After two seismic years, the hospitality sector is entering recovery mode and so too is sector M&A. While bumps in the road remain, thoughts are returning to how management teams will fund future growth and provide existing investors with an exit.
It is probably fair to say that sector M&A feels like it is in a holding pattern. After the significant bump in the road of Plan B restrictions at Christmas, many in the industry are still moving up through the operational gears. Aside from a clutch of outliers, such as the acquisition of Punch late last year, and the more recent deals for Brasserie Bar Co and Inn Collection Group, it is very much a case of waiting for the dust to settle on trading levels and, also, the extent of the impact of the material cost inflation that is confronting the market.
That said, the mindset is, of course when, not if: plenty of work is going on behind the scenes, by operators and investors alike, to get themselves in a position to take advantage of the opportunities that the next 12 months and beyond will bring.
Ahead of that though, it seems reasonable to conclude that in general investors will want clarity on the trading environment, and to see a recovery that has demonstrably taken hold, before pushing any significant M&A buttons – although of course it’s possible that bullish investors may want to “jump the queue” for specific assets. Further ‘bumps’ that will drive the timing of this, aside from any further COVID variants, include the impact of April’s so-called ‘cliff edge’ when VAT is scheduled to return to 20%, headline minimum wage rates moving higher, and the rent moratorium ending. More fundamental, perhaps, is the rise in the cost of living and its impact on discretionary consumer spending, as well as the speed of the return to in-person working and its effects on sites in travel hubs and business districts.
It is fair to say that, in the face of these headwinds, work around margin, pricing elasticity, and frequency of guest visits is a material focus for management teams right now. While the first two months of the year have brought encouraging signs of pent-up demand for eating and drinking out, operators are aware of the need not to push pricing too far, acknowledging that, certainly in the short term, there may be the need to absorb some of this cost pressure so as not to inflict too much bill shock on the customer. This brings pressure on margins and profit forecasts, and those best able to navigate this complex trading landscape will be in the box seat when it comes to attracting investor interest.
Before looking at the current and future deals outlook, it is worth looking back at what trends emerged in 2021. Even though the year was another one punctuated by lockdowns and restrictions, deals were concluded across the whole spectrum of the sector.
Attractiveness of operational real estate drives pub sector activity
A key theme, and one we expect to continue, is that operational real estate has emerged once more as a highly attractive asset class, particularly for large investors looking for platforms. Launched last February, the Rooney Anand-led, Oaktree Capital-backed, RedCat Pub Company has built a circa 100-strong business, highlighting the appeal of freehold pubs as an asset class, and in its acquisition of pubs with rooms, the continued strength of the staycation market. In December, Punch was acquired by Fortress Investment Group, the US-based investor, from Patron Capital Partners for an undisclosed sum . The acquisition of a quality platform provides the opportunity for further bolt-ons, and we expect to see more of this over the course of the year.
At the same time, further new investment entered the pub sector. The likes of Urban Pubs & Bars (Davidson Kempner), Valiant Pub Company (Njord Partners) and Portobello Brewery (Zetland Capital Partners) all secured new backers last year and subsequently began building their estates or making additions to their existing portfolio. That cohort has now been joined by the Alchemy Partners-backed White Brasseries, and all will hope to make further inroads this year. Weighing on these ambitions will be the increasing competition for quality assets, with some of the larger pub companies expected to re-enter the market.
Owners of pub assets continued to churn estates to raise capital to acquire sites that fit their go-forward acquisition criteria, with buyers again particularly attracted to freehold assets. Fuelled by the sale of its tenanted arm to Punch, Young’s has seemingly got ahead of its larger rivals on this front, acquiring quality individual assets, such as the award-winning The Bull at Ditchling and, more recently, six of the seven sites owned by the highly-regarded Cotswolds-based Lucky Onion Group. The Alchemy-backed Inn Collection and the RedCat-owned Coaching Inn Group has also made a number of additions to their respective pipelines.
This activity could also be supplemented by new investors entering the market as well as consolidation plays leading to significant portfolio disposals. On the former, there is a sense that Fortress has acquired Punch to use as a vehicle to further consolidate the pub market. Funds looked last year at Marston’s and the long-term returns it can yield, and these funds will be looking for more opportunities to make their mark.
Restaurant sector could heat up following early movers in 2021
The coming year may also see the likes of Epiris, Towerbrook and Partners Group – the backers of Big Table Group, Azzurri Group, and Côte – make further inroads into the restaurant sector, although it is felt that all three would make strong returns on their investments, without the risk of adding further brands to their estates. Restaurant businesses with scalable and multi-location types, and those on-trend brands that work with delivery were also able to transact during 2021. The likes of Pho, Itsu and Leon, were able to secure new funding platforms and reignite or boost their respective expansion plans, ahead of the recovery of many of their peers.
The question for those looking to make similar moves is how easy and quick it will be to move from survival to growth mode again, and some have already started to explore the market, such as Mowgli and Hickory’s, buoyed by the trading levels experienced, post-Omicron.
Flurry of public market activity last year – will valuations support similar activity in 2022?
Public markets also acted as a conduit to transaction activity, highlighted by the continued growth of Nightcap, which acquired the likes of the Adventure Bar Group and Barrio Bars last year, and Escape Hunt’s acquisition of Boom Battle Bars for £17.4m through a share placing. It will be interesting to see whether Hostmore, the parent company of Fridays, which also listed last year, will also get the opportunity to use its new platform to pick up complementary, smaller brands. Burger King UK is expected to be first out of the blocks this year in terms of a rumoured IPO, aided by the fact the QSR has had a ‘good’ crisis, relatively. It could be followed by YO! owner, the Snowfox Group, although with its estate more now US-facing, a listing in New York could be favoured over London.
As the year progresses, the likes of Giggling Squid and Oakman Group will be keen to see how the public markets rebound and whether it does so to a level that will underline each of their mooted desires to list. If not, there will be no shortage of PE-style investors ready to talk.
It could be a busy market in the second half of 2022
A host of operators were gearing up to transact pre-COVID. Understandably, many of these plans were put on hold, but if trading continues to be robust, we would expect them to be planning to launch over the next 12 months. Timing will as always be key, but we expect to see a significant uptick in activity in Q2 and Q3 of this year as investors take a view on the impact of sector headwinds on the speed of the recovery. It remains all to play for, once the field of play settles down.
An earlier version of this article was previously published by MCA.