Tough ‘90s Make Restaurant Chains Stumble, Refocus : Eating out: Excesses of the go-go ‘80s have dealt harshly with three Orange County groups.
Staggering net losses, forced asset sales and bankruptcy weren’t part of the game plan in the late 1980s when executives at three Orange County restaurant companies accumulated $1.2 billion in debt that funded a string of high-profile acquisitions.
Rather, officials at American Restaurant Group, Del Taco Inc. and Restaurant Enterprises Group believed they were simply taking advantage of a window of opportunity: Many of the nation’s largest companies were spinning off subsidiaries and there was plenty of junk bond and bank financing available to do deals.
In the last seven years, American Restaurant, Del Taco and REG gained control of 1,100 restaurants, including Black Angus, Grandy’s, Carrows, Coco’s, Reuben’s and Allie’s. But the harsh economic climate of the 1990s has transformed that mountain of accumulated debt into an unbearably heavy load that is forcing the three companies to change how they do business.
* On March 29, Costa Mesa-based Del Taco blamed its monstrous long-term debt--estimated at $170 million--for a Chapter 11 bankruptcy filing. The nation’s second-largest Mexican-style fast-food chain said it can’t compete with market leader Taco Bell unless it restructures its debt, renegotiates expensive leases and closes lackluster locations.
* Irvine-based REG, which is expected to report at least a $210-million net loss for 1992, hopes to complete a voluntary debt restructuring by year’s end. The troubled company is negotiating with potential buyers for up to a quarter of its 587 restaurants to pay for an ongoing renovation program.
* Newport Beach-based American Restaurant restructured $244 million in debt accumulated during 1986. American Restaurant refuses to discuss its debt situation. But according to a May, 1992, filing with the Securities and Exchange Commission, the company still had $120 million in 12% senior secured notes outstanding.
The SEC filing showed that even with its debt restructured, American Restaurant was still a “highly leveraged” company that could be forced to sell assets should revenue slow.
None of the executives at the three restaurant companies anticipated such problems in the go-go ‘80s.
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Across the country, in industry after industry, executives were doing the same thing: taking subsidiaries of public companies and making them large private companies under their control. Debt wasn’t a problem, because it would be paid off by cash flow from the acquired businesses or from cash generated by selling assets.
During the 1980s, the restaurant industry was in flux because several large corporations were unloading restaurant holdings. Marriott, for example, wanted to focus on hotels, while W.R. Grace & Co. was concentrating on its chemicals business.
Restaurant industry executives surfaced as willing buyers for the unwanted divisions. To finance the deals, they turned to the same sources as the rest of corporate America: friendly thrifts and banks with liberal loan policies and the junk bond market.
At the time, the leveraged buyouts seemed to make sense.
During the 1980s, “cash was king,” said Mike Mooslin, a former Naugles Inc. president who now is president of Kookooroo, a small, Los Angeles-based restaurant chain. “If you had cash, you could tie up properties, build stores (and) put in income-generating equipment,” Mooslin said. “You didn’t mind going out on a limb to secure those income-generators.”
Managers “thought they could be more flexible in the way they managed the businesses, that they could be smaller and leaner,” said Jannie Herchuk, a restaurant industry specialist with Deloitte & Touche in Costa Mesa. “And, in some cases, it worked.”
The buying binge began in 1986 when a group of W.R. Grace & Co. managers accumulated about $737 million in bank loans and subordinated debt financing to purchase Grace’s restaurant division, which included the Reuben’s, El Torito and the Coco’s and Carrows chains. The deal was initiated by Orange County restaurateur Anwar Soliman, the former chief of Grace’s restaurant division, who left shortly before the buyout was completed.
A few months later, Soliman paid $244 million for several restaurant chains owned by Marriott. The deal gave Soliman--identified in 1992 SEC documents as the “beneficial owner” of all American Restaurant stock--control over Stuart Anderson’s Black Angus, Grandy’s Fried Chicken and a handful of trendy restaurants scattered throughout California.
Soliman also acquired Del Taco in 1988, but sold that business in January, 1990, to a management group led by Wayne W. Armstrong. Del Taco officials declined to state the value of that transaction, but according to bankruptcy filings, Armstrong’s group paid at least $170 million.
But the wheeling and dealing didn’t stop there.
Before his Del Taco acquisition, Soliman had spent much of 1987 on an unsuccessful $98-million bid for Restaurant Associates Industries, a New York-based company.
