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Private Equity Firm LNK Partners & Bakery-Café Chain Au Bon Pain

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Private Equity Firm LNK Partners & Bakery-Café Chain Au Bon Pain LNK Investor Brief, May 27, 2015 UNITE HERE Analyst: Brooks Bitterman, Ph.D. [email protected] (212) 332-9335 Private Equity Firm LNK Partners & Bakery-Café chain Au Bon Pain Given Au Bon Pain’s underperformance, has LNK Partners valued it properly for limited partners? I. Au Bon Pain’s performance under LNK’s ownership and its implications LNK Partners is a private equity firm with $763 million in assets under management in two funds.1 In 2008, LNK acquired a majority stake in the Boston-based Au Bon Pain bakery-café chain. This report investigates Au Bon Pain’s performance during LNK’s ownership and raises questions about LNK’s valuation of Au Bon Pain. Based largely on data on the “bakery-café”2 segment from Nations Restaurant News, the leading trade publication for the restaurant industry, we found that Au Bon Pain’s growth lagged behind its competitors in several key growth indicators. As we show in this report, between fiscal years 2008 and 2013, as compared with the five largest Bakery-Café chains:3 • Au Bon Pain lost the most market share in the U.S.; • Au Bon Pain ranked last in U.S. unit growth and expansion; • Au Bon Pain ranked last in growth of U.S. systemwide sales.6 Corner Bakery’s U.S. system- wide sales grew at more than 4 times the Compound Annual Growth Rate (CAGR) of Au Bon Pain, and Panera’s at over 9 times the rate of Au Bon Pain. • Au Bon Pain’s sales per café (U.S.) remained relatively flat at approximately $1.7 million, while Panera’s grew from around $1.6 million to over $2.5 million. Moreover, while Au Bon Pain’s performance has lagged, competition in the bakery-café segment has continued to heat up. Panera has now captured over 65% of the bakery-café segment’s U.S. systemwide sales. Au Bon Pain, which is present in certain geographic markets and venues (e.g., hospitals and train stations), is seeing new competitors expanding or potentially expanding into those areas. In addition to Panera, these include more established operators like Corner Bakery, Einstein Bros., La Madeleine, Le Pain Quotidien, Pret a Manger, Cosi, Potbelly Sandwich, Hale and Hearty, Tossed, Chopt, and others. Newer competitors include companies like Sweet Green, Freshii, Lyfe Kitchen, and others. Finally, other fast-casual companies, and even fast-food restaurants, are changing in ways that compete with Au Bon Pain and the bakery-café segment, while coffee segment operators, including Starbucks and Dunkin Donuts, are also transitioning to offer more bakery-café food. LNK Partners In March 2015, LNK committed capital to a minority investment in Life Time Fitness,5 a third investment of LNK Partners II, its most recently raised fund.6 The capital committed comes out of LNK Partners II’s $236 million of dry powder (capital committed to the fund that has not yet been invested) available before the investment.7 LNK typically invests up to $150 million of equity per transaction.8 LNK will need to raise a new fund by the time its current fund’s capital is committed in order to continue its investing activity. Given its recent investment in Life Time Fitness, LNK may go to market to raise a new middle market buyout fund in the coming months. LNK’s Performance Record a) LNK Partners II LNK’s performance record has been mixed. Preqin is an established source for evaluating private equity performance. According to Preqin data, the manager’s most recent fund, LNK Partners II, had underperformed the majority of its peers as of June 2014.9 According to Preqin, LNK Partners II had generated a 3.4% Internal Rate of Return (IRR), far lower than the 12.3% benchmark IRR. b) LNK Partners I LNK’s 2006 vintage buyout fund, LNK Partners I, looks stronger, with an 11.3% IRR and 1.57x multiple as of mid-year 2014. Yet around a third of that multiple had not been returned to investors. Bakery-café operator Au Bon Pain Corp., a majority stake of which was acquired by LNK in 2008,10 represents a majority of the remaining assets under management in LNK Partners I, raised in 200611. LNK Partners I has performed in line with peers so far, but continues to hold Au Bon Pain. According to Preqin, LNK Partners I had achieved an IRR of 11.3% compared to the 9.6% benchmark IRR. However, its success has been reliant not on buyouts but on an insider minority stake of stock in Phillips Van Heusen (PVH), which LNK quickly exited after 2 years and 8 months for a net multiple of 2.01. Bruce Klatsky, a founding partner of LNK, was the CEO and Chairman of the Board of Philips Van Heusen from 1993 to 2007. Unlike PVH, LNK has held Au Bon Pain for