an investor group affiliated with BRIX Holdings LLC, a Dallas franchising company that owns Red Mango, Smoothie Factory, RedBrick Pizza and Souper Salad (Remember them?). The deal will apparently keep most Friendly’s locations open but cover only a small fraction of the $89 million in secured debt.

We cannot judge the bottom line result of this investment, since we don’t know how the balance sheet was managed during the course of Sun Capital’s ownership, including the sale of the distribution business for $155M in late 2018 to Dean Foods, who happened to declare bankruptcy less than a year later.

BOSTON MARKET

We actively followed publicly held, rapidly growing, unit level profit challenged, Boston Market (BM) in the 1990s. Stock market darling BM raised a lot of capital inexpensively, some of which financed franchisees, grew to over 1,100 systemwide units, then went bankrupt. McDonald’s purchased it out of bankruptcy in 2000 for $173.5M. Sun Capital took it off MCD’s hands in 2007, purchase terms unknown, with 630 locations systemwide. Sun Capital was rumored to put BM up for sale in 2017, seeking $400M, but not to be.  In July, 2019, 45 restaurants were closed, bringing the unit count down close to 400. Engage Brands (owner of Pizza Hut, Checker’s & Rally’s) bought Boston Market (down to 390 stores) from Sun Capital in 2019.

Terms of the purchase from McDonald’s and the sale to Engage Brands were not disclosed but there is no apparent way that Sun could have been successful with this investment.

SMOKEY BONES

Originated by Darden Restaurants in Orlando, FL in 1999, Smokey Bones (SB) was grown to a peak of 128 locations, reduced to 73 locations when Sun Capital bought it from Darden in early 2008. The purchase price was reported to be $80M. As of August, 2015, 66 locations were operating. There have been a number of top management changes within the last 13 years, the most recent of which was the appointment of well regarded James O’Reilly (previously with Long John Silver’s, Sonic Corp, YUM and Pepsico) as CEO in November, 2019. At that point, there were 61 locations in 16 states. Smokey Bones remains under the ownership of Sun Capital. Most recently, James O’Reilly announced the opening of 122 Virtual Restaurants, delivery-only, working out of SB’s ghost kitchen in Chicago and the existing 61 restaurants, featuring a limited menu of burgers and wings.

This investment remains a work in progress.

TIMOTHY’S COFFEE

In March, 2008, when purchased by Sun Capital, Timothy’s Coffees of the World (TC), an operator of a retail chain of 166 store, 70% within Ontario, was an operator of Timothy’s, mmmuffins, and Michel’s Baguette. Timothy’s was also a wholesale distributor of single serve coffee and tea products. Purchase terms were not disclosed. In November, 2009, Sun sold Timothy’s to Green Mountain Coffee Roaster’s for a reported $157M in cash. Immediately prior to the sale, Sun Capital’s Bruegger’s bought the Canadian franchised locations (for an undisclosed price), which remained with Bruegger’s until its sale to Group Le Duff in 2011.

Timothy’s was no doubt a very successful transaction, since it was purchased and sold in a short 20 months, and the franchised Timothy’s that were transferred to Bruegger’s may have also made a tangible contribution to the EBITDA at Bruegger’s which was later monetized.

CAPTAIN D’S

Captain D’s (CD), originated in 1969, and built under the ownership of Shoney’s, was comprised of 539 locations across 25 states when Sun Capital bought it in 2010. Captain D’s, in turn, acquired Grandy’s in 2011 from bankrupt Spectrum. Grandy’s has not helped anyone in a long time, shrinking from 72 units in 2007 to 65 locations when CD purchased it in 2011, to 38 locations in 2019 and 27 units by August, 2020 (long after Sun’s departure from CD), still a sister concept of Captain D’s. Sun sold CD in December, 2013 (with 521 restaurants systemwide, fewer than the 539 when purchased in 2010) to Centre Partners. Through a combination of initiatives EBITDA had reportedly gone from $12M to $25.5M over less than four years of Sun’s ownership and Sun made 8x their investment, a stunning 105% internal annualized rate of return. Ain’t leverage grand ?

Captain D’s was an obvious grand slam home run. It’s interesting that Centre Partners “flipped” Captain D’s (with the similar 530 stores systemwide) five years later, saying “We are very proud of our successful investment in Captain D’s”. Only in America (worldwide, actually) with zero percent interest rates.

