Study uncovers souring restaurant chain valuation multiples

A recently published study by Restaurant Research, LLC highlights a disturbing trend in the restaurant industry.  The 6th Annual Restaurant Valuation Trends Industry Data Report "outlines EBITDA multiple estimates on 30 chains based on data provided by several leading appraisal firms.”  This year’s survey showed that “restaurant valuations declined to their lowest levels in four years, while cap rates continued to rise.”  Rising food and fuel costs and the tightening of credit markets makes this unlikely to change in the near future. 

The announcement of this study comes on the heels of the recently announced Chapter 7 bankruptcy filings by S&A Restaurant Corp., the parent company of restaurant chains Bennigans and Steak & Ale.  According to, the filing was the largest restaurant bankruptcy since 1997.  Though it may be tempting to lay the blame on tough economic conditions, it’s important to know that S&A Restaurant Corp.’s parent company, Metromedia, changed CEOs three times in the last three years.

While investors and venture capitalists may be lukewarm on the restaurant market right now, a recent query found that by far, more Pratt’s Stats® users were looking for transaction data relating to SIC 5812 (restaurants, non-drinking) than any other industry (BVWire #67-4 Wednesday, April 23, 2008), suggesting that this industry is still quite dynamic.  And not all necessarily in the wrong direction either.  Panera Bread, one of the companies included in the Restaurant Valuation study, announced 2nd quarter earnings of $0.55 a share on July 23rd, and beat estimates by $0.06 a share.   Whether S&A’s failure was mainly based on a difficult economic climate, or whether poor management and a weak concept was to blame for their downfall, the clear message is that the market is following the law of the jungle: Only the strong survive. 

Kevin Yeanoplos CPA/ABV, ASA (Brueggeman and Johnson Yeanoplos, P.C., Seattle, Washington), who has appraised many a restaurant, provided the BVWire with the following comments on this recent development:

"Only the strong survive" hits the nail on the head.  And without any question, we're talking about strength of management.  Some business appraisers make the mistake of focusing almost exclusively on the quantitative aspects of a restaurant, looking just at the raw numbers.  From this limited perspective, a business' value changes simply due to changes in income, EBITDA or some other measure.  They forget to consider the very important qualitative aspects of the business.  The ability or inability of management to change a company's future economic performance is arguably the most important qualitative factor that should be considered.  These qualitative factors are at least as important if not more important in determining the value of a closely-held business.

Meanwhile in the banking sector – turmoil impacts valuations

Once upon a timenot too long agobanks were considered fairly safe investments given a high level of regulatory oversight, less variance in earnings from period to period, and favorable dividends.  What’s happened?  Andrew Gibbs, CFA, CPA/ABV (Mercer Capital, Memphis, TN) analyzes the impact of earnings quality on valuation analysis in his article Bank Valuation: A Focus on Earnings Quality (originally published in Mercer Capital’s Bank Watch 2008-03).  He points out that bank stocks, as reflected in the total return for the SNL Bank Index, were down 31.3% from 1/1/07-2/29/08 compared to a decrease of 6.07% for the S&P 500 during the same period. 

Now is the time for appraisers to re-think the framework for bank valuations.  In order to address the unique challenges in bank valuations and to help canonize the thought leadership in this practice area, Andrew and William Wilhelm, CPA/ABV (Crowe Chizek, Indianapolis, IN) are hosting "Current Topics in Bank Valuation - Reflections on Industry Trends and Emerging Financial Reporting Issues"—a teleconference on Tuesday August 12 (10 a.m. PT/1 p.m. ET).  To view the complete agenda and register, please click hereyou’ll also find on the registration page, Andrew’s complete article available as a free download!

Justified hypocrisy?

Because transfer taxes (gift and estate taxes) are paid based on the value of the business interests being transferred, taxpayers typically seek low values to minimize their tax paid while the IRS generally seeks higher values to maximize their tax revenue.  The differing values typically hinge on discounts for lack of control and marketability. 