During 1990, Armstrong left Del Taco and turned the company over to a new management team led by former Burger King executive Kevin Moriarty. The new team made plans for a dramatic expansion that would make market leader Taco Bell sit up and take notice. Such talk raised industry eyebrows because Del Taco, with about 300 locations, was a distant second to market leader Taco Bell, which has more than 4,000 restaurants worldwide.
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Irvine-based REG surprised observers by taking on $67.9 million in additional debt to finance the acquisition of 109 Bob’s Big Boy and Allie’s restaurants from Marriott Corp. REG then began to convert the former Marriott properties into Carrows and Coco’s restaurants.
The accumulated debt assumed by the three companies proved to be unexpectedly heavy, however, when revenue stalled during a nationwide recession that began in 1990 and continued through last year.
REG, American Restaurant and Del Taco were hit harder than many competitors because of their strong reliance upon locations in California, which some economists suggest is still in recession. American Restaurant and Del Taco operate almost exclusively in California; REG now intends to focus its efforts in the western states, including California, and sell off restaurants located elsewhere.
When the deals were struck, managers firmly believed that “there would always be a golden glow in the California economy,” said Herchuk, at Deloitte & Touche. “They believed that the California economy could never go down.”
The bubble burst, however, when aerospace cutbacks occurred and other businesses left California, said Janet Lowder, a restaurant industry consultant based in Rancho Palos Verdes. “There was a snowball effect,” Lowder said.
“You can take the problems and issues in these three specific examples and blow it out across America,” said Arthur Perrone, chairman of Eureka Capital Markets, a Newport Beach-based firm that arranges financing for small, privately held companies.
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When the debt-heavy deals were done during the 1980s, “there was incredible confidence” that business would continue to boom, Perrone said. But revenue stalled and, “now, the capital structure, in many cases, is out of whack,” Perrone said. “What has to happen is a restructuring of that debt.”
Also since the recession started, budget-conscious consumers have been shopping for better values. Savvy operators responded with lower-cost menus that further trimmed the restaurant industry’s already-thin profit margins.
Discounting hurt bottom lines across the board, but was especially painful at weaker chains such as Del Taco. “If the big guys were discounting (prices) you have to go along or lose business,” Lowder said. “That means profit margins are going to be squeezed even more.”
When revenue stalled, restaurant executives “found themselves in the same position as the tenant who (during good economic times) rented an apartment for $1,200, and now finds everyone else in the building is paying $900 a month,” Lowder said. “They have to try and renegotiate their leases . . . loosen up their debt a little bit.”
Was it wise to accumulate all of that debt?
“Hindsight is always 20/20,” said REG President Norm Habermann. “Looking back is an unrealistic exercise. Who could have predicted that we’d still be in the longest and deepest recession since the Great Depression? Who would have predicted that the Southern California economy would run out of gas or that real estate
prices would have dropped as precipitously as they have?”
REG has used cash generated by operations to cut its debt by more than $380 million. But the company has been forced to work with lenders to restructure debt.
“Our whole outlook is to pare down and rid the company of debt that--perhaps in the 1980s--was more acceptable on the balance sheet,” Habermann said. “That’s not the case in the tough markets of the 1990s.”
Habermann argues that REG’s financial woes don’t “mean that our restaurant concepts or financial plans as they existed in 1986 were wrong . . . but 1986’s forecast for the future turned out to be somewhat inaccurate.”
With limited resources available for renovation and expansion, REG elected to focus on its Coco’s (156 locations), Carrows (126) and Bob’s (76) restaurants. The Bob’s restaurants are being converted into Coco’s and Carrows.
REG will “streamline” its dinner house operation by building its El Torito brand in California, Oregon and Arizona. Company officials declined to comment on recently published reports that Taco Bell is interested in buying its El Torito chain.
Last in line at REG are the aging Reuben’s and Charley Brown’s chains, whose fates are up in the air. REG hasn’t said whether those chains will be closed, but Habermann did say that REG has “not had the necessary capital to keep all our (restaurants) as current as the consumers of the ‘90s have demanded.”
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REG is focusing on Coco’s, Carrows and El Torito because those chains represent the company’s “greatest chance for success” in courting value-conscious consumers, Habermann said.
Similarly, American Restaurant is closing, converting or selling its 14 Velvet Turtle locations because the high-end chain has “limited long-term potential,” according to the 1992 SEC filing.
