Vice President: Ivan Petkov
Associate: Riccardo Vittorio Perego
Analysts: Adam Hrehovcik, Leonardo Mottareale, Rhea Bhasin, Simon Sandewall
Introduction
In a momentous deal for the fast-food industry, Roark Capital agreed to buy the historically family-owned Subway, valuing the sandwich chain at around $9.55 billion including debt (subject to performance conditions). The deal was finalised at an auction, and an earn-out agreement was crucial in helping Roark outcompete buyout firms TDR Capital and Sycamore Partners, who offered $8.75 billion including earn-out. Considering that Subway’s owning families – DeLuca and Buck – were looking to garner $10 billion for Subway, Roark’s offer seemed closest to their aspiration.
The deal is structured such that full deal price will be paid conditionally on Subway’s cash flow hitting pre-decided targets over the following two or more years. Roark will also pay Subway’s owners a break-up fee of 4% if antitrust regulators disallow the acquisition. Speculatively, the sale of Subway stems from tax-shielding considerations, as co-founder Peter Buck had donated 50% of his stake in Subway to his philanthropic foundation through will.
Interestingly, Roark, a private equity firm with $37 billion in assets under management, holds a powerful food portfolio, with Subway being a tactical addition. The firm’s portfolio includes Arby’s, Auntie Anne’s, Buffalo Wild Wings, Baskin Robbins, Carvel, Sonic and several other well-known brands. Roark also owns rival sandwich chain Jimmy John’s, which has over 2,600 stores in 43 states in the USA. The addition of Subway to this portfolio is well-thought out. Subway’s intrinsic value as a recognised brand with over 37,000 restaurants in over 100 countries, combined with Roark’s expertise in the food space make for a synergistically healthy acquisition.
Subway in its sale announcement boasted a 10th consecutive quarter of positive same store sales. However, this does not reflect well the US food market, which “remains well below the peak it hit a few years ago.” Subway has shut down thousands of stores since 2016, and is struggling with losing market share in the face of rising competition in an already saturated market.
Overall, it is evident through both deal structure and value that Roark has considered the risk of acquiring a player as large and powerful as Subway.
Rationale
Roark Capital is strengthening its presence in the fast-food restaurant industry by the acquisition of Subway. Considering its existing stakes in restaurant chains, this acquisition is a clear indication that Roark Capital sees high potential in franchise based fast-food restaurants and is perhaps looking for some synergistic effects to increase the value of their investments. With its 37 000 outlets (NPR, 2023) and a substantial slice of the food service industry, Roark capital will gain access to practically the whole world, although a significant proportion of restaurants is concentrated in US and Canada. According to Subway CEO John Chidsey global expansion and restaurant modernisation will continue under the ownership of Roark (NPR, 2023). Roark’s extensive experience in the food service industry makes them well positioned to support Subway with these initiatives. Roark Capital will probably be aiming to extract untapped potential in regions of Southeast Asia, South America or large African economies such as Nigeria or Kenya. Planned international expansion would help Subway grow and diversify its revenue and gain competitive advantage by establishing its brand in new markets before its competitors. The initiative of restaurant modernisation could be a part of larger brand revitalisation to boost consumer demand for Subway products in markets where the brand is already established. The brand rejuvenation could comprise menu innovation, customer experience enhancement, digital transformation, as well as the aforementioned store modernisation. Subway could also benefit from synergies with Roark’s other investments in the form of cross-promotion with other brands or supply chain innovation through joint negotiations and resource pooling. Additionally, Roark may be able to apply some of the best operational practices from other companies to Subway to improve its operational processes.
Industry analysis
The global fast-food market was valued at $731.65bn in 2022 (Straits Research, 2022). This market is also projected to reach the size of $1087.31bn by 2031, implying a CAGR of 4.5% (Straits Research, 2022) during the forecast period. One of the key drivers of the growth is the fast paced lifestyle which also affects consumer’s eating habits with more and more emphasis being placed on efficiency and convenience. However, there is also a drawback of health concerns that could slow down the industry growth. Fast food meals often have elevated levels of calories, unhealthy fats, added sugars, and large amounts of sodium, which can cause health issues such as obesity, heart disease, high blood pressure, and digestive problems. It is, therefore, reasonable to assume that awareness of these risks will act as a restraint to the expansion of the global market.
