RBC Capital Markets, LLC Christopher Carril (Analyst) (617) 725-2109 [email protected] November 10, 2020 Restaurants: Updating Our Thoughts on M&A In light of the recently announced deal for DNKN to be acquired by Inspire Brands, in this note we take a look at recent trends in restaurant M&A, and what it means for the companies in our coverage. Is the DNKN deal a sign of things to come? Restaurants have been an active space for M&A—we EQUITY RESEARCH estimate that approximately 40% of the top 100 largest brands in the US have changed ownership over the last ten years—and we expect this trend to continue. Restaurants make attractive acquisition targets, particularly single brand, asset-light "all-franchised" companies able to generate significant free cash flow (e.g. DNKN w/near-100% FCF conversion). Additionally, this year's pandemic has also highlighted the resilience of fast food models, and especially those featuring significant drive-thru or delivery/carryout mix (conversely, over 80% of recent large chain bankruptcies are in the full service segment). However, the bargain hunting window has largely closed, with average valuations of single brand companies back to (or above) pre-COVID levels. But holding this aside, we expect the attractive qualities of restaurants to continue to draw the interest of potential acquirers, setting the stage for continued M&A activity. Thinking through the universe of potential acquirers: We expect private equity to remain active participants in restaurant M&A given the reasons cited above, and driven by substantial available dry powder. Notably, the large, privately held multi-brand owners (e.g. Inspire Brands, JAB Holding, Focus Brands) have been quite active in recent years, taking six public restaurant companies private since 2016, in some of the largest deals in the space. From our perspective, we are also interested in what a potential acceleration in M&A activity would mean for the public multi-brand owners in our own coverage (YUM, QSR, DRI). We believe that as opportunities arise and business conditions improve, these companies will continue to execute against their respective strategies, which includes adding brands through M&A and leveraging their scale advantages (to corporate overhead, marketing, development, etc.). However, we would note that the public platforms may not necessarily be in a hurry to add more brands to their portfolios, given: 1) opportunities remain in each of these portfolios for further improvement/upside (e.g. QSR's Tim Hortons); 2) substantial longer-term opportunities to gain share for existing brands, given the significant disruption in the industry (which we've previously written about with our RBC Consumer colleagues here); and 3) elevated—but not significantly higher—leverage currently carried by these companies versus historical levels, which may lead to prioritization of debt reduction over M&A, at least in the near-term. It's important to highlight that M&A in restaurants is not necessarily limited to acquisitions of other restaurant brands. One possible avenue for M&A is a company acquiring its own brand's franchised restaurants. Notable examples of this have been completed by EAT, which has acquired nearly 20% of the Chili's domestic system in recent years via transactions with franchisees. We have also seen some of the larger companies in our coverage make acquisitions of tech companies. Examples of this include MCD's acquisition of Dynamic Yield (personalization and decision logic technology) for ~$300M in early 2019, followed by its purchase of Apprente (voice technology) later that same year. In the case of MCD, which boasts global system sales of >$100B, the acquisition of another mostly-franchised brand would result in—in the majority of cases—relatively little impact to the bottom line, while ROI on tech that potentially drive higher same store sales and unit volumes could be more attractive. Finally, we would note that M&A need not be transformational in nature. The most recent example of this was YUM's acquisition of Habit Burger, which represents <1% of YUM's total global footprint. Priced as of prior trading day's market close, EST (unless otherwise noted). Disseminated: Nov 10, 2020 00:45ET; Produced: Nov 10, 2020 00:31ET All values in USD unless otherwise noted. For Required Conflicts Disclosures, see Page 12. Restaurants: Updating Our Thoughts on M&A How We Are Thinking About M&A Moving Forward Restaurants have been an active space for M&A, and we expect this trend to continue. This is highlighted by our estimate that approximately 40% of the top 100 largest brands in the US have changed ownership over the last ten years (see Appendix for more detail on the industry’s largest brands, both public and private, including ownership detail). Restaurants make attractive acquisition targets, particularly single brand, asset-light "all-franchised" companies able to generate significant free cash flow (e.g. DNKN w/near-100% FCF conversion). Additionally, 2020's pandemic has also highlighted the resilience of fast food models, in particular, that feature significant drive-thru or delivery/carryout mix (conversely >80% of recent large chain bankruptcies are in the full service segment). In our view, the most likely restaurant M&A targets are companies that own or operate a single brand, and especially those in fast food. This has largely been the case for acquisitions of publicly-owned restaurant brands in recent years—see Exhibit 1 below. In examining other elements across these deals—deal size, strategic vs. financial buyer, category/segment, etc.