M&A in Hospitality: Significant number of PE businesses looking to transact

High-performance coaches and athletes (and sometimes aging 1990s boy bands, too) speak of the essential requirement to ‘hang tough’; to remain determined and on task, even when there are significant problems and difficulties, and the players are stressed. In modern footballing parlance, it’s all about the ability to ‘suffer’, as a group, in testing moments or phases of a game. 

It’s an admirable quality built through experience and muscle memory, and one that defines the best teams. As we face into April – and everything we know it will bring – one can only imagine how good many hospitality leaders have become in developing this stoic skill, in the face of adversity.  Running businesses in difficult circumstances amid extended periods of uncertainty has started to feel like a new normal. Many colleagues would quite like it to change, though, and soon.  

There is no one-size-fits-all solution for this latest cost challenge, given the varying operating models in hospitality, and until the impact of the Budget is fully understood, there will likely be something of a pause in most investment and M&A activity, as financial forecasts are reworked and assessed against the latest, new reality. However, that is not to say that established sector investors and new entities are not readying themselves to move, when conditions become clearer and the right opportunities present themselves. 

An improving picture – quality not quantity

The outlook for hospitality’s guests will improve, given the cumulative growth of disposable incomes, as income growth continues to outstrip inflation. The downward movement of interest rates will also enable consumers to start to feel better about their disposable incomes. As Greggs chief executive Roisin Currie said recently, “the fundamentals (for growth) are good,” reiterating that the rise in the minimum wage would help increase household spending power. 

The market has become smaller, and more competitive. From the pandemic to now, there has been a 16% reduction in licensed food outlets in the UK, with the bulk of the closures coming in the independent sector. However, there are nuances, with larger groups broadly holding steady to where they were in 2020. Mid-sized companies – the likes of Flat Iron, Gail’s, Pizza Pilgrims, Pho, and Wingstop – have delivered 72% growth in numbers. 

But how is this feeding through to transactions? Traditional deal volumes over the last 18 months have declined, primarily driven by reduced private equity activity in the mid-market (with some exceptions). Private investors – individuals, family offices, crowdfunding – have filled some of that gap, with recent examples including crowdfunds by WatchHouse and Yolk as well as private investment into better burger brand The Beefy Boys. 

Momentum is also starting to build with larger institutional investors. Over the last two months the recently approved acquisition of Loungers by Fortress and Wingstop’s reported £400m-plus deal with Sixth Street (following Epiris investing in Amber Taverns and Apollo’s take-private of TRG in late 2023). These transactions illustrate the desire for private equity to deploy capital into the sector and could help provide other institutional backers with the confidence for doing deals in 2025. 

Talking of Loungers, where next for the sector’s listed companies? Loungers more than doubled the size of its business in five years, even with a global pandemic. Despite this, on the Monday before the first Fortress offer was announced, its shares were trading at just 4p above where they closed after the company’s very first day of trading in April 2019. It is difficult to see that the markets will recover anytime soon – investor sentiment on the public markets towards UK consumer businesses remains extremely bearish, which may open up the opportunity for other listed companies to go private. 

Deal activity from trade buyers has continued to move forward in the past 12 months, with corporates focusing on acquisitions with a clear strategic rationale. It was the driver behind QSRP’s move for Chopstix, the fast-growing Asian QSR brand. The deal gave QSRP a foothold in the UK, added an Asian brand to the portfolio and offered Chopstix opportunities to accelerate its expansion both in the UK and Europe. The acquisition of 200 Degrees by Caffe Nero delivered a high-quality brand to enhance Nero’s portfolio, and gave 200 Degrees access to more expansion opportunities, plus the scale and synergy benefits created by joining a much bigger business. The pub sector also saw continued trade activity, most notably Young’s acquisition of City Pub Group in March for £162m. 

Stepping back, global expansion shows how far some hospitality businesses and brands have come. In turn, it has become a more prominent theme for investors, as illustrated by Hawksmoor, Big Mamma Group, F1 Arcade, Lane7 and Chaiiwala, who continue to open new units internationally and will continue with Dishoom and JKS Restaurants, who have announced international growth ambitions. 

Unsurprisingly and unfortunately, deals borne from distress or by the need to restructure will continue, with investment platforms – such as Breal Group, Calveton, and Karali Group – seeing value in stepping in to support brands in difficult situations, and as seen recently with US fund Directional Capital acquiring Pizza Hut UK. We expect more such acquirers to enter the market this year, lured by the opportunity to take fundamentally good brands (and their best sites) that require investment, scale and stability. These restructuring-led deals also present an opportunity for trade acquirers to capture new brands. 

The fundamentals have not changed

What investors are looking for now hasn’t fundamentally changed. Rising costs mean the ability to demonstrate sustained top-line growth is more important than ever, from existing channels and in new ones. Overseas expansion tends to be on investors’ radars more readily and at an earlier stage in the development of brands, and the rapid rise of institutional QSR as a sector mainstay has also brought a sharp focus on franchising. Investor scrutiny is also alive to the ability of a brand (and management team) to pivot to new formats and retail channels. 

The fundamentals remain centred on the strength of management, the strength-in-depth of a business, the current like-for-like performance (revenue but also cover growth), and the ability to protect and grow margins, despite inflationary pressures. There is increased upfront focus on the likely exit and who the likely buyers will be. Businesses that can tick these boxes will generate much interest, and can deliver a stellar exit, as the aforementioned sale of Wingstop UK illustrates, and there are a number of operators that have the potential to do the same over the next 12 months.  

There remain a significant number of private equity-backed businesses out there, which have been held for six years and more, where current owners wish to transact in the next 12-18 months. We think we will start to see M&A movement for these businesses. These businesses often have low or no debt on their balance sheet and generate healthy cash surpluses. One theme we expect to play out with these companies is raising new debt to buy out long-standing shareholders who want an exit. This leaves the remaining shareholders and management to continue to grow the business with an increased shareholding. The recent Caravan deal is an example of this type of approach. 

And so back to the Budget. Without mitigation, we think the raw drop in site EBITDA margin has the potential be around 3 percentage points, and the reduction in absolute site EBITDA could drive in excess of double-digit declines. Our sense is that most businesses (largely) focused on delivering Christmas in Q4, and have spent the time since the turn of the year on the serious work of addressing this impact; to what extent cost challenges can be mitigated, through pricing, labour productivity, use of automation, or looking into procurement and supply chain efficiencies. For those unable to derive the necessary improvements, it means we may see further restructurings, to both portfolios and rental models, as more sites become uneconomic to operate at existing rental levels. 

We believe that there is still an improving picture, once we wash through the Budget impact, as the consumer spending outlook improves, particularly in the critical younger demographic who benefit most from the increase in the minimum wage. Demand to eat and drink out and socialise remains, but competition is fierce. An uptick in deal activity will breed momentum, especially as the larger private equity firms potentially return for more deals in hospitality and leisure (witness Apollo, Fortress, and KKR). This, in turn, will give more confidence to business leaders to carry on and complete more transactions in 2025.

This article was first published in MCA.