Evolving from surviving to thriving in hospitality and leisure

From a Mergers and Acquisitions (M&A) perspective, the past 12 months have definitely represented a game of two halves. From this time last year, up to and including the late summer and early autumn, there were clearly some seismic business challenges in play within hospitality and leisure, not least supply chain, staffing and energy costs. Yet from a transacting standpoint, these headwinds represented challenges that could be navigated and overcome, and therefore were not necessarily barriers to deals, allowing some management teams and investors to start contemplating refinancing or possible exits.

However, come the autumn, the market was derailed due to changed economic conditions triggered by the market fallout from the mini-Budget, which sparked rising interest rates, a softening of the debt market and the devaluation of sterling. There was a severe reduction in the availability – and an increase in the cost – of debt finance, which meant valuation expectations were unachievable and transaction activity stalled.

If the ensuing winter weather helped to capture the prevailing mood for the sector’s dealmakers, the question is: will the eventual arrival of spring give way to new beginnings and a rebirth of activity? The reality is that, despite the aforementioned challenges and temporary hiatus, M&A activity and investment has and will continue, with some notable themes emerging.

Change, challenge, and also opportunity

We have seen the return of the trade buyer, with examples including Greene King’s acquisition of Hickory’s, Big Table Group’s capture of Banana Tree, and The Restaurant Group’s deal for Barburrito. At the same time, growth capital raises, the expansion of competitive socialising concepts and the roll out of franchising models and quick service restaurants (QSR) have continued (witness Chopstix and Tortilla alongside the big international players).

Buyers in the marketplace also include operational real estate funds (such as Alchemy Partners with its investment in Brasserie Bar Co) and specialist private equity firms, which are long-term investors in the sector; the likes of Imbiba, Piper, and TriSpan, the latter of which recently put the finishing touches on its deal for Mowgli. What we haven’t seen yet, and what we need to see to get the deal market back to previous levels of activity, is the return of mainstream private equity. This becomes more likely as the debt market recovers.

Clearly, on a three-year view, a whirling maelstrom has enveloped the marketplace, creating change, challenge, but also opportunity. If anything, this flux has accelerated in the past 12 months. These dynamics, which include unprecedented cost-base inflation as well as evolving consumer behaviour, such as new working patterns, mean that site economics have fundamentally changed. Business plans will need to reflect this new normal and operators, if they haven’t already, will be urgently assessing the potential to convert or dispose of marginal sites and any locations rendered unviable, which will drive further estate consolidation and churn.

With the current market uncertainty and volatility in mind, investors are increasingly seeking solace in robust data – supporting evidence is more important than ever when engaging with potential new backers.

Front of mind is how the business stacks up against relevant, prevailing trends. Is it providing both hospitality and an experience? Is it getting ahead of the environmental, social and governance and responsible business agenda? Is it a progressive employer with a coherent wellness and well-being strategy? Is it tech-enabled and does it show up well online – does it “bang” on Instagram, and has it built a meaningful digital audience? Operationally, are the fundamentals credible and can the offer translate to different formats and channels? Financially, can projected business growth be backed up by data? And what is the profile of margin recovery, management’s understanding of its energy position, its debt position, its staff recruitment and retention plans, and the robustness of its supply chain? Many, many questions to be answered, but you get the idea.

Four key areas of focus for operators

Looking forward, we expect to see sustained investment in growth concepts, as highlighted by the recommended cash offer from Japan’s Toridoll and sector investor Capdesia for Fulham Shore, the Franco Manca and The Real Greek operator. The outlook will also likely include further strategic trade acquisitions, the continued expansion of QSR brands – both here and internationally – the participation of operational real estate investors in the sector plus the churn of larger company estates, more refinancing deals and (inevitably) restructuring-led transactions.

The cadence of activity, though, will hinge on debt market recovery, a concerted return of private equity to the sector more broadly (beyond the sector specialists), businesses being able to generate consistent profitability with growth, and some visibility on the inflationary outlook.

With all this in mind, we believe there are four key areas of focus for operators this year.

1. The ability to evolve from a state of survival to one focused on growth. This will involve finding the inflection point in margins, the ability and readiness to capture market share following local closures, a continual focus on pricing and the flexibility to trial new ideas. 
   
   
2. Management teams must bring a determination to focus on growth, whether that is new sites, new channels, exploring franchise models, new brands or formats, or new territories – either regionally or internationally. 
   
   
3. New opportunities can emerge from the creative use of real estate. Landlords are facing a challenge to repurpose their space away from retail and one of the growth areas for the use of space is leisure – see the growth of competitive socialising and activity concepts (like the backing of Gravity by the investment fund Sculptor). Operators can take advantage of this and secure attractive deals from landlords, particularly if they can demonstrate their proposition drives footfall to the particular location that can benefit others. There may be opportunities for hospitality and leisure operators to collaborate to provide a whole site or whole area solution for landlords. 
   
   
4. When it comes to refinancing, beware of the risks involved, especially as debt has become less predictable and more expensive. Any refinancing will require careful planning, and there should be a focus on having and exploring multiple options when it comes to this process. Don’t just assume that you will be able to get the same level of debt as the last time you refinanced, and you should expect to have to explore broader sources of debt finance from banks to credit funds to make sure you can be successful.

Returning to football cliches, we anticipate another year of two halves, with the first half seeing an emergence from generationally high levels of inflation to more stable levels and the second likely to see transactions being completed in a more stable environment.

We are already seeing processes starting to spool up to take advantage of this increasing stability. As the market turns and the outlook brightens, fortune should favour the brave. In the end, investors committed to the sector will want to move fast and avoid missing out on the early recovery bounce. The question then will be: Are you in the right position to take advantage?

This article was first published in Propel.