Fate of Chain Restaurants: Spring of Hope or Winter of Despair

December 3, 2020Articles The Legal Intelligencer

Charles Dicken’s “A Tale of Two Cities” famously opens with “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness … .”

This opening could be applied to the results of the last political election, the public health of our nation, or even the strains of work and family under the current challenges. The words also fit the dichotomy exhibited in the restaurant and franchise commercial environment today.

We miss our restaurants and they miss us. Before COVID, off-premises dining was a cutting-edge concept being investigated as a supplemental-income stream. Now curbside and delivery, as well are architectural changes are a necessity and a matter of survival. Let’s see how this is playing out now, and will in the future.

First, dine-in restaurants had to learn about new architecture. Plexiglas counter windows, masks and expedited ordering required additional investment in infrastructure. In the meanwhile, cooks and servers had to fight the virus and dwindling customers. Labor lawyers were called as often as physicians to address the difficult issues of compliance with public health initiatives as applied to labor issues. Restaurants had to go to curbside pick-up and reinvest in delivery options, often sacrificing margins and profitability to survive.

The Winter of Despair

Even before COVID-19, many restaurants were financially challenged. Older chains were under pressure from changing demographics, increased competition and rising costs for years. Even those restaurants that began reconfiguration in 2019 found their progress stymied by the impact of COVID-19, resulting in accelerated closure of both franchised and company-operated locations. COVID broke the back of iconic chains such as Chuck E Cheese, Sizzler, Toojay’s Deli, Il Mulino, Le Pain Quotidian, California Pizza Kitchens, Cosi, and Friendly’s Restaurants. The companies were forced to close underperforming locations, rejection of overpriced leases and sale to strategic buyers with the wherewithal to continue the best practice of the brand. Experts predict somewhere between 40% to 60% of restaurants nationally will close permanently. For these restaurants, this is the season of despair.

Many of these franchised chains have huge franchisees that also had to reorganize in Chapter 11. The largest franchisee of Golden Coral, 1069 Restaurant Group, almost took the chain down by itself. NPC International Inc., the nation’s largest franchisee of Pizza Hut and Wendy’s restaurants, filed bankruptcy and wants to sell its entire company to the Flynn Restaurant Group.

The Season of Hope

The bankruptcy of NPC International also shows that the death of restaurants has been somewhat overstated. With reduced competition, bidding wars and increased merger-and-acquisition activity of restaurant chains have developed.

As of Dec. 1, Wendy’s has opposed NPC’s sale to Flynn, the largest restaurant franchisee in the United States. Wendy’s instead has made its own offer with a consortium of regional franchisees. Wendy’s is in talks with NPC to drop its opposition in return for an agreement by Flynn to invest tens of millions of dollars in NPC’s Wendy’s restaurants. San Francisco-based Flynn owns more than 1,200 restaurants, including Applebee’s (452), Arby’s (639), Taco Bell (282) and Panera Bread (136) brands across 33 states. Some of those brands compete with Wendy’s. as defined in some of the Wendy’s franchise agreements, but not in others.

Dunkin’ Brands, operator of both Dunkin’ Donuts and Baskin-Robbins, has agreed to be acquired by Inspire Brands for $11 billion. Inspire Brands is backed by private equity firm Roark Capital. Inspire Brands is also the owner of Arby’s and of Corner Bakery. Corner Bakery is exploring a strategic acquisition as well. Zaxby’s, the 900-unit chicken restaurant chain founded by two partners 30 years ago is selling a significant stake to Goldman Sachs to allow it to go national. Merger and acquisition is alive and well.

Overheard at the Restaurant Finance and Development Conference in November 2020 was the report that franchise and restaurant investment capital is plentiful, but not at traditional banks. Some banks are open to it, but most of the bankers interested are in those nontraditional banks, who have little competition, and charge accordingly. Private equity and private placement money is available as well at reasonable costs.

Some chains are going public. Burger Fi, a Florida based “better burger” franchise chain has sought to be acquired by a special purpose acquisition company (a SPAC), sometimes referred to as a blank check company, because the investors’ money is collected first and then an acquisition is targeted. In this case, the SPAC is Opes Acquisition Corp. Burger Fi is a 77-unit chain on a growth spurt, and with additional cash, will be able to saturate markets outside of its core market in Florida.

Companies positioned for increased delivery, drive-thru efficiencies and home delivery have prospered. Pizza restaurants have reported steady 20% increases, and some brands have even quadrupled their sales. Yum Brands, a publicly held owner of various brands reports same store sales increases for its U.S. operations, including KFC, which is up 9%, Pizza Hut up 6% and Taco Bell up 3%.

As we move toward the holiday season, more restaurant shakeouts and consolidation will occur. Independent chefs will move into the former space of aged-out restaurants, and continue the cycle of rejuvenation. All the more reason to visit your favorite eateries now, and to look forward to the innovations that will adopt to changing customer needs and values.

Reprinted with permission from the December 3 issue of The Legal Intelligencer. (c) 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.