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IPO markets backs off for now


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Beginning in the fall of 2015, there was a significant slowdown of initial public offering activity in the restaurant industry. This near cessation in IPOs across most industries has continued into 2016.

Restaurant companies, especially those potentially interested in an IPO this year, should be mindful of recent trends that will likely influence receptivity to new equity situations in the second half of 2016, as the equity market begins to open up. And given the positive long-term trends that benefit the restaurant sector (and on which we know institutional equity investors are focused), we are highly confident the market will re-open this year.

We saw a dramatic wave of companies accessing the public equity markets in 2014 and 2015, notably names like Shake Shack, Habit Burger and Wingstop. These IPOs were priced aggressively relative to historical multiples—given growth expectations and the market’s infatuation with the restaurant industry—and proceeded to trade up further on the first day of trading due to strong investor buying.

Habit Burger, for example, is up roughly 5 percent from its IPO price, but down more than 50 percent measured against where the stock closed on the first day of trading.

At these extremely lofty valuations, the market expected many of these companies to dramatically exceed expectations on metrics like same-store sales growth, as well as profitability. Many IPOs from 2015 merely met or mildly exceeded these expectations, which was not enough to satisfy investors.

Moving forward, the market will likely be looking for slightly larger IPOs that can offer meaningful liquidity and companies will be expected to set targets they can comfortably exceed in the first several quarters after their debut on the public markets.  

For the second half of 2016, we will likely see an IPO market that may want to see companies’ valuations grow over time, rather than hitting likely unsustainable levels out of the gate. When Shake Shack was trading at roughly 100X forward EBITDA, or gross earnings, few were confident it could sustain this valuation multiple, and accordingly it has contracted significantly to a still highly attractive multiple in the high 20s on forward EBITDA.

As the IPO market has cooled, other options are now back on the table for private companies, including seeking private equity for a majority or minority stake and modest debt financing (for modest dividend recapitalizations)—options that were less appealing when the IPO market was very attractive.

Restaurants are facing historic challenges from expected medium-term increases in wages, as well as competition for labor. Many states and municipalities like Seattle and New York are setting higher standards in their markets, and at the same time large employers, such as Walmart and Target, now have a $10 minimum wage for their workers.

These forces are making it more difficult to find and retain labor across the country for restaurant operators. The current hiring strategy for many restaurants is to continue to raise wages where possible and to stay ahead of the hiring trends to retain great workers.

In a fortunate turn of events as it relates to profit margins, the cost of food has actually declined given the lack of inflation over the past 12 to 18 months. Although many concepts are choosing to upgrade their food quality, most restaurant companies have seen food costs decline, ultimately benefitting margins.

This is important in the quick-service restaurant space, where the rising minimum wage will be a significant headwind over time, given the prevalence of minimum wage workers, and yet the industry has continued to discount their offering as their food input prices have moved lower.

Millennials are typically spending a higher percentage of their credit card bills on restaurants, compared to baby  boomers and generation X. Food is one of the top priorities for millennials who care about what goes into their bodies and view eating out as a core social activity.

This means restaurants must adapt to the tastes of millennials to succeed. What we are seeing in a lot of start-ups by millennials and targeting millennials is this demographic places a value on certain attributes: healthy or “clean” food; locally sourced or organic food; great-tasting food that is authentic; or food that consumers crave with superior ingredients.

Many traditional casual dining concepts are losing traffic and capital is being funneled to restaurants that can adapt their supply chains and offerings quickly enough to cater to millennial tastes.

More established and mature brands are also focused on investing in new ways to reach millennials and other customers via digital and online services. The National Restaurant Association’s Industry Forecast found about a quarter of consumers see technology as being an important feature in their choice of restaurant. Taco Bell, for example, has invested heavily in its new mobile ordering app, which yields a 20 percent higher bill from customers than traditional in-person orders.

At the highest level there remains tremendous optimism around the restaurant sector. According to data from the NRA’s Restaurant Performance Index, 53 percent of operators plan to spend money on equipment, expansion or remodeling in the next six months.

Based on our discussions with the leading institutional investors, there remains confidence in the importance of the restaurant sector as a tremendous source for earnings growth. For those operators looking to expand and grow in 2016, they’ll want to consider broader sources of funding, including the equity markets, private equity firms and modest debt financing to stay on track to meet their goals. But the IPO will re-open and when it does, potential issuers will want to be ready.

Roger Matthews is managing director and head of restaurant investment banking at Bank of America Merrill Lynch in New York.

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