One of GRS Group’s clients that focuses on the restaurants sector is MarshallMorgan, LLC, which is a franchisee financial advisory firm based in Dallas. The outfit got started in 2000 and primarily worked for Tricon Global Restaurants, which was an offshoot of Pepsico’s fast-food operations, which included Taco Bell, Pizza Hut and KFC. MarshallMorgan did workouts and restructuring work for Tricon and its franchisees. Tricon eventually became the behemoth fast-food player Yum! Brands, and MarshallMorgan still works with its franchisees, as well as firms that operate Church’s Chicken, Popeyes and Wendy’s, and some casual-dining chains.
MarshallMorgan executives have been working with GRS Group for years, specifically with Barry Bain, a director with GRS | Centaur, the group’s financial advisory firm. Bain recently helped MarshallMorgan with the transaction of a number of Burger King restaurants. He, as well as Amer Quraishi and Larry Simmons, co-founders of MarshallMorgan, spoke to us about the relationship between the two firms, trends in the restaurant industry as well as last year’s Restaurant Finance & Development Conference.
First of all, how did the relationships between GRS and MarshallMorgan get started?
Amer Quraishi: We’ve known Barry since he was at the REIT Sovereign Investment, and we had done a lot of work with Barry from that time. So the way we connected, especially last year, in that we came across some transactions where there was a large amount of real estate that required a REIT to purchase the real estate. Barry is obviously an expert in that field. We wanted to use his expertise to bring us REITs that we weren’t familiar with in the industry. We were looking for a unique group that was intelligent when it came to buying real estate but was also price competitive. So we used Agree Realty, which we did two transactions with, and we’ve done exceptionally well.
How do you feel that the industry is doing as a result of the RFDC show?
Quraishi: We felt like the mood was very upbeat. A lot of the people that we came across were very confident about the future of the restaurant industry. There were a lot of banks that are very aggressively lending to the sector. We have seen over the last 14 years that we’ve gone to this conference that this was probably one of the strongest periods where private-equity groups were everywhere. They were coming to our booth and talking about the fact that they have a lot of private-equity capital to invest in the restaurant industry and are actively looking for markets. They seemed more aggressive on the multiples and were looking for large markets and consolidation of their existing markets. The mood was very upbeat overall at the conference.
Barry Bain: It sort of took me back to the run between 2004 and 2007 and how things just really seemed to be very vibrant, and there was a lot of activity. I don’t want to correlate this period with that period because we know what followed, and none of us want to go through that again. The continued sentiment of confidence, the amount of capital that is out there from private equity, as well as franchisees that sustained themselves through the recession remains very strong. From a financing standpoint, there seems to be more banks in the industry now than there ever have been. Thus, it’s definitely a franchisee market if they’re looking to sell, refinance, expand and/or acquire. The activity at the conference was really good. Generally you have two days of exhibiting and the second day tails off substantially. I didn’t see that so much this year. The second day was just as busy, if not busier, than the first day.
But didn’t this sector fare pretty well during the recession compared to other property types?
Bain: If you look at the restaurant industry, people are always going to go eat. What they’ll generally do is dial it down a bit. Instead of going to a white tablecloth, they go to casual dining. Those that typically go to casual dining will go to fast casual, and so on.
Quraishi: What we’ve seen is the population goes from the fine dining to one notch down and one notch down. However, in a recession both the business and real estate multiples tend to deteriorate as banks get more conservative and asset valuations tend to decline.
Bain: Even though cap rates are going down, the valuations are still very supportable, and we all have learned that we need to keep our fundamental underwriting in place and don’t lose sight of that even though cap rates are going low and multiples are going higher.
Did you attend any sessions of note that you got any new insight from?
Quraishi: Not really, the mood was generally upbeat as everyone felt that 2015 would continue to be strong.
Larry Simmons: Many times what you see are speakers who don’t really want to tell you inside information that they’ve developed, and they keep it very basic and very generic. We attended one about different sources about financing, and it was basic stuff that anyone would have known that has been in the business.