But while American Restaurant refinanced its debt, it remains “highly leveraged . . . a significant downturn in the company’s business could cause the company to . . . violate one or more of (its) covenants . . . (and) cause the company to be unable to pay principal or interest” on its notes, according to the filing.
Debt is also a primary concern for Moriarty at Del Taco. Absent its debt, De Taco is is strong enough to survive and prosper, Moriarty said.
That’s a definite contrast from Moriarty’s initial description of Del Taco: “a sleepy, tired brand that was stuck in the 1960s.”
Since arriving in August, 1990, Moriarty has upgraded Del Taco’s restaurants, shut down slower stores and remade the menu by concentrating on freshly prepared foods and “attractive” prices.
Restaurant industry observers agree that Del Taco has turned the corner. “Kevin Moriarty has done an excellent job,” Mooslin said. “But it will fall apart because of the prior debt . . . unless he gets relief through bankruptcy.”
Moriarty and Executive Vice President Paul Hitzelberger own 21.1% of Del Taco’s stock. General Electric Capital owns the remaining shares.
GE Capital, which also is Del Taco’s largest secured creditor, supports Moriarty.
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“Kevin and his team have gone a long way toward repositioning the brand,” said Paul Street, general manager of GE Capital’s corporate restructuring group. “They’ve modernized the image, upgraded the physical facilities at relatively little cost, refocused the menu and developed a very competitive pricing strategy.”
The only obstacle remaining, according to Moriarty, is the heavy debt that was assumed by the previous management team. He maintains that Del Taco can grow only if management is allowed to “invest in the future and not in the past.”
“We have a healthy brand name and an unhealthy company,” Moriarty said. “But (it is) a company that is growing toward health.”
Moriarty’s assessment is reinforced by the company’s operating results since the March 29 bankruptcy filing.
During an April 13 bankruptcy court session, Del Taco’s attorneys said that the company hasn’t had to touch a $3-million line of credit advanced by General Electric Capital Corp., which is Del Taco’s major shareholder and largest secured creditor.
Moriarty, who won’t discuss revenue or profit figures, did say that same-store sales are up 45% in the past two years.
Orange County Eats Out
The restaurant industry measures activity in 320 metropolitan areas across the United States. Two indexes are widely used to indicate restaurant activity. They indicate Orange County residents are 50% more likely than average to eat out and that the local market could support 10% growth. All figures are for 1992.
* Restaurant Activity index:
Indicates propensity to eat out; 100 is nationwide average.
* Restaurant Growth Index:
Relationship between supply and demand; amount exceeding 100 indicates percentage market could grow.
* Eating/drinking establishment sales: $2,743,687,000 Fast-food sales: $985,578,000 Restaurant sales $1,369,936,000 Restaurant Activity Index: 154 Restaurant Growth Index: 110
* County Comparisons
Compared to other counties, Orange County residents do more than their fair share of dinning out, preferring full-service restaurants to fast-food establishments.
* Los Angeles Fast food: 36% Full-service: 53% Other: 11% Orange Fast food: 39% Full-service: 53% Other: 8% Riverside/San Bernardino Fast food: 48% Full-service: 47% Other: 5% San Diego Fast food: 39% Full-service: 54% Other: 7% Los Angeles: 133 Orange: 154 Riverside/San Bernardino: 104 San Diego: 132 National Average 100
* Restaurant Roundup
During the 1980s, three local restaurant groups expanded both in the United States and abroad. Here’s a look at the chains each owns and operates.
* Restaurant Enterprises Group: A variety of eateries located in 24 states and District of Columbia. Coco’s: 156 Carrows: 126 El Torito: 120 Bob’s, Jojo and Allie’s: 76 Casa Galardo: 28 Charlie Brown’s: 27 Reuben’s: 20 All other dinner houses: 24 Total: 577
* American Restaurant Group:
Restaurants located in California, Pacific Northwest, Arizona, Texas, Oklahoma, Florida. Other Grandy’s are in the U.S. South and Far East. Grandy’s: 104 Black Angus: 88 Spoons: 17 Spectrum: 16 Velvet Turtle: 14 Total: 239
* Del Taco Inc:
These fast-food eateries can be found in California, Utah, Nevada, Missouri, Illinois and Arizona. Del Taco: 275 Naugles: 30 Total: 305
* The market share information does not include food purchased at delicatessens and mini-markets.
* Sources: Del Taco Inc., American Restaurant Group, Restaurant Enterprises Group, California Restaurant Assn.; Researched by APRIL JACKSON and GREG JOHNSON / Los Angeles Times
