Hospitality businesses have had a pretty sleepless three years. Good hospitality operations are focused on their customers, working hard in many different ways to offer a warm welcome and give guests what they want. But it’s fair to say the mood in the sector has been distinctly chilly of late. Hotels, restaurants, pubs and other leisure businesses have all been hit hard.

First there was COVID-19 and the various prolonged lockdowns across the globe that began in March 2020. Then, just as the world emerged from the pandemic, the Russian invasion of Ukraine saw energy prices spiral, exacerbating the cost-of-living crisis that was beginning to build not just in the UK, threatening to make meals out, holidays and even a few pints unaffordable for many.

Such a backdrop has hardly been conducive to M&A activity, says Peter Hemington, a corporate finance partner specialising in the leisure sector. He currently heads up the M&A practice at BDO; Gurpal Ahluwalia takes over the role in July, while Hemington will continue to advise on M&A in the sector.

Activity across the UK M&A market as a whole bounced back strongly in 2021 and much of 2022, but the hospitality sector flatlined and then dropped, according to data from Refinitiv. There were $13.6bn of deals involving UK hospitality targets announced in 2020, which increased to $14.5bn in 2021. That fell back to $8.4bn last year. But, Hemington suggests, the hospitality deals market has actually held up better than expected.

Small portions

Dealmaking did not disappear altogether, but transactions have been smaller, often involving a single asset rather than entire businesses or portfolios. Refintiv reports that deal volumes rose from 235 to 376 in the sector between 2020 and 2021, before falling back to 289 last year – which was, however, higher than any year pre-2021.

“The picture is very mixed,” says Hemington. “We’ve been involved in some good transactions involving businesses with a really strong proposition. We’ve also seen areas of the market where it is much more challenging.”

In the former category, Hemington points to Greene King’s acquisition last October of Hickory’s, a BBQ smokehouse restaurant group, as a good example. BDO advised Hickory’s, which he said sold at 9xEBITDA. Hemington describes it as “a very well-managed business with a clear proposition and a well-defined target demographic”. From Greene King’s perspective, it has acquired a well-liked brand, which will enable it to diversify into a new area of the market. The pub company plans further restaurant openings of the chain.

Rick Jones, who heads up hospitality, travel and leisure corporate finance at PwC, agrees that “it’s definitely a market with its challenges”, but like any good M&A adviser he has a glass half-full view: “There are levers that good management teams can pull to differentiate themselves, and that will lead to success, investment and deals.”

He says it isn’t a matter of looking for a particular sub-sector of hospitality that might do well in a challenging market, but that within any individual sub-sector there is a key characteristic of successful businesses: “It will be those that truly focus on customers’ needs and wants. Serve them to a high level and that will be an attractive business to private equity across all sectors.”

Most importantly, it’s about getting all the detail right, says Jones. In this economic climate there needs to be a lot of granularity in management actions: “If the focus is on cost of living, management need to think thoroughly about the perceived value of an offering – the size of a meal, and price point for instance. Then the method of service – what is the use of technology?”

But most importantly, when people might be limiting the number of times they dine out, use a hotel or go on holiday, he says you must ask: “What is the quality of the experience for people?”

What’s on the menu?

At first sight, the outlook for the year ahead doesn’t look much more encouraging than last year, with the economic climate set to continue to constrain consumers. Hospitality businesses face the same inflationary pressures as their customers, with the soaring cost of food and energy. Add in the headache of staffing, with labour shortages making it very tough to recruit, and it looks like a difficult circle for dealmakers to square for investors.

However, Andreas Scriven, head of hospitality and leisure at Deloitte, believes there really are reasons to be positive: “In fact, consumers are proving much more resilient than expected – they appear not to be cutting back on things like eating out and travel, which are no longer regarded as just ‘nice to have’,” he says. “Maybe more importantly, the investor pool is deep, with a range of different types of buyers still interested in the sector.”