BAR LOUIE’S

Bar Louie’s (BL), started in Chicago in 1991, was purchased by Sun Capital in June, 2010. At that point there were 36 company operated and 8 franchised units systemwide. We have no knowledge of the operating history in the ten years since purchase, but no doubt a great deal of debt was in place, typical of private equity ownership, as the chain was expanded from 36 to 110 company operated locations, providing a substantial burden on corporate cash flow. Even before the pandemic, the traffic declines at shopping malls, where many of the 110 corporate units were located, penalized sales and profits.  In early 2020, after closing 38 of its 134 locations restaurants and arranging to sell its remaining locations to lenders, Bar Louie’s filed for chapter II bankruptcy protection. Creditors were apparently owed $110M.  On April 27, 2020 the court approved the sale to secured lender, GE Capital affiliate, Antares Capital LP and the chain emerged from bankruptcy in early June.

There is no indication that Sun Capital emerged with any post-bankrupt equity but there might have been at least a  partial recovery of capital in a recap while owned.

JOHNNY ROCKET’S

Johnny Rockets, founded in 1986 by Ronn Teitelbaum, consisted of 300 locations, almost all franchised, in June, 2013 when purchased by Sun Capital, reportedly for about $80M. It’s interesting that Sun Capital bought it from RedZone Capital (backed by billionaire Dan Snyder, owner of the Washington Redskins football team) who had bought it in 2007 from Centre Partners/Apax Partners. Earlier in 2020, after seven years of ownership, Sun Capital sold JR (with 325 stores, including 9 company operated) to publicly traded FAT Brands (FAT) for $25M.

Based on the $80M or thereabouts that Sun Capital paid for Johnny Rockets, and the $25M that Sun Capital received, it seems likely that this deal didn’t provide a great outcome for Sun’s investors.

THE BOTTOM LINE

Bruegger’s – a grand slam home run – supposedly 13x their investment

Souper Salad – not good

Garden Fresh – not good

Real Mex – not good

Fazoli’s – a reported 3x return

Restaurants Unlimited – not good

Friendly’s – not great, might have gotten out whole

Boston Market – not bankrupt, but not good

Smokey Bones – work in progress

Timothy’s Coffee – an apparent grand slam, especially over only 20 months

Captain D’s – a grand slam home run – supposedly 8x their investment

Bar Louie’s – not good

Johnny Rockets – can’t make much if you receive a third of what you pay

SUMMARY

Three out of the twelve closed out positions were grand slam successes (Bruegger’s, Captain D’s and Timothy’s), and one (Fazoli’s) was a triple, so that offsets the losses on the majority of the portfolio. Losses for both the sponsor and limited partners  can also be mitigated somewhat by fees for the sponsor and recapitalizations that can benefit both.

Two of the concepts, Garden Fresh and Souper Salad were concepts that just got old, so reinvention was a huge challenge. Real Mex and Restaurants Unlimited were always going to hard to monetize: multiple brands spread over many geographies. With Boston Market they should have called me.  (I think there could still be some potential there. The product used to be good and bone-in chicken serves today’s off-premise customer because it travels so well ! Look how well El Pollo Loco has survived the pandemic.) Back to Sun Capital: They might have gotten out of Friendly’s “whole”, largely by stripping and selling the distribution business for $155M. Fazoli’s worked out because the chain had been so poorly run by the previous owner. Johnny Rockets’ franchise operation might have worked, given more time, with good management, but Sun paid a full price in 2013 and ran out of patience after this year’s pandemic.

It is especially noteworthy that the three or four most successful investments were franchising situations; Bruegger’s, Timothy’s & Captain D’s & Fazoli’s. Franchise systems have to be supported by reinvesting some of that supposedly free cash flow, but at least the balance sheet leverage predictably employed by the private equity sponsors won’t kill you if the economy turns down for a year or two.

CONCLUSION

Don’t give up on the restaurant industry as an investment, just because Sun Capital has had enough. From what we have read Karp/Reilly, Catterton, Roark, Bruckmann/Rosser/Sherrill and others have had better batting averages. I guarantee that there are lots of strong concepts incubating that are equipped to please the public who will always be interested in good food prepared away from home. For our readership that is perhaps managing a small number of privately owned restaurants: consider that a restaurant generating $100k annually pretax is more challenging day to day but financially equivalent to $20M invested in presumably safe short term US Treasury securities. It’s best to protect that cash flow because you may not be able to easily find $20M after taxes.

Roger Lipton