Restaurant biz a tough game for PE players

Private equity participation is fairly robust in India’s eating out sector with Burger King's India foray in-partnership with PE firm Everstone Capital the latest to grab headlines

But as CNBC-TV18’s Farah Bookwala reports, there is a growing chorus in PE circles that the restaurant business is not palatable enough, given the tough operating environment and modest returns.
PEs seek a 3-4x return or a 25 percent Internal Rate of Return (IRR) from their investments in this space. But this has been hard to achieve due to reasons like tough economic climate, changing consumer palette, and high cost of operations. Let's look at a few case studies.
SAIF capital has a 10.64 percent stake in Speciality Restaurants, which runs Mainland China and Oh Calcutta! chain of restaurants.
Sources say, SAIF is looking to offload its stake as it had remained invested since December 2007. But given Speciality's current market capitalisation of Rs 515 crore, a stake sale today would fetch SAIF an IRR of only 8-10 percent on its 6-year long investment.
When TVS Capital invested Rs 50 crore in 2010 in Om Pizzas - which runs the Papa John’s pizza franchise - for a 47.6 percent stake, the company was valued at Rs 105 crore.
In 2012, when TVS Capital bought an additional 15 percent stake for Rs 10 crore, the valuation slipped to only Rs 67 crore. The revenue multiple slipped from 4.6 times to 1.6 times too.
Now, TVS Capital says it is looking to exit Om Pizzas within a week. It claims that the QSR format requires high level of execution, has lower ticket sizes and managing the supply chain and logistics is a tough job.
TVS says the biggest learning is that PEs have to choose the format that will yield the highest returns in the shortest span.
Gopal Srinivasan, founder chairman and MD, TVS capital says “We do not want cuisine risk. So we back global franchise formats where supply chain is derisked and we like high ticket sizes per restaurant so that we can stay for a shorter period of time. Even with a smaller investment, we can make more revenues and then hand it over to the next investor or promoter group that wants to acquire it.”
 
That’s why TVS considers the casual dining format 'Chilis' it invested in a successful bet. TVS claims ‘Chilis’ generates revenues of Rs 6-10 crore per restaurant because of the affluent set of customers it can attract, for whom eating out is a small fraction of their wallet.
 
PEs also say that the cycle of investment in the restaurant space is a challenge as this is a long-stay industry. While fund houses look to exit investments in 4-6 years, a restaurant takes 6-9 years to complete one business cycle.
 
Srinivasan says “It’s a very long stay industry. You have to be able to stay for 6-9 years because the first 2-3 years is all about taking each region and proving yourself. Next 2-3 years is about building scale and building brand awareness through broadcast media. So, you have to stay for the entire cycle to be able to get returns on your dollars.”
 
Further, PEs say the requirement for collateral to finance debt is also a challenge as most promoters do not own their restaurant premises but instead take them up on lease. Neither do they have other assets to pledge.
“India is very obsessed with asset-based debt cover. But this is a huge challenge to the service industry. We must move to the system of financing future expected cash flows,” says Srinivasan.