— there are generally few identifiable shared characteristics across most deals involving publicly- owned companies. Exhibit 1: Transaction Detail for Recent Take-Private Deals Valuation Announced Deal Size (EV/LTM Date Target Acquirer (EV, $M) EBITDA) May-16 Krispy Kreme JAB Holding Company 1,264 18x January-17 Bob Evans Golden Gate Capital 615 7x February-17 Popeyes Louisiana Kitchen Restaurant Brands International 1,736 21x April-17 Panera Bread JAB Holding Company 7,486 18x October-17 Ruby Tuesday NRD Capital Management 312 9x November-17 Buffalo Wild Wings Arby's/Inspire Brands (Roark Capital) 2,810 11x December-17 Qdoba Apollo Global Management 305 6x February-18 Fogo de Chao Rhone Capital 545 10x March-18 Bravo Brio Spice Private Equity 100 4x August-18 Jamba Focus Brands (Roark Capital) 195 14x August-18 Zoes Kitchen Cava Group 295 15x September-18 Sonic Inspire Brands (Roark Capital) 2,214 16x November-18 Bojangles Durational Capital / The Jordan Company 716 11x April-19 Papa Murphy's MTY Food Group 197 10x January-20 Habit Burger Yum! Brands 375 9x October-20 Dunkin' Brands Inspire Brands (Roark Capital) 11,494 25x Full Service Average 876 8x Fast Food / Fast Casual Average 2,389 15x >$1.5B Deal Size Average 5,148 18x Total Average 1,916 13x Source: FactSet, company reports, press reports November 10, 2020 2 Restaurants: Updating Our Thoughts on M&A Investors have also generally viewed potential category gaps in multi-brand operator portfolios as a way of screening for potential M&A targets: for example, QSR does not own a pizza brand, therefore the category could be a targeted focus for the company. However, we would highlight that there are examples of brand aggregators that have focused on building a portfolio around one or two categories, including JAB’s Pret Panera portfolio—see Exhibit 2 below for more detail on category focus across the various public and private restaurant platforms. Exhibit 2: Multi-Brand Operator Brand/Category Map Public Private Restaurant Inspire Focus Pret Panera Krispy Kreme Brands Yum! Darden Bloomin' Brands Brands Holding (JAB (JAB Category International Brands Restaurants Brands (Roark Capital) (Roark Capital) Holding Co.) Holding Co.) Habit Burger Burger Burger King Sonic Drive-In Grill Pizza Pizza Hut Coffee / Dunkin' Caribou Coffee, Tim Hortons Krispy Kreme Café (Deal Announced) Espresso House Sandwich / Arby's, McAlister's Deli, Pret A Manger, Bakery Jimmy John's Schlotzsky's Panera Bread Popeyes Chicken KFC Louisiana Kitchen Moe's Southwest Fast Food / Fast Casual / Fast Food Fast Mexican Taco Bell Grill Frozen Baskin-Robbins Carvel Desserts (Deal Announced) Auntie Anne's, Other Bagel Brands Insomnia Cookies Cinnabon, Jamba Italian / Olive Garden Carrabba's Pizza LongHorn Outback Steak Steakhouse Steakhouse Cheddar's, Varied Yard House, Menu Bahama Breeze, Seasons 52 Casual Dining Casual Buffalo Wild Sports Bar Wings Seafood Bonefish Grill The Capital Fleming's Prime Steak Grille Steakhouse Seafood Eddie V's Fine Dining Source: Company reports November 10, 2020 3 Restaurants: Updating Our Thoughts on M&A It is also important to recognize that the consideration set does not necessarily end with publicly traded brands. Among the 100 largest domestic restaurant brands (by total US system sales), 58 of those brands are privately held and together represent nearly 20% of the restaurant industry’s total sales. Given the significant representation by privately held brands across the restaurant industry (including those owned by private equity), we feel it is worth highlighting that the list of potential targets is far larger than just the publicly traded brands. For more detail on the largest brands—both public and private—including ownership detail, please refer to the Appendix of this report. Exhibit 3: Restaurant Industry Sales Mix by Size of Brands (US, 2020E) While much attention is paid to the public brands as potential M&A targets, we note that large private brands make up a meaningful portion of the 42 Public industry Ex-Top 100 Top 100 Brands in Top 100 Brands Brands 58 Private ($158B) ($228B) ($248B) Brands in Top 100 ($89B) Source: Technomic Regarding valuation, we would highlight that the bargain-hunting window following initial pandemic-related valuation drawdowns has now largely closed.