When stock is contributed to charity, the best interests of the taxpayer and the IRS become reversed as the taxpayer seeks a higher value for the stock to maximize their charitable income tax deduction.  Although this seems like a simple role reversal, the “IRS has to be mindful since the arguments it makes for a low value may be used against it in a later transfer tax case when it is seeking a high value for the same type of asset,” says Charles Rubin, Esq. (Gutter Chaves Josepher Rubin Forman Fleisher, Boca Raton, FL) in his blog. He points out that the IRS’ support for a 35% lack of control discount and 45% lack of marketability discount in the recent Bergquist v. Commissioner case would never have flown in a transfer tax case—“the IRS would clearly have vigorously objected.”  Will the IRS’ discounts come back to haunt them? Only time will tell.

Watch for a comprehensive abstract of Bergquist v. Commissioner in the September issue of the Business Valuation Update, and read the full court opinion in BVLaw.

Speed it up or slow it down? 141R may dictate pace of acquisitions

It is clear that SFAS 141R accounting cannot be applied retrospectively—only business combinations on or after the effective date (December 15, 2008) will use the new rules.  This means that, dependent on the specific characteristics (e.g. the existence of contingent consideration, in-process R&D, etc.), the closing of some acquisitions will be more beneficial to the acquirer prior to the rules becoming effective while others will be more beneficial after.

In the July 31st webinar sponsored by Compliance Week and titled "Getting Ready for SFAS 141R, Business Combinations," Matthew Crow, ASA, CFA (Mercer Capital, Memphis, TN) opined, “Some acquisitions may be moved up because they are more advantageous under 141, while others may be pushed back because they are more advantageous under the new 141R.”

Co-presenter Travis Harms, CPA/ABV, CFA (Mercer Capital, Memphis, TN) re-iterated that the upcoming quarter could see more acquisitions due to the adoption of 141R.

Crow and Harms have also teamed up to create a Free Podcast just posted last week and available on the Mercer Capital website here that’s titled Mercer Capital Podcast: SFAS 157—Portfolio Valuation.

All’s fair in love and war… but please define 'fair'

Although fair market value has been the predominate standard of value in divorce cases, the argument for replacing fair market value with the fair value standard has grown increasingly prevalent in recent years. As early as 1989, attorneys for the non-business owning spouse began arguing that fair market value is not the appropriate standard of value in divorce.  They claim that denying the non-operating spouse a pro rata share of a marital business inequitably enriches the operating spouse and denies the non-operating spouse the fruits of his or her contributions to growing the business during the marriage.  By analogy, the proponents of fair value point to the dissenting shareholders’ rights and remedies under the applicable state business corporation act.

As the fair value standard gains traction in divorce, make sure to see The State of the Fair Value Standard in Divorce article posted at our Free Downloads page, as well as our newly-updated annual publication titled BVR's Guide to Fair Value in Shareholder Dissent, Oppression, and Marital Dissolution, which includes an expanded chapter on the hot topic of fair value in divorce.

Getting specific on CSRPs

In the American Society of Appraiser’s current issue of the Business Valuation Review, Keith Pinkerton, ASA, CFA, and Peter J. Butler, CFA, ASA (both of Hooper Cornell, Boise, ID) submitted a “Letter to the Editor” as a response to a published article on quantifying company-specific risk premiums (CSRP) for privately held firms using a Monte Carlo simulation (download the Letter to the Editor as a free PDF here). 

Although they give kudos to the article, they discuss the need to use market evidence as empirical support for quantifying CSRPs and ask, “Why ignore the data?” Good question. Pinkerton and Butler developed the Butler Pinkerton Model™ to objectively quantify CSRPs.  Learn more about the Butler Pinkerton Model here, and read articles about the Model here.

Financial expert advice

Working with a BV expert on a valuation-related case is more of a necessity than a luxury.  The goal is for the attorney and the expert to work in synergistic harmony, yet when coming from different knowledge and training backgrounds, the two may not see eye-to-eye. Susan Mangiero, Ph.D., AIFA, AVA, CFA, FRM (Business Valuation Analytics and Pension Governance, LLC, Trumbull, CT) writes, If men are from Mars and women are from Venus, attorneys are from Mercury and experts are from Neptune” in her new article Tips from the Experts: Working Effectively with a Financial Expert Witness (available on our Free Downloads page). No need to fret—Susan’s article is filled with tips on how to achieve an optimal working relationship between the two, as well as success in the courtroom.

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