Analysis: Burger King sale may stoke restaurant deals

LOS ANGELES Mon Sep 6, 2010 8:45am EDT

A meal is pictured at a Burger King at a restaurant in Annandale, VA, August 24, 2010. REUTERS/Kevin Lamarque

A meal is pictured at a Burger King at a restaurant in Annandale, VA, August 24, 2010.

Credit: Reuters/Kevin Lamarque

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LOS ANGELES (Reuters) - Burger King Holdings Inc's BKC.N $3.26 billion buyout by investment firm 3G Capital may be the first in a new flurry of restaurant deals, with private equity firms hungry for high cash flow and low valuations.

Private equity firms are sitting on mountains of cash after raising bumper funds before the credit crisis, and they are still trying to invest that money.

Restaurants are prime targets. Some company valuations are low, most generate a lot of cash, and chains that have a high percentage of their units owned by franchisees have low capital requirements.

"It potentially could be the first of several transactions in the restaurant space," Morningstar analyst R.J. Hottovy said. "Private equity funds are sitting on a lot of undeployed capital at this point. This activity probably means good things for more acquisitions."

Diners have cut back on meals away from home amid high U.S. unemployment and a fumbling economic recovery. That has depressed sales and share prices at some restaurant chains, lowering potential sale prices and creating an opportunity for a buyer to profit when the economy recovers.

In July, Apollo Management bought Carl's Jr and Hardee's parent, CKE Restaurants Inc, for $694 million. Golden Gate Capital acquired On the Border Mexican Grill & Cantina from Brinker International Inc (EAT.N) for about $180 million.

In August, Mill Road Capital took Rubio's Restaurants private in a $91 million deal, and Kelso & Co agreed to buy Logan's Roadhouse. No terms were disclosed.

The recent mergers and acquisitions interest could help California Pizza Kitchen CPKI.O, which has announced its desire to sell, find a suitor.

If the stocks of companies with strong cash flows remain under pressure, "You may see more transactions," said Telsey Advisory Group analyst Tom Forte. He named Chili's Grill & Bar owner Brinker and its rival Ruby Tuesday (RT.N) as "attractive candidates for private equity".

Ruby Tuesday and Brinker each have valuations that are below their peer group.

Stifel Nicolaus analyst Steve West added pizza chain Papa John's International Inc (PZZA.O), and fast-food operators Jack in the Box Inc (JACK.O) and Sonic Corp (SONC.O) to the list of potential candidates.

Upscale steakhouse chain Morton's Restaurant Group MRT.N, juice seller Jamba (JMBA.O) and barbecue joint Famous Dave's of America (DAVE.O) have been the subject to takeover rumors on Wall Street.

And, with investors' recent hunger for hamburger chains, there also is speculation swirling around Red Robin Gourmet Burgers (RRGB.O).

MORE WHOPPERS IN THE WORKS?

With a value of about $4 billion including debt, the Burger King/3G deal is the industry's biggest since Arby's owner Triarc bought Wendy's for $2 billion in September 2008. More importantly, the deal set a new bar for valuation at almost nine times cash flow over the last 12 months.

"We think further signs of buyout activity could support group multiples in the near term, as private equity firms seemingly have a strong appetite for deals," R.W. Baird analyst David Tarantino said in a client note.

Tarantino said the Burger King deal highlighted the value of several restaurants he covers, including Buffalo Wild Wings (BWLD.O), Panera Bread Co (PNRA.O), Cheesecake Factory (CAKE.O), P.F. Chang's China Bistro PFCB.O, Texas Roadhouse (TXRH.O) and California Pizza Kitchen.

As of August 31, before the Burger King/3G deal was announced, there were $128 billion of private equity-backed deals worldwide, a 165 percent increase on the same period the previous year, according to Thomson Reuters data.

That represents 8 percent of the total volume mergers and acquisitions, higher than last year's 4 percent, but still far lower than around 20 percent during the M&A boom in 2006 and 2007.

"Burger King is probably as big as we're going to see at this point," Hottovy said. Private equity still does not have an appetite for the mega deals seen in the boom, he said.

Nevertheless, Wendy's/Arby's Group WEN.N Chairman Nelson Peltz said in June that an unnamed party had expressed interest in a potential deal involving the fast-food company. It is not known if that party was 3G Capital.

"Wendy's/Arby's looks cheap (from a stock perspective), and you have a management team that is obviously willing to explore M&A activity," Hottovy said.

(Additional reporting by Megan Davies in New York; Editing by Ilaina Jonas)

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