The key trends in the current fast-food industry are healthy fast-food options but also offerings of vegan, vegetarian, and organic food options. Although the success of the alternative food items varies a lot based on specific company and specific product, the majority of consumers view this trend as a positive. The focus on health is becoming increasingly popular especially in Europe and North America, meaning that thriving in these regions will require successful implementation of healthier and plant-based food items. This is also an area in which Subway may be lacking behind its competitors.
Another vital trend is digital transformation. The technology is reshaping the industry through online ordering, mobile apps, and delivery services - integral to customer convenience. The technology also enables a larger degree of personalisation which can take the form of customising a meal in an app, or offer recommendations based on previous orders. Personalisation can thus lead to better customer experience and encourage repeat business.
Source: Maximise Market Research, 2022
Geographically, regions with the largest fast-food market growth are expected to be Asia-Pacific, currently making up only 11% of the global market. The phenomena of rapid urbanisation, changing lifestyles, and a growing middle class are predicted to lead to increased demand for convenient meals (Maximise Market Research, 2022). However, the region has strong cultural preferences which require global companies to adjust the offerings to the local demand. Global firms such as Subway also face strong competition by local players.
Europe and North America make up 74% of the global market and share very similar consumer habits. The current trend among consumers is to seek high-quality ingredients, gourmet choices, and a strong commitment to sustainability. Another important aspect in these markets are regulatory pressures regarding ingredient sourcing, nutritional labelling, and marketing to children which have continuously affected the menu composition and marketing strategies.
South America, with 7% market share, presents a mix of opportunities and challenges for the fast-food industry. Regional players are gaining popularity because of their localised offerings, even though international chains are still experiencing growth. While economic fluctuations can impact consumer spending, the appeal of fast food's convenience remains strong in this region.
The Middle East and Africa have exhibited a burgeoning interest in international fast-food brands. The proliferation of urbanisation, expansion of the youth population, and the aspiration for Western-style dining experiences are the prime drivers of growth. A successful penetration of these markets by large international brands may, however, depend on the ability to create halal offerings and menu customisation to align with dietary preferences in these regions.
Financial Analysis
The following table lists the assumptions that were made for the LBO model. Additionally, since Subway is a privately held company, the only available financial information was the EBITDA, Revenue, and EBITDA multiple. Hence, the line items used in the model were primarily derived from industry averages given by NYU Stern.
The Revenue growth assumption was derived by taking into account a 4.3% expected CAGR of the global fast-food industry between 2021 and 2029 (Grand View Research). Even though Subway’s sales in the US were in decline from 2015 to 2021 (Statista), our core assumption is that Roark’s growth strategy will be up to pace with the industry average.
The deal is 52.08% financed by debt, which is in line with the increase in the cost of borrowing. Additionally, with the relatively low profit margins of Subway, an increase in the interest expense could have a significant adverse effect on the growth goals of the company.
Using these assumptions, our LBO model implies a 23.86% internal rate of return (IRR), which is significantly higher than the average annual market return of 12.39% for the last 10 years (SoFi, 2023). It is, however, important to note that the IRR is highly sensitive to exit multiple variations, so even a small drop in it would significantly decrease the IRR of this investment.
Risks and Prospects
The acquisition presents both risks and prospects for Roark. The acquisition will enable Roark Capital to diversify its portfolio, introducing a globally recognised brand with a substantial international footprint. Subway’s extensive reach offers the opportunity to expand into untapped markets and the potential of revitalizing the brand in areas where it may have underperformed. Furthermore, Roark’s experience in the restaurant industry is elucidated in its ownership of other successful chains like Jimmy John’s and Arby’s could prove invaluable in steering Subway towards renewed growth and profitability. As a major player in the industry, Roark's decision to add Subway to its stable of brands further validates the enduring appeal of restaurant investments. However, it also highlights the intensifying competition among private equity firms to secure deals in this sector, potentially driving up acquisition prices.
