Interface: Scott Pressly

How the chain-restaurant market looks to a private equity firm

By Jamie Popp, Senior Editor -- Restaurants & Institutions, 7/1/2006

In recent years, chain operators increasingly have turned to private equity firms for growth capital as an alternative to becoming publicly traded. As partner at one such company, Atlanta-based Roark Capital Group, Scott Pressly assesses growth potential of companies seeking capital. Concepts in which Roark has invested include Carvel Corp., Cinnabon International and McAlister’s Deli.

Q. Why has there been so much activity with private investments in restaurant companies?
A. There always has been a need for growth capital for restaurants and franchise businesses, and where a company goes for that liquidity has changed over time. Previously, [corporations] were active and providing liquidity for growing restaurant concepts: McDonald’s buying Chipotle, for example. What you’re seeing now is private equity as a source of capital for concepts.

Q. Wall Street traditionally has been wary of restaurant companies because of seasonal sales fluctuations and other factors. Has that wariness diminished?
A. The restaurant industry always has been cyclical, and I don’t think the fundamentals have changed. During the past four years, we’ve seen strong GDP growth and it’s been a great time to own a restaurant company. [Now] we’re seeing softness in comp-store sales across all segments and I’m not smart enough to predict when expansion will end.

Q. Will we see fewer restaurant companies go public?
A. Historically, if I started a concept and grew to 100 units, I’m going to look for liquidity for what I have done. The question is: Where do they access growth capital: public markets, private equity or a strategic buyer? You’re seeing larger companies go public but not seeing smaller concepts with 10 units going public. You’re seeing liquidity being provided by private equity firms. In the 1990s, restaurants went public with 10 or 20 units. You’re not seeing that today.

Q. What metrics do you look at to evaluate the potential of a restaurant chain?
A. We start with the management team. Restaurants are operationally and people intense. Having a team in place is critical to setting up the infrastructure for an ongoing successful restaurant chain. Next, we look at the concept itself. It can’t just work for the consumer. Ultimately, it has to work at a store level. Boston Chicken [now Boston Market] was a good product, but the stores didn’t work because labor costs were high and it was operationally too complex to make money. We look at balancing what it costs to invest in the restaurant and what revenues and cash flows we’re getting out.

People sometimes get lost in the shuffle of the experience of owning a restaurant, but underlying economics drive sustainable growth. That’s why Chipotle is so hot. Its stores are averaging nearly $1.5 million and generating 20% cash-flow margins, which allow them to build more stores and increase earnings. In restaurants there is a tendency to look for the next sexy concept or neatest trend, but it still boils down to unit economics and long-term viability of the concept.

Q. Is there one change you most often make to improve operations after an acquisition?
A. There is no silver bullet, and that’s why restaurants historically have been hard to operate. When Wendy’s brought Baja Fresh they thought they could bring in expertise, tools and resources to revamp the concept, but they had some real challenges.

Restaurants need to look at their menus and what their competition is doing. Build cost, size of store, décor, advertising, food cost and labor model: Every part has to come together to create a successful concept.

We bring perspective to a company’s board and provide talented and experienced advisors who supply functional expertise in marketing, operations or strategy that help the CEO think about all these things and build the business.

Q. How confident are you about chain restaurants’ ability to adapt to changing consumer tastes?
A. There are going to be winners and losers. There always have been. There are positive macro-trends in restaurants, such as the number of occurrences people eat out. But for every Chipotle, there’s a Krispy Kreme. There is a sex appeal about restaurants, but it’s about day in and day out execution. Sometimes it sounds better from the outside.