A growing resurgence of sector M&A, amid more robust profit margins, means this year could be a busy time for both investors and management teams alike.

As we enter a fresh year, it is clear that new momentum has been injected into leisure sector M&A. The deals in the last quarter of 2023, which saw US private equity firm Apollo Capital Management secure Wagamama-owner The Restaurant Group, for circa £700m (including debt), Young’s acquire City Pub Group for £162m, and Trive Capital acquire Ten Entertainment for 
£287m, have provided much-needed impetus. 

These transactions followed Fulham Shore and arrived at a time when the sector again faced increasing pressure. The combination of current market dynamics coupled with evolving consumer trends is creating a more polarising market, with winners and losers. To answer who will come out on top in 2024, it is worth exploring these prevailing market conditions and how they are playing into investor behaviour. 

Through the cost-of-living crisis, we have witnessed money not being evenly distributed between customer groupings; it has clearly impacted younger demographics more than older ones. At the same time, and unsurprisingly, the customer is ever-more discerning; there is an even greater focus on quality and value. In most market segments, there is also a continued focus on the digital customer journey (not to mention those lnstagram-able moments, in venue) as an integral part of the overall experience or occasion. Another influential customer trend we see only growing in importance in the next 12 months is around wellness and ESG; operators are focused on the authenticity of their offer, but the best are going further, looking at what they can provide that resonates with the rise of purpose and impact. It’s about brands and businesses standing for more. 

Margin expansion returns 
From a financial performance perspective, inflation and higher costs of capital are continuing to place a premium on growth. At the same time, newer businesses that are more aligned to consumer trends are succeeding. In a positive step, we are also seeing businesses start the return to margin expansion; public companies are forecasting an end to the recent squeeze on conversion, with material profit margin improvement forecast in their current and new financial years. Alongside the previously mentioned moves on TRG, Ten Entertainment, and City Pub Group, this improving margin picture is one of the other factors that has supported a recovery in public company share prices. 

In short, this improving story around margins, coupled with a resurgence in larger-cap deal activity, makes for a more positive picture versus a few months ago, and is important as it will influence investor sentiment when it comes to driving deals in private companies. 

Keeping growth ahead of inflation 
We can see that inflation is falling, but it remains historically high. Importantly, we see that wage inflation is growing ahead of overall inflation; whilst challenging from an operational management point-of-view, this is positive from a consumer spending perspective and an essential barometer for the overall health of the economy. That said, though, interest rates and the cost of capital (being the level of equity return investors are targeting) have increased, which is material when people are making investment decisions. It’s easier to commit to borrow money and invest when the percentage paid in bank interest is much lower than your target returns; it is much harder and requires more consideration when the all-in cost of borrowing has moved out to, typically, anything up to (and potentially over) 10%, which needs to be offset through growth, to simply keep the value of the business constant. Put simply, investing requires a sharp focus on growth; it is what is going to colour the views on all investments this year. 

What is going to drive growth?
There is an attractiveness to smaller businesses with a lot of white space to grow into, and that has remained consistent throughout the recent (somewhat straitened) past. Good businesses that resonate with the customer and still have a lot of ‘low-hanging fruit’ available to them in terms of obvious locations where they know there is a very similar customer base, are typically in demand from landlords and can potentially secure attractive property deals. This is a good recipe for success and these small, winning concepts continue to be a focus for investors. 

We’ve also seen increasing interest in businesses that are able to franchise. This capital-lite model, with growth driven by franchise partners, has become increasingly appealing to the investor community. Scope for international growth is also a question that is now asked more regularly of smaller businesses – witness Flight Club and Alchemist. Investors are seeing that businesses from the UK can take their propositions and be successful overseas. Finally, propositions with a track record of high return on investment, such as leading QSR brands like Chopstix, remain attractive. 

Investor interest returns 
Perhaps most significantly, different types of investors are returning, in terms of taking an interest in the market and tracking deals and prospects. When we see large private equity funds like Apollo and TOR coming back to the sector in a material way it is hugely significant. The broad interest from private equity is being driven by value creation opportunities via businesses deemed to be significantly unloved and/or undervalued. 

At the same time, the industry specialist private equity players such as lmbiba, Piper, and TriSpan are constantly looking at those businesses that are new and innovative. International buyers are also coming to the UK, as demonstrated by Toridoll’s acquisition of Fulham Shore and Dallas-based Trive’s acquisition of Ten Entertainment. Then there are operational investment funds, the likes of McWin, which are looking at how you combine accessing capital and providing operational capabilities that can really help accelerate growth. Trade buyers, such as Big Table Group and Greene King, remain focused on strategic consolidation, and the ability to secure synergies and grow their footprints. There also remains a question around the future acquisition intentions of TRG, now that the management have backing from Apollo. 

We have also seen an increase in activity from operational platform investors and trade buyers who are leveraging central functions to help support growth. They can bring operational expertise and expansion know-how into the mix. At the same time, access to branding, marketing, and technology functions become more and more important. The ability to have a larger, single function with more money to invest in things like digital technology, but importantly also that bring a track record of experience of not only investing in digital technology but also implementing it into the business successfully, is going to become more and more attractive. 

Over the past couple of years, it has really been a game of two parts in each year, when it comes to investment activity, with an ebb and flow in each year. We are optimistic that the pick-up in deal volumes that we saw in the second half of 2023 will continue in 2024, for a number of reasons; debt will need refinancing; firms will need to exit long-held investments; there will be more strategic consolidation; the continued return of private equity; and the return of roll-out investment. 

Additionally, when you one of the biggest investors out there, like Apollo, makes a big move into a sector, it can only be positive. It breeds interest and should lead to other private equity funds looking at the sector too, for fear of missing out. People will not want to be too late to this (New Year) party. 

This article was first published by MCA