Sentinel Capital builds investments, brick-by-brick
David Lobel, Sentinel Capital’s founder and managing partner, is a meticulous man.
Past the receptionist (ahem, the director of first impressions as is her official title), it’s an enviable view from the 27th floor conference room of Sentinel Capital Partners in Manhattan.
Before his interview, Sentinel’s founder and managing partner David Lobel explains the careful destruction of a neighboring building. He said he’s watched workmen slowly demolish a building, floor-by-floor, for months.
The methodical, precise nature of the work seems to speak to him, maybe delight him. The meticulous approach is his approach.
Since founding Sentinel in 1995, Lobel and his team have watchfully grown a number of investments in the middle market, creating infrastructure and building them up for a good return.
“When you focus on the lower end of the middle market, many of these companies are big small businesses and what we’re really trying to do is make them small big businesses—all the resources of a big company but they just happen to be small so that we grow into it,” said Lobel. “We find that many lower middle market companies need more foundation, infrastructure before they can actually run fast, so that’s one of the things we do. One of our investment strategies is to put that in place so they can run.”
Sentinel has touched many franchise systems on both the franchisor and franchisee side, including Massage Envy, Tony Roma’s, Fazoli’s, Yum Brands, Checker’s, Church’s Chicken, Newk’s, and it currently has a majority stake in TGI Fridays.
Every investment thesis is a little different, but Lobel said there are a few things he looks for right away in a prospective acquisition target.
First, there’s the numbers. Generally speaking, private equity investors like Sentinel will take cash flow over revenue—something the franchising world does especially well. A key metric to determine how well is “return on net tangible capital.”
“We like companies that are high free cash flow. We don’t like very capital-intensive businesses. One of the reasons we like franchising is because it’s not capital intensive, it’s a very asset-light business,” said Lobel. “So you take a look at the EBITDA minus the capex and divide it by the net tangible capital utilized in the business. If that number is at least 40 percent, we get interested, and if it’s not, our interest wanes.” (That’s gross earnings and capital expenditures in finance speak.)
Then, unlike the many small private equity firms grabbing up small brands across industries, Lobel said he seeks the advantage, sustainability and defensibility of category leaders.
“We like companies that are leaders in what they do. Because we’re in the lower end of the middle market, we’re dealing with relatively small businesses. When guys come to us and say, ‘We’re tackling a gigantic market and we have 3 percent market share and we can grow forever,’ it’s not that interesting to us because it means there are big players out there and they’re swimming with sharks,” said Lobel. “We like to be the big boy in the market.”
Before jumping on an investment, Lobel said vetting the management team is also critical. A good businessperson may not thrive under a private equity arrangement, especially if they’re looking for work-life balance.
“The private equity model is basically to empower executives, give them a lot of autonomy but in exchange for that, a lot of accountability,” said Lobel. “We want entrepreneurial-minded, equity-oriented executives that are really trying in their own way to establish personal wealth by taking a risk—not having a cushy job with lifetime employment and a nice retirement package.”
If an investment passes muster, it’s right to work on the investment thesis. Lobel said once the management teams and Sentinel agree on a path forward, they move quickly.
“We’re trying to accomplish something significant inside the space of five years, and it goes pretty quickly. Believe me five years goes very, very fast,” said Lobel.
As every investment is different, the needs of investment companies are also different. Newk’s, for instance, was one of those big small businesses that was well run, but needed capital to build runway for growth.
“New senior executives had to be hired, new systems and controls needed to be put in place, new computer infrastructure, new IT infrastructure. We saw that going into the deal and we knew that unless those things were done, the company would not be able to grow rapidly and keep control,” said Lobel. “That became part of our investment thesis: grow deliberately in the first 18 months, not supersonically, while at the same time retrofit the business with infrastructure to support aggressive growth in chapter two.”
Fazoli’s was a different animal; a former private equity firm had already “effectuated the turnaround” of the once-troubled brand. So Sentinel is focused on growth and building a few company stores.
Similarly, during a 33-month investment in Massage Envy, Sentinel oversaw the opening of 2,015 locations in another growth-focused push. And when Sentinel took a majority stake in TGI Fridays, a major part of the investment thesis was refranchising corporate locations, which accounted for 40 percent of the restaurants.
Breaking up the locations into regional pods, they sold the pods to mostly existing multi-unit operators. First, Sentinel took the lead, teaching executives how to make the large transactions required in the plan, then turned over the refranchising to TGI Fridays. With that tactic, the company went from about 400 corporate locations to just 55.
A big part of the TGI Fridays refranchising thesis was something Lobel learned from three investments on the franchisee side of a company.“One of the truths in franchising, it’s almost axiomatic, is that franchisees operate their units better than the franchisor operates them itself,” said Lobel.
It’s been a rarity at Sentinel, but as franchisees took advantage of a refranchising at TGI Fridays, so too did Lobel when he got into the Pizza Hut system in 2008 with a 123-store purchase from Yum Brands and a seasoned operator at the helm. The business grew through acquisitions to 224 restaurants before ultimately being sold to another private equity firm in 2012.
That same careful planning and methodical execution is plain to see across Sentinel’s franchise investments. Brick-by-brick the firm has constructed and renovated across the industry, as seen in the accompanying chart—that’s a lot of bricks.