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Industry deals continue despite credit crunch

31 July 2008 by

Kicking off a series of articles on coping with the credit crunch, we look at the money men and women behind some major recent investments in the catering industry. Many operators are cutting back but, as Glynn Davis finds, the City is still not averse to shaking on a good deal

It is nigh on impossible to pick up a newspaper, read a magazine or search the internet and avoid reading about property prices collapsing, food prices increasing and energy bills continuing to climb. Many will see this as the end of any growth in their business - but perhaps they should think again. Admittedly, it's harder than it once was to persuade investors to part with their cash. However, we can highlight some recent hotel and restaurant deals which show that, if you're savvy enough, money can still be found. It's a tough market, but there's a range of funding to be had for expansion.

The bank

The banks are among those least likely to part with their money right now, but a good track record helped the London Bar Company increase its loan by 50%. This forms part of the funding it requires for expansion, with the number of food-led pubs run by the firm set to rise.

The company started working with Lloyds Corporate two years ago and had little trouble raising the extra money recently. Managing director Rupert Beak says: "Gaining the loan was painless, as we've an ongoing relationship with the bank. And we expect no problem with any future funding."

The banking industry is still lending to businesses in the hospitality and leisure sector in general, although there is recognition that things are now much tougher for potential borrowers. According to Bob Silk, relationship director of hospitality and leisure at Barclays Commercial Bank: "In a marketplace where credit for the sector has tightened, we're still open for business. What's changed, however, is that the price of credit has increased, because the spread has widened."

"What remains constant," according to Silk, "is the underwriting criteria of Barclays, as it still looks for the same attributes in a business that it lends to, regardless of the economic backdrop. We're interested in people with a proven track record, because the quality of the management is by far the most important consideration for banks sizing up a lending prospect".

It was not so easy for Simon Mullins to raise some of the extra funding he needed for the opening of Dehesa restaurant in Soho, London. Two banks had turned him down. "HSBC were enthusiastic," he says, "but then they decided not to support us. Their take was that restaurants are too risky and they had stricter selection criteria for this part of the market." He then went back to NatWest and was lucky second time. After quizzing the bank about its policy, it reconsidered and gave him the loan.

Having a proven concept helps swing the decision, believes Silk. "This has become increasingly important, particularly in the case of hotels. A new concept looking to exploit a niche in the market versus an operator who wants to franchise an existing brand is no contest. It's much easier to back the well-known brand than something fresh out of the box," he says.

Although management with both a track record and a proven concept provides no guarantee of success, the banks see this as helping mitigate the risks. However, Silk says: "I still welcome new concepts knocking on my door. I would always encourage people to talk to us."

Private Equity

It would be a mistake to think the door to private equity funding has completely closed, although this area appears most hit by the downturn. There have been a number of deals signed in recent months across the industry, one of the largest being the £50m backing by Zeus Private Equity of hoteliers Arnold Schnegg and James Hawksworth to build a collection of four-star hotels as the Hallmark Hotel Group.

Schnegg and Hawksworth had worked together at Paramount and QHotels, and it was their track record that was attractive to Zeus. Ed Fazakerley, founding partner of Zeus Private Equity, says: "We invest in management, and Arnold and James were positive managers. They had a specific model of transforming underperforming three-star hotels into four-star boutique hotels, with operational improvements and improved top-line sales."

The company has quickly grown to five hotels, including the 81-bedroom Belfry House near Manchester Airport, and another five are expected to be added over the next 12-18 months.

Fazakerley believes the sector still provides opportunities. "At the right price and with a robust team the doors are not closed," he says.

It was another robust team that attracted finance from private equity firm LDC to buy the five-unit Mediterranean-style restaurant chain Ego from its founders for £9.1m at the end of March. LDC has backed James Horler and his team of four experienced operators, who built up the La Tasca chain before selling out to Robert Tchenguiz, to roll out the fledgling concept to 40-plus outlets around the UK (see panel, page 28).

Craig Armour, senior director of LDC, is a respected investor in the sector and previously backed Geronimo Inns in a £24.5m deal when working at private equity firm Penta Capital. He says: "Some private equity firms aren't investing now, but there are pockets where there is a niche that's doing well, such as Ego. James is going places with his strategy, and we endorse it."