However, the deal also carries inherent risks. Subway's dependence on an earn-out structure, where the total purchase price is contingent on future financial performance, introduces uncertainty. Roark must ensure that Subway achieves the required milestones to realize the full $9.55 billion value, which could be challenging given potential market saturation and competition concerns. Furthermore, managing the transition and integration of Subway into Roark's portfolio of restaurant brands will demand careful execution to maintain Subway's identity and customer loyalty. Looking at the restaurant sector, any struggles in revitalizing Subway could serve as a cautionary tale for investors, emphasizing the importance of thorough due diligence and effective post-acquisition management. Finally, as current excess savings are trending towards 0, this may pose a short-term risk to Roark from the potential decrease in consumption from consumers. Roark’s overexposure to the restaurant sector is indicative of the value-creation opportunities there, but may backfire. Overall, while this acquisition holds the potential to bolster Roark's restaurant portfolio and enhance its market presence, achieving the deal's full value hinges on overcoming these challenges.
Conclusion
In conclusion, Roark Capital's acquisition of Subway represents a significant milestone in the restaurant industry. This deal encapsulates the dual nature of such transactions, with promising prospects for revitalizing a globally recognized brand but also substantial risks tied to performance targets and market dynamics. While Subway's recent positive same store sales are promising, it's imperative to acknowledge the challenges facing the broader U.S. food market. With thousands of store closures since 2016, Subway confronts heightened competition in an already saturated market. Leveraging its extensive experience in the restaurant sector and a dedicated commitment to fostering brand growth, Roark emerges as a pivotal player in Subway's potential resurgence. Beyond this specific deal, the industry-wide implications of this acquisition resonate deeply, setting a precedent for how private equity firms strategically navigate the evolving landscape of restaurant investments. As the deal unfolds, it will provide valuable insights into the ability of established brands to adapt and thrive in today's competitive market, offering lessons for both investors and the wider business community. Ultimately, the success of the Roark-Subway partnership will hinge on the firm's strategic vision and execution in unlocking Subway's full potential.
References
Fast food market: Global industry analysis and forecast (2023-2029) (2023) MAXIMIZE MARKET RESEARCH. Available at: https://www.maximizemarketresearch.com/market-report/global-fast-food-market/28718/ (Accessed: 03 September 2023).
Research, S. (no date) Fast Food Market Size, growth, trends and forecast to 2031., Straits Research. Available at: https://straitsresearch.com/report/fast-food-market (Accessed: 03 September 2023).
Press, T.A. (2023) Sandwich chain subway will be sold to fast-food investor Roark Capital, NPR. Available at: https://www.npr.org/2023/08/24/1195845260/sandwich-chain-subway-will-be-sold-to-fast-food-investor-roark-capital (Accessed: 03 September 2023).
Charlebois, S. (2023) Analyzing Roark capital’s risky venture to resurrect fast food icon subway [op-ed], Retail Insider. Available at: https://retail-insider.com/retail-insider/2023/08/analyzing-roark-capitals-risky-venture-to-resurrect-fast-food-icon-subway-op-ed/ (Accessed: 03 September 2023).
Portfolio companies (no date) Roark. Available at: https://www.roarkcapital.com/portfolio#s2_Restaurant_and_Food (Accessed: 03 September 2023).
Restaurant Dive. (2023). What Roark deal means for Subway franchisees. [online] Available at: https://www.restaurantdive.com/news/subway-franchisees-may-benefit-from-roark-deal-impact/692434/
Summerville, A., Sen, A., Sophia, D.M., Summerville, A. and Sen, A. (2023). Sandwich chain Subway to sell itself for $9.55 bln to Roark Capital - sources. Reuters. [online] 24 Aug. Available at: https://www.reuters.com/markets/deals/sandwich-chain-subway-agrees-sell-itself-roark-capital-2023-08-24/
Subway/Roark: PE firm adds sandwiches to the menu. (2023). Financial Times. [online] 24 Aug. Available at: https://www.ft.com/content/6ddc0332-7f46-4ebd-9eb5-34cf254bc88b
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