over seven 2 years, with lagging growth in U.S. locations and U.S. revenue as compared to peers, while collecting an annual management fee that is generally 2% per year of invested capital.12 LNK and Au Bon Pain Private equity typically seeks to either expand restaurant chains or to increase sales at each location through innovations in offerings, branding, culture, etc. After LNK made its investment in Au Bon Pain in 2008, Susan Morelli13 remained President/CEO, a position she continues to hold today.14 Despite optimistic projections made at the time by LNK and Au Bon Pain management, Au Bon Pain’s record from the 2008 through the 2013 fiscal years, as demonstrated below, is lower growth than comparable Bakery-Cafes. This report analyzes Au Bon Pain’s unit and sales growth compared to peers in fiscal years 2008 through 2013, and asks whether the 1.57x multiple of LNK Partners I is accurate. It further asks whether LNK has sufficiently used its acquisition of Au Bon Pain to capitalize on significant growth in the bakery-café segment. Finally, it highlights headwinds for Au Bon Pain, as competition grows. As reported in Preqin’s May 2015 newsletter: Median holding periods for private equity companies have typically been between 3 and 5 years.15 Since 2008, median holding times increased to 5.9 years in 2014.16 For companies sold in 2015, however, the median holding period dropped to 5.5 years, and “the exit environment appears to be fervent with the number and total value of private equity- backed exits in 2014 reaching their highest levels on record.”17 LNK has now held Au Bon Pain for over seven years. QUESTIONS FOR LNK PARTNERS: 1. Has LNK valued Au Bon Pain and LNK Partners I correctly, given Au Bon Pain’s lagging growth under LNK Partners? 2. Was Au Bon Pain a smart investment decision for LNK Partners? 3. Why hasn’t Au Bon Pain been able to expand as rapidly as other Bakery-Cafes? 4. Why did LNK Partners not bring in new management for Au Bon Pain? 5. How will Au Bon Pain’s lagging growth, and increasing competition in its segment, affect its valuation at the time of sale, and will it impact future returns to LNK limited partners? 3 II. Au Bon Pain’s performance: market share, systemwide sales, and sales per unit Private equity limited partners investing in restaurant chains expect fund managers to make necessary changes to expand, increase revenue, and improve performance. Data from Nations Restaurant News, along with other sources, allow us to assess Au Bon Pain’s performance in fiscal years 2008, when LNK became the majority owner, through 2013. i. The Promise in 2008: “Poised for significant growth” In January 2008, as LNK and Au Bon Pain announced LNK’s purchase of a majority stake in Au Bon Pain, LNK founding partner Henry Nasella justified its expenditure: “Au Bon Pain is poised for significant growth, building on the brand’s 30 years of success in the U.S. and internationally.”18 In fact, LNK’s press release was sub-titled “Company to Accelerate Expansion of Distinctive Fast Casual Restaurant Brand.” According to Nasella, “For us, this is about management continuing to do what they’ve already proven they know how to do and the opportunity to expand the footprint domestically and internationally. It isn’t often you get to invest in a 30-year-old, well-established brand with a very strong management team that at the same time has a tremendous amount of opportunity to expand an d g row.” 19 In a March 4, 2008 article reporting the new ownership of Au Bon Pain, The New England Franchise Association reported that “[Au Bon Pain CEO Sue] Morelli said that Au Bon Pain will continue to open locations in its core markets in the Northeast, and will fill in some gaps between Chicago and the East Coast… We think there’s enough opportunity in the markets that we’re in now . .Ultimately, we can and will open in new markets contiguous to where we are.’’20 In January 2008, LNK stated that “the investment will support Au Bon Pain’s expansion strategy in the United States and in selected global markets.” Jeff Perlman, who was a Managing Director of LNK Partners on January 16, 2008 and is a current board member of ABP,21 said, “We are very excited to be backing the Au Bon Pain management team. The Au Bon Pain brand is highly recognized and uniquely positioned with a strong and differentiated consumer value proposition. Further, the company is conservatively capitalized to enable significant future growth.”22 Some ten months later, Fast Casual magazine reported that: Six months after being purchased by private-equity firm LNK Partners for $250 million, the senior-management team at Boston-based Au Bon Pain is reveling in the excitement and freedom that has come with their acquisition.
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