Although Armour admits that hospitality is, at present, a "fragile market", he insists the downturn will also "present opportunities for growing businesses, as other operators will be more amenable to sell up or offload specific sites at lower valuations".

Indian restaurant business Moti Mahal, operator of the Ad Lib bar on Fulham Road in south-west London, is on the lookout for just such acquisitions following the securing of up to £25m of funding from its private equity owner, C&C Alpha Group, to expand the business.

Sebastian Chaniac, operations director at Moti Mahal, says the company intends to open further Moti Mahals as well as adding other concepts to the portfolio. Chaniac has already tabled an offer on a pair of restaurants in the capital, and he is looking at a shell unit in the City, too.

"There are lots of opportunities out there, but there a lot of them are rotten," according to Chaniac. "So when they're really good, there's a lot of interest."

Franchising

Franchising is often associated with operations such as McDonald's and Subway, but it is also proving attractive to smaller organisations as a way to expand quickly with limited capital outlay.

Although Indian restaurant and fast-food concept Tiffinbites had already secured private equity funding from Napier Brown Holdings, it is now taking the franchising route. The firm aims to grow its restaurant base in the UK from four outlets to as many as 50 by the end of 2009, as well as opening up a network around the world, with its first franchisee signed up in Dubai.

For companies seeking rapid growth that are unwilling or unable in the current climate to source funding from investors - who would also dilute their shareholdings - franchising is a possible route. Franchisees fund the opening of new outlets and pay the franchisor a percentage, often 5%, of gross sales net of VAT.

In addition to continuing to open further company-owned restaurants, Jamal Hirani, founder of Tiffinbites, says franchising will provide a second method of expansion, as it will enable the Tiffinbites brand to be developed by people who are prepared to invest in the business. "The company gains from brand development and increased market share, while also benefiting from the additional commitment of franchisees," he says.

Julie Waites, director of the Franchise Company, which is working with Tiffinbites on its expansion, says franchising is a powerful route to grow a business during a downturn. That's because risk-averse banks are more likely to back individuals wanting to run franchised outlets of a proven concept, rather than funding the roll-out of 50 units by a single operator.

"They can monitor the first one or two and then lend on the success of these early ones," says Waites. "It helps the franchisor to grow their organisation during a downturn, and enables the franchisees to enter the industry when the chance of securing finance for their own unproven start-up would be difficult."

Vincent McKevitt, founder of salad bar concept Tossed, which has four company-owned outlets, has chosen franchising as a route to expand his business, as he believes the right franchisees will help maintain the entrepreneurial culture of the company.

"We considered venture capitalists, investors and banks, as they were all dying to get their hands on the business, but I like the franchising route. You can either embrace entrepreneurial franchisees or go with faceless venture capitalists who treat the investment as just one of many projects," he explains.

McKevitt plans to open the first franchised unit of his bar on Baker Street in London in August and follow this up with two more outlets before the end of the year. Overall, he aims to have a 60:40 split between franchised and company-owned restaurants.

In partnership

Although the London Bar Company recently increased its loan with Lloyds Corporate to fund the expansion of its "pub de luxe" restaurant and cocktail bar concept (see page 26), it is also supplementing this with capital from one of its key suppliers, Scottish Courage.

This trade partnership has so far involved the drinks company providing about 25% of the finance for the fit-out of the company's first two London pubs, Ruby & Sequoia in Notting Hill and Idlewild in Maida Vale. That has come in exchange for a "barrelage commitment".

If the business fails to achieve a certain level of sales of Scottish Courage products, then a proportion of the money converts into a loan. "They have the money and want to develop their brands, and this is a great opportunity for them," says Rupert Beak, managing director of the London Bar Company. "As we are in a downturn, it helps them make some headway in the market."

Such is the keenness of Scottish Courage to be associated with the London Bar Company that Beak says the supplier is now willing to contribute up to 50% on a forthcoming site in the City of London, the terms of which are currently being negotiated.

"Scottish Courage don't want us to lose this site, so they are being really helpful. We hope to build a partnership with them such that they'll help us find sites in the future. This could be an opportunity on our part to grow a lot quicker. As for Scottish Courage, they'll get a greater exposure for their products, plus grow volumes," he explains.

