May 18, 2017    7 minute read

Why a Takeover of Brinker International by 3G Capital Would Make Sense

Part I    May 18, 2017    7 minute read

Why a Takeover of Brinker International by 3G Capital Would Make Sense

This article proposes that Brinker International, a leading global player in the casual dining industry, is a suitable acquisition target for the Brazilian private equity fund, 3G Capital.

3G Capital has a great track record in the food and consumer discretionary sector. The firm recently made an unsuccessful bid for Unilever, which revealed it has $15bn available to deploy. As such, 3G Capital could leverage its experience in the sector to deliver a solid value creation plan for Brinker over the next five years.

The transaction size would amount to about $5bn, including the paying down of Brinker’s total existing debt, which stood at $1.2bn at the end of 2016.

3G Capital

3G Capital is a global investment firm that has raised billion of dollars of capital over the years and focuses on maximising the potential of businesses and brands.

3G’s track record demonstrates its ability to generate value from operational excellence, networking, sector expertise, and deep involvement. The private equity firm has, after all, worked on huge deals involving Burger King, Heinz and Kraft and Restaurant Brands International.

However, the restaurant industry poses several challenges. Indeed, it is characterised by slow sales growth, which had a compounded annual growth rate (CAGR) from 2008 to 2015 of just 0.4%, as well as diminishing casual-dining traffic, which has seen a -1.9% CAGR over the last seven years.

Brinker International, Inc.

Brinker is one of the world’s leading players in the casual-dining industry, with a market capitalisation of $3bn. It owns and manages two famous brands, Chili’s Grill & Bar and Maggiano’s Little Italy. Brinker mainly operates in the United States and of its 1,647 restaurants, 80% are based there. Combined, the two restaurants receive 1m visitors a day and employ 100,000 people. In 2015, Brinker’s revenues came in at $3bn. The company is listed on the NYSE under the ticker “EAT” and is included in the S&P Restaurant Index.

The company’s valuation multiples are lower than many of its competitors. Brinker’s EV/EBITDA ratio is lower than the median of its core competitors. There is potential for market undervaluation since Brinker’s latest strategy might not be fully priced in; Brinker recently aimed to massively increase EBITDA by using technology and shrinking its headcount and labour costs.

Chilli’s Bar & Grill

Chili’s is one of the world’s leading casual dining restaurants and has 1,596 restaurants in 31 different countries. The brand operates mainly in the US but is growing internationally through its franchising operations, which have been especially successful in Latin America and Asia.

Chili’s offers an energetic and fun atmosphere, coupled with delicious food. Furthermore, Chili’s is a technology pioneer in the restaurant industry and has the largest tabletop tablet network in the US, which greatly enhances the customer experience.

In 2015, Chili’s average revenue per meal amounted to $14.50 per person, when including beverages. Food and non-alcoholic drinks account for more than 85% of sales with the outstanding 15% coming from spirits sales. On average, Chili’s restaurant sales reached $3.1m in 2015.

Maggiano’s Little Italy

Maggiano’s is one of the world’s leading polished casual restaurants brand and has 51 restaurants based in the US that are all owned by Brinker. Maggiano’s specialises in Italian-American cuisine with a focus on pasta and Italian dishes. The brand also caters for business events, wedding and special occasions.

In 2015, Maggiano’s average revenue per meal amounted to $27 per person. Food and soft drinks account for more than 83% of sales with the remaining part determined by spirits. Events produced 17% of the overall sales. On average, Maggiano’s restaurant sales reached $8.6m in 2015.

Suitability for an LBO

Brinker is ideally suited for 3G Capital and a leveraged buyout transaction. 3G Capital tends to improve margins by cutting costs with a particular focus on labour cost. A possible deal provides room for efficiency improvements largely due to the increasing implementation of technology in the restaurant industry.

Moreover, Brinker provides 3G with several exit solutions: it can either go back to the stock market or sell off Brinker’s two brands separately. Furthermore, Brinker’s management has presided over several divestitures over the years, including Corner Bakery Café, EatZi’s and Romano’s Macaroni Grill, implying proven experience in exit strategies.

The company also has a vast and valuable asset base since it owns 60% of the 1,647 restaurants under its brands. Therefore, Brinker owns land for a total net book value of $260m and buildings for an implied value of $342m. The overall property and equipment value achieves a $1bn net book value when furniture, leasehold improvements and construction in progress are all factored in. These real estate assets enable 3G Capital to take on collateralised debt at a favourable cost.

Additionally, Brinker has also increased its efficiency by shrinking net working capital year on year, meaning it now needs less money to generate profits. This has consequently improved its cash flows, which enables more debt to be taken on.

Chain Restaurants Industry Overview

The chain restaurant industry showed a 4.3% growth over five years from 2011 to 2016. Improved economic fundamentals are the primary drivers of the recent growth of the restaurant industry.

Indeed, the per capita income increased and the unemployment went down boosting consumer spending which showed a 2.4% annual growth in the last five years. The casual dining industry sales peaked $87.5bn in 2015 with a 0.4% CAGR in the period 2008 to 2015. However, the casual dining traffic showed a negative trend from 2008 to 2015 with a -1.9% CAGR, although for Chili’s the figure was only -0.4%.

The industry is expected to experience a 2% annual growth over the period from 2016 to 2021, in line with the world GDP expected growth. The primary growth driver is the improving economic conditions, with consumer spending expected to increase at an annual rate of 2.8% in the next five years.

Restaurants are experiencing higher margins because of cost reductions due to the implementation of technology. New software and devices allow large chains to cut their headcount massively. This is crucial because the restaurant industry is highly dependent on the labour force. Electronic ordering systems and tabletop tablets are likely to proliferate, as they allow a reduction in the workforce, a decrease in the customer wait time, and a faster table turnover.

The chief external pressure comes from increased competition from fast casual restaurants as Chipotle Mexican Grill, which offer high-quality food without table services. Fast casual food restaurants have shown growth over the last few years, and have gained a greater market share, at the expense of full-service chain restaurants.

A Mature Industry

Overall, the chain restaurant industry is at a mature stage. The revenues tend to growth at the same pace of the US GDP since the industry begin to reach a saturation point in the domestic market.

There is also a consolidation trend in the sector as major operators seek to increase their market shares acquiring smaller competitors and integrate them into their restaurants’ portfolio. In this mature and slow-growth environment, there is a high price-base competition to increase the market shares.

A modern trend in the Industry is the increasing concern about healthy food as confirmed by the recent acquisition of WhiteWave from Danone for more than $10bn.

Rising demand for natural ingredients and minimally processed and locally grown food is putting pressure on restaurants to alter their product mix and increase healthy options available on their menus. The “healthy trend” is negatively affecting players that based their menus on unhealthy food such as fried food or hamburgers, and didn’t respond promptly to the change in consumer preferences.

Another technology-related trend is linked to the use of social media. Social media is becoming a major factor of chain restaurant marketing strategy. Social networks like Instagram, Facebook and Twitter, are becoming increasingly important to brand improvement and customer loyalty.

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