Distressed Debt Opportunities in the Restaurant Business: A Crowded Trade

Talk to any investment banker in the restaurant business these days and they’ll tell you about the frequent calls they’re receiving from investors looking for distressed investment opportunities.

Investing in a distressed situation typically involves buying debt or equity of a troubled company at a deep discount and then selling it later, once the business has recovered, at a profit. Investment bankers tell us there aren’t many deals in QSR, especially with so many brands now sales positive over last year. But that could change once second quarter financial statements are filed with the lenders and covenants are tripped. The workout action right now is in the sit-down category, which hasn’t benefitted from having a drive-thru window that prints money.

Six public sit-down dining brands—Darden (DRI), Bloomin’ Brands (BLMN), Cheesecake Factory (CAKE), Ruth’s Restaurant Group (RUTH), BJ’s Restaurants (BJRI) and Brinker International (EAT)—have sold equity or debt to investors at a discount. According to their bankers, the deals were oversubscribed, despite the use of proceeds essentially being used to stave off cash burn. As reopening optimism gathers steam, the share prices of these companies are rising.

Now the Covid-19 distress hunters are scouring the private restaurant market, where many fast casual and sit-down dining chains are either closed, or operating at 30-40% of pre-Covid capacity. The typical restaurant restructuring takes place in bankruptcy court after the debtor breaches loan covenants and fails to successfully renegotiate leases on losing stores. By the time a debtor reaches bankruptcy court, a deal has usually been made to sell the company to the debt holders and a new management team has been recruited.

However, CR3 Partners Managing Director Barak Tulin sees Covid-19 distress as a completely different situation than a typical debt and lease restructuring exercise. He thinks investors will have trouble projecting the actual liquidity and capital they’ll need to return the business to glory.

"How do you rehabilitate a company that is in hibernation, or doing minimal business and then ramp it up back to normal?" asked Tulin in a recent Monitor webinar.

Rehabilitation is especially tricky for sit-down restaurants, many of which struggled pre-Covid. Unbridled Capital Founder Rick Ormsby thinks distressed investors would fare better if they partnered with a strong owner/operator looking to expand. Ormsby sees opportunity in teaming up to buy an overleveraged company, meanwhile taking out a lender’s senior position at a discount. Why involve an experienced owner/operator in a distressed debt transaction?

"In the last second of a basketball game, you don’t put the ball in the hands of a rookie," said Ormsby.

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