Quraishi: We attended a speech about higher wages, and a speaker talked about how workers can be convinced that they don’t need higher wages by pointing out the benefits of working in restaurants, free uniforms, free food and flexible hours. But the fact of the matter is that higher wages are going to come, and the food industry needs to be prepared for it as opposed to fighting it. There is a huge momentum building in the country to raise the federal hourly wages.
Simmons: The speakers didn’t want to say things that would stir people up about how to actually deal with the reality of the higher wages that are coming and the reality of healthcare costs. I don’t hear anything about how you are practically going to deal with it or negotiate the best rates possible with the most benefits. You only hear things about evading or minimizing it.
Bain: My view is that it’s going to hurt the smaller and regional concepts and smaller franchisees to some degree. It might tell them they haven’t been in it long enough and that they want to get out.
Simmons: I would take a more contrarian view on this. There have been test models of this in Oregon and California and Massachusetts, and their business environments are doing just fine. California is second in the nation in employment growth, despite all of the griping you hear about high taxes. These states are still hot beds of growth there, even though they are paying higher wages. Additionally, people are more likely to stick with a company who provides healthcare benefits and that pays them a decent wages. This, in turn, reduces training costs and turnover because people are largely more motivated and loyal to a company that appreciates the efforts of its employees.
For a firm like MarshallMorgan, do these issues concern you?
Simmons: It concerns us because it puts a chilling effect on decisions being made by people who want to buy because they want to undervalue the business by overestimating the healthcare costs and wage increases, but they don’t take into account the price increases or elasticity of pricing or the lowering of training costs or the increased productivity coming out of employees. They only look at the negative (even though there is no empirical or quantifiable information), and of course that works in their favor in attempting to lower the price, and, of course, the seller doesn’t want to take unquantifiable costs into account because they have a thriving business that is currently very profitable. Obviously, these unknowns about the impact of healthcare costs and higher wages is something you have to consider. It does impact negotiations on pricing in some markets. But in the very large markets, there is enough money out there that we never hear it brought up. With the REITs and investment firms that want to buy up large chunks of markets, it’s never discussed. To them, it’s a non factor. But when we’re dealing with franchiseesIt concerns us because it puts a chilling effect on decisions being made by people who want to buy because they want to undervalue the business by overestimating the healthcare costs and wage increases, but they don’t take into account the price increases or elasticity of pricing or the lowering of training costs or the increased productivity coming out of employees. They only look at the negative (even though there is no empirical or quantifiable information), and of course that works in their favor in attempting to lower the price, and, of course, the seller doesn’t want to take unquantifiable costs into account because they have a thriving business that is currently very profitable. Obviously, these unknowns about the impact of healthcare costs and higher wages is something you have to consider. It does impact negotiations on pricing in some markets. But in the very large markets, there is enough money out there that we never hear it brought up. With the REITs and investment firms that want to buy up large chunks of markets, it’s never discussed. To them, it’s a non factor. But when we’re dealing with franchisees, it becomes a big leverage point. However, what we do is try to help companies recognize the benefits and to assess and quantify the impacts of the new regulations.
Are you seeing different types of investors entering the market right now?
Simmons: You’re seeing more and more of the investment firms getting interested. They’ve always been interested, but there seems to be a bigger rush of larger firms that want to buy into this industry. Across the board, there just aren’t enough new-investment possibilities out there, that it’s just a natural flow of what happens when there so much money to be placed with only a limited amount of possibilities. People who might have wanted to do something high tech in the past are now looking at the restaurant industry.
Bain: In each potential acquisition or merger out there, you definitely see some new names pop up, and it may be there first investment into the restaurant industry.
Is consolidation of franchising groups a big factor in the industry right now?
Bain: You are seeing quite a bit of that. You have one franchisee acquiring another franchisee trying to expand contiguously to their existing markets. There are larger acquisitions made, and that’s where the private-equity firms definitely get involved. You see a lot of these older-generation franchisees that haven’t gotten real big interested in selling, and it’s the franchisee in the next market that may be most interested in acquiring them.
Simmons: Franchisors made the conscious decision a few years ago that they needed to have more deep pocketed franchisees involved in developing their brand and expanding it, and they came to realize that the older franchisees were largely not interested in growing the brand and the smaller franchisees didn’t have the credit lines to grow. Accordingly, their thinking led the opinion that larger, more aggressive investment groups would be more likely to help their brands to develop new markets and to re-image existing assets. It’s also easier to manage 30 or 40 franchisees than it is 600 spread all across the United States.