The downturn is also making it easier for Beak to negotiate better deals on sites. The initial upfront payment on the City unit has already been reduced significantly from £350,000 to a possible £150,000. In fact, this could be split into half now and half in a year's time.

Friends and family

Ahead of opening his second restaurant, Dehesa in central London, in January, Simon Mullins, co-owner of restaurant group Tortelli, replicated the funding route he had taken with his first outlet, Salt Yard, by sourcing capital from friends and family.

This involved selling the concept of the new outlet to his people, who between them have already owned more than 40% of the business since 2005. Mullins and partner Sanja Morris have the remainder.

Mullins says he considered all options of fundraising, including private equity, but the success of the original arrangement led him to take out new loans from all the existing shareholders. The funding was supplemented with additional business loans from the company's bank.

He believes the success in sourcing capital this way was helped by limiting the number of investors to fewer than 10 and giving them each the same shareholding in the business. "We kept the number to a minimum so that people have to be serious about contributing. They were required to invest a large chunk," explains Mullins.

"We have control now," adds Mullins, "both from a creative and operational point of view - and we hope it remains this way. We have a quarterly contact with our investors, and they've enjoyed a healthy return so far of over 20%."

Daniel Potter, owner of the 62-seat Oriental fusion restaurant Inamo, with soft opening scheduled for 11 August, will be hoping for the same sort of returns for himself and family from his innovative concept which involves an interactive ordering service with the menus projected on to the tables. It's going to cost a bit, but Potter has found more funds from people he knows. "There were options such as bank and Government loans, but this is the most straightforward way," he says.

Private Investors

One of the main providers of funding continues to be successful people who are still bringing both money and experience to new ventures, despite the economic downturn.

In January entrepreneur Richard Caring struck a £105m deal to buy a majority stake in Soho House. This not only bought out the 28 minority investors in the group but also provided the company with some of the capital it needed to fund continued expansion around the world. Founder Nick Jones also increased his stake from 13% to 20%.

Another deal, struck at the back end of 2007, was the buyout of Merchant Inns by property veteran Sir John Ritblat through a joint venture with the company's executive chairman, Robert Breare.

The £11m agreement paid off existing shareholders and took on the debts of the business. Further funds will be injected into the company by Ritblat for the continued acquisition of pubs, which are then converted into boutique hotels. Merchant Inns will be adding 15 sites per year for the next three years.

Fast-growing food chain Leon is also raising funds privately, and the fourth round of this process was completed last year. Backers include James Horler, who recently became Leon's chairman, Robert and Vincent Tchenguiz, and the former owner of Whyte & Mackay, Vivian Immerman.

Recent major deals

  • Richard Caring's £105m majority-stake buyout of Soho House.
  • £50m backing by Zeus Private Equity of the Hallmark Hotel Group.
  • £25m of funding from private equity owner C&C Alpha Group to expand the London Ad Lib bar business.
  • £11m buyout of Merchant Inns by property veteran Sir John Ritblat.
  • Private equity firm LDC's £9.1m purchase of restaurant chain Ego from its founders.

Ego has landed on its feet

The decision by James Horler and a management team that had previously worked with him on La Tasca to buy out the founders of the Ego restaurant chain was based on what they saw as ideal demographics being targeted by the brand.

Ego is aimed at the under-served 45-plus age group in middle England based outside city centres, and currently consists of five outlets. The team assembled by Horler, including experienced restaurateurs John Barnes and Ian Edward, proved sufficiently attractive to bring in funding from private equity firm LDC.

LDC provided finance for the buyout of the founders, and this will be securing the debt to fund the roll-out of the chain around the UK. Horler says the aim is to quickly grow the business to 41 restaurants by 2011 at a rate of 10 per year from an expected base of 10 outlets at the end of this year.

What has made the deal especially attractive to Horler and LDC is, surprisingly, the current state of the market. This has enabled the business to be bought at an appealing six times greater than EBITDA (earnings before interest, tax, depreciation and amortisation), which compares very favourably with the much loftier 12 times greater that Horler sold La Tasca for at the peak of the market in 2007.

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