It may be a wistful mistake to look back at the start of this year, but entering 2020, there were plenty of predictions (from myself included) stating that the sector was looking forward to a period of stability after more than three years dealing with the uncertainty Brexit had thrown up. There was even a feeling that the pent-up investment demand generated through those years was set to be unleashed, resulting in a relatively buoyant period for M&A. There were a number of businesses set to come to market and, more importantly, set themselves up for their next phase of growth under new ownership. Of course, the outbreak and continuing impact of Covid-19 has radically changed that picture.
However, despite the headwinds, there remains a desire among investors to seek out new deals and take advantage of the dislocation in the market. Over the past few months, there have been many examples to highlight that there are still funds out there interested in the hospitality sector and are willing to take a risk at the right price; from the new backers of Azzurri Group and The Big Table, to Byron and Cote. Of course, that price takes into account the need to fund a war chest to cover the cash they may need to spend between now and when we might get back to more normalised trading levels, including the need to cover the risk of further lockdowns.
The hallmark of the transactions that have completed to date is that these businesses were unable to solvently deal with the liabilities that had built up over the pandemic, meaning they were effectively forced sellers. Whilst many companies still face these challenges – and we expect to see further deals of this type, particularly in the wet-led or late-night sector – some businesses are beginning to see light at the end of the tunnel and are planning for the future.
Given the current environment, any deals of this type will likely have to incorporate some earn-out structure over a period of time to reflect the fact that historical EBITDA right now is not reflective of the underlying earning potential of the business. It is also not yet clear when trading will return to pre-pandemic levels. This enables buyers to offset some risk but also enables a seller to realise value at a time when the market is uncertain.
If valuation can be agreed, then the focus can shift to what needs to be invested to ensure the business is in the right shape. What does the business want to do – what is the ambition? Is there opportunity to strengthen its position in the market and capitalise when we emerge through the crisis. Might it look at the opportunity to go down the expansion route because competitors are going to be weaker? Landlords will likely be desperate to get anybody in their sites who is willing to pay some form of rent so there is opportunity for those agreements to be more flexible and lower than they were, which can also add to the positive deal dynamics for all parties. These are uncertain times but I am sure some will look it as a great opportunity to expand, take the listing of Hugh Osmond’s Various Eateries for example – a vehicle specifically set up to take advantage of the current buying conditions in the market.
A lot will depend on what part of the sector you are focusing on. New restrictions and the threat of further lockdowns mean that investors will need to understand the potential impact of these on the business model. Stronger trading in earlier day parts will be looked on more favourably. It will depend on the individual business and its key drivers, with some more impacted by a late-night curfew than others. The closer you get to late-night or vertical drinking it is a more difficult market, especially given some are still without a reopening date.
With government support starting to taper off, further insolvency and CVA activity is likely. Cash remains king and operators will continue to seek ways to run as efficiently as they can. What will life look like when the furlough scheme ends later this month? Businesses will be leaner, with support functions and head offices resized. Everyone should now have a view across how many people they need to operate their business and these new structures and operating models will inevitably lead to permanent job losses.
What will be worrying management teams is the impact on consumer confidence from government messaging and restrictions and the long-term impact of the reintroduced work-from-home message on those over-indexed in city centres. Our Market Recovery Monitor, produced with CGA Insights, shows cities lagging behind on openings. Our view remains that if sites aren’t open by the end of this month then they are unlikely to reopen at all under their current ownership unless they are part of a larger group.
The sector is steeling itself for tough times ahead as we head into the autumn and winter months. Those that have taken on additional debt to survive this crisis will have a focus on how quickly profits can recover in order to pay this back and return to shareholder value. Of course, there is pain to come but the net result will be a set of leaner and more agile companies; those that tackle the coming period with pragmatism and innovation will be in the best position to emerge on the other side and take advantage of the growth opportunities that arise.