How does that impact the way you do business?
Simmons: Eventually it could have an impact because if you get down to only a handful of mega franchisees, they have the staff and financial ability to do all of these transactions themselves. The middle five franchisees that are a little bit larger tend to more trust companies like ourselves. Even though they have CFO’s, it’s not something they do in terms of valuation or sourcing funds. The bigger they get, the less likely they are to use consulting firms.
Quraishi: But it’s also a bit of a fad. Franchisors say they want smaller operators because they have skin in the game, then they want larger operators to fund the high capital costs of development, then they eventually discover that the larger operators are not afraid of saying no to the franchisor on various mandates set by the franchisor and taking them to court. It vacillates and fluctuates. We’ve had many franchisor CFO’s admit to the fact that there was a time when they wanted smaller franchisees in the system because they had skin in the game and passion for the store. Then they went and sold to all of the big operators and private equity groups, which they initially were against. So, that’s why I don’t think it will impact our business because I think it’s a moving target.
How do you feel overall about the regional chains that are getting a lot of attention in the media? Are you comfortable with some of these quickly expanding startup concepts?
Quraishi: We don’t focus on them like we do with the more mature brands. We don’t get involved with the regional brands at all. I don’t really know what I have read, and what I have read is that banks are still pretty adverse to lending to regional brands as opposed to the more mature brands.
Simmons: We’ve had a few discussions with lenders out there, but you can tell that the lenders’ tastes are more toward the more proven brands. I would suspect that most of the financing for these comes from banking relationships that these franchisees and franchisors already have. And for sure it’s not at the multiples that we see for Taco Bell.
Do you think there is an overheating in this part of the sector?
Simmons: Common sense tells us that with all of these burger wars and all the different chains that are coming up that there is going to be some falling out because they can’t all be successful competing for the same customer.
Quraishi: Tacos are now all the rage, at least in Dallas we’ve seen a new chain coming up every other week with a new concept for tacos or burritos. These are fast-casual concepts appealing to a higher-income demographic.
Simmons: Now they’re even tailoring to toward an ethnic clientele as well, but over and above, it’s just another taco stand. There are just tons of these coming on to the market. There is going to be a shakeout. I don’t know which ones will be successful. You can’t all be competing for the same product.
Bain: You have to figure that there’s some of these brands that you see…it almost seems like they may be fads. It’s sort of like the bacon rush right now. Everybody has to have some bacon-flavored something on the menu.
Quraishi: Or pretzel buns!
Bain: What happened to our health-conscious society? Do they not remember how bad bacon is actually for you?
Simmons: On that point, though, in this sector that has never been as good a selling point as you would have thought. McDonald’s, Pizza Hut and everybody has tried going to a more healthy menu, but they don’t sell they way you would have thought they would have. In fact, the biggest sellers have always been the ones with the most calories, like that Burger King breakfast bun.
Quraishi: What we see is that people just revert back to comfort food.
Simmons: They don’t think of it as a healthy choice. They want the flavor, tasted and comfort out of it. You’re going to get filled up. Especially for lunch, you’ve got construction workers who are out there in the field, they’re working in the morning, and they’re hungry, and they want to get filled up to make it through the rest of the day.
Finally, how do you guys see 2015 shaking out?
Quraishi: It’s going to be a lot like 2014. There’s still going to be a lot of M&A activity, there’s still going to be a lot of capital and plenty of banks. Everything we’ve learned from the Fed is that they’re not going to raise interest rates any time soon, and based where the stock market and general economy are, we feel confident that it’s going to be strong year for our business, similar to the year 2014. We’re already seeing some activity from franchisees that have already called on us to look at potential sales in their market. We’re seeing the same type of activity that we saw in 2014.
Simmons: I would agree. Prices are at an all-time high, so franchisees recognize that this is the time they should sell if they are toward the end of their careers in this business. They want to sell at the highest possible price before those prices go down.
Bain: I concur and see 2015 being another 2014. Valuations and activity should all be sustained. I think it will bring another good year of increase in same-store sales, or just a validation in the market.