Greedy bankers and human nature

Pizza Express, Byron, Carluccio’s, Jamie’s Italian… It seems that many household-name chains in the UK have been struggling financially in the last few years.

Bookings for many of these places, particularly in mid-sized UK towns, used to be maxed out, persuading investors to pour more and more money in and fuelling a dizzying rate of expansion.

At one-point, major chains like Nando’s were expanding at a rate of one new restaurant opening every single week in the UK, cheerfully paying six-figure sums to prime leases.

Now, most big chains are loss-making or only just profitable, and are being forced to close stores. Byron and Jamie’s Italian closed 1/3 of their stores each in 2018. Prezzo closed 93 stores that year, and others followed suit. What happened?

I think it’s a great example of the capital cycle in action – as outlined in my book review of Capital Returns last Friday, which you can read here.

Some new and exciting restaurants open up.

They are delicious, popular and profitable.

They open up a second restaurant in another part of town, then a few more, and then a branch in each of the UK’s major cities.

Private equity (PE) firms, which borrow money to buy out businesses, see the growth and snap up the whole chain.

They proceed to do their dirty work. Corners are cut, prices are not.

Expansion is rapid now – with borrowed money paying for new sites everywhere, the market is flush with choice.

All ingredients are centrally ordered for better prices, but this means they are a day older by the time they reach the restaurants.

Portion sizes are trimmed once, twice, three times over, increasing the profit per plate, but subtly decreasing enjoyment per plate at the same time.

And suddenly, that thing which the restaurant had where a food-loving founder was striving to make the best burgers possible for a tenner, is suddenly turning out good but not great burgers for £12, not including chips, and milkshakes are £5.50 rather than £3.75.

And I haven’t been to Byron, my favourite childhood restaurant, even once in the last five years (especially livid about the £5.50 milkshakes – they tipped me over the edge).

However, the private equity firm has tripled revenues and improved margins too, so while the going’s good it flips the whole thing – now to another PE firm which will try and eke out a little more juice from this now ageing chain.

But expansion is a fickle friend.

Higher revenues and better margins may not last forever, as all over the country, the same story is repeating itself. And don’t forget, the customer experience is worse – higher prices, smaller portions and less delicious food.

Once charming and vibrant restaurants are being stretched thin, and soon every high street in the country looks the same.

And the sales per restaurant you expected to replicate suddenly aren’t there.

Not only are there plenty more options to choose from, but it turns out that thing you had – great food at reasonable prices – was quite important.

Your new offering of average burgers at slightly uncomfortable prices isn’t making customers excited to come back. Instead they’re thinking – next time let’s try some Thai.

The original success of a few small players encouraged them to expand, and encouraged outsiders to get involved in the form of private equity.

Here’s a list of restaurants and who they’re currently owned by:

Hawksmoor – Graphite Capital
Pho – Gresham House
Prezzo – TPG Capital
Yo! Sushi – Mayfair Equity Partners
TGI Fridays – Electra PE
Honest Burger, Leon – Active Partners
Cote Brasserie – BC Partners
Rosa’s Thai – Connection Capital/TriSpan
Wagamama, Frankie and Benny’s, Chiquito, Garfunkel’s – The Restaurant Group
Franco Manca, The Real Greek – Fulham Shore
Coco di Mama, ASK, Zizzi – Azzurri (of Bridgepoint)
Slug and Lettuce – Stonegate
Ed’s Easy Diner, Carluccio’s, Giraffe – Boparan Restaurant Group

While that may seem sensible – expanding when business is good – that’s not true if you overdo it while everyone is doing the exact same thing.

Higher returns on capital in the early days attract investment and expansion.

If everyone does it, then competition increases, volumes per site decline, and margins thin.

Suddenly, the UK was awash with all manner of chain restaurants, none of them seeming to make any money.

Soon they issued vouchers each meal, to encourage you to come back, but then consumers got used to vouchers and never went without one, so prices had to rise even further to account for that and now without a voucher, it’s really bad value.

And so, even before coronavirus, many were starting to go bankrupt.

Most notably in the last six months Pizza Express announced it was staring death in the face.

It was bought by a Chinese PE firm (Hony Capital) from a different, UK-based PE firm (Cinven) back in 2014, and was now paying unsustainable amounts in interest on its £1.1bn of debt.

Interest payments alone were costing the company £91m per year, and it made two years of losses in a row as a result, losing £55m in 2019 alone.

Debt-fuelled, diminishing returns

Since 2014, private equity firms have spent £10.4bn on 132 deals in the restaurant and bars sub-sector in the UK, according to data from PitchBook.

Accountancy firm UHY Hacker Young said there were more than 1,400 insolvencies in the restaurant sector between June 2018 and June 2019. That’s a 25% increase.

Source: UHY Hacker Young, via The Guardian

Private equity is not solely to blame though – because business rates (rent payments for businesses) have been rising faster than inflation since 2015. And since Brexit, the pound’s weaker status has made foreign goods more expensive, increasing costs for international restaurant cuisine.

And all that was before coronavirus hit.

Coronavirus came at the worst time. January and February are always quiet, and at the end of March, quarterly rent, often about 30% of costs for many of these businesses, fell due.

In the week before the lockdown, UK restaurants saw a 58% drop in footfall compared to the previous year, according to data from Wireless Social – a provider of analytics to the UK hospitality sector.

Carluccio’s, Byron, Chiquito, and Food & Fuel have all already sought out help from administrators. Prezzo and Café Rouge are under particular pressure, and have been for years. Azzurri, the Bridgepoint-backed group behind Zizzi and ASK Italian, is in talks with its banks to provide extra funding, as is Active Partners, which owns Honest Burgers.

“It’s a sector under some pressure. There’s been a lot of the companies struggling. They were overleveraged and there was over capacity in the market,” said an analyst who is working on the Carluccio’s administration.

According to the Financial Times, one private banker said that the coronavirus crisis will “create a drastic Darwinian environment for casual dining”.

And that’s how it goes.

High returns attract expansion and new entrants, until there is an oversupply of dining options. Private equity helps to fuel and accelerate this process, pushing it way beyond capacity, and, in fact, destroying all that was good about the once-delightful restaurants.

Overexpansion, too much competition and high levels of debt combined with a lower quality product means worse performance.

It’s almost like a game of pass the parcel, except that when the music stops you are left with a burden of debt and unsatisfied consumers, not a lovely present.

Darwinian-Schumpeterian creative destruction will ensue, and the logic of life will run its course.

Supply, as elaborated in Capital Returns fluctuates around demand, it does not track it. Undersupply leads to high returns, driving a shift to oversupply, and back again.

Perhaps, once the pandemic has done its worst and much of the competition has been swept away, restaurants in the UK may provide some nice investment opportunities again.

I’ll keep an eye on it.

Best wishes,

Kit Winder
Editor, UK Uncensored

1 Comment
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