Price is an issue, he concedes. Amid uncertainty about what the ‘new normal’ might look like post-pandemic, buyers have found it difficult to price deals. The lack of activity has meant that any revaluation of the sector, which might have forced sellers to be more realistic, has been piecemeal. “Some vendors are looking for prices that buyers just can’t get their heads around,” Scriven warns. “We’ve seen quite a number of deals fail because an agreement on price could not be reached.”

Investors such as private equity, real estate funds and even sovereign wealth funds are still interested in the sector, but are finding price particularly difficult to manage – especially as rising interest rates drive up the cost of capital and the pressure of leverage on portfolio companies.

Taste of success

PwC’s Jones advised Foresight on the sale of its stake in Mowgli Street Food, an Indian restaurant business, to private equity firm TriSpan, at the end of January this year. “It’s a great dining experience,” he says. “It’s really focused both on its customers and its management teams and is making great use of its social media interactions with its customers. Because of its focus on service and quality of experience, it generates great enthusiasm among its very loyal customers.”

Launched in Liverpool, it has 16 sites across the UK and a strong pipeline of openings, including in Edinburgh and Bristol. “What the TriSpan investment in Mowgli really demonstrates is that even in a challenging sector like casual dining, private equity will still do deals for best-in-class businesses and management teams.”

In July 2022, Inflexion sold Virgin Experience Days – the leading online provider of experience day gifts – to Equistone Partners Europe. Jones also advised on that deal: “It shows that in the post-COVID-19 world there is resilience of gifting experiences in a difficult consumer environment.” Under Inflexion’s ownership, there was a rise in use of digital channels and a US opportunity came into focus: “We helped Virgin Experience acquire a smaller business in the US. And part of the story now is that Equistone will continue to grow that under the Virgin brand in the States.”

Not just desserts

Trade buyers focused on strategic activity to reposition in the wake of the crisis may be more accommodating. The latter often win the day, says Henry Wells, the head of consumer at finnCap Group. “Buyers need the ability to assess various operating pressures such as energy and food price inflation, so trade buyers who have that deep-seated operational expertise can have an advantage here,” he says. “Deals are getting done, but in the current environment, buyers have to be smart and sellers must be realistic about terms and value.”

In addition to the Greene King-Hickory’s transaction, Wells points to two recent deals in the pub and restaurant space as good examples of strategic M&A. The Restaurant Group’s acquisition of Mexican food specialist Barburrito gave it a route into the quick-service restaurant sector and the potential to invest in a roll-out strategy. Revolution Bars’ purchase of Peach Pubs added a portfolio of gastropubs in affluent rural locations to a business previously focused on city-centre drinking.

In the hotel sub-sector, meanwhile, trade buyers have also made strategic acquisitions. The Inn Collection Group, for example, made no fewer than six deals last year, typically for single assets beyond its core market in the North of England. TUI Travel, meanwhile, raised €500m at the beginning of 2022 to finance an expansion of its hotel portfolio.

Still, private equity buyers have not given up on hospitality – quite the reverse, says Hemington: “The roll-out strategy is not dead; the great thing about multi-site leisure is that if you understand why it works, you can continue to roll it out.”

Safe landing

Another deal Rick Jones advised on, which completed on the same day as the Mowgli deal, was the listed Australian travel giant Flight Centre’s acquisition of luxury tailor-made travel specialist Scott Dunn in a deal worth £121m. Flight Centre is an ASX-listed diversified travel group, with a market capitalisation of nearly AUS$4bn. It handles corporate and leisure travel, has high street shops, agents, on-line flights and holidays, and it offers many long-haul bespoke holidays. Scott Dunn offers tailor-made luxury travel. The deal was received well by the markets – Flight Centre’s shares are around 20% higher than they were prior to its announcement.

“The Scott Dunn deal shows international trade buyers are looking for strategic acquisitions,” says Jones. But striking a price has been tough: “During lockdown we couldn’t go to restaurants, we couldn’t travel internationally. So whether you are a private business doing a transaction or you’re a listed business with a share price, it’s very difficult to see what the multiple is in this sector because revenues streams were not there during lockdown.”

More trust has to be put in forecasts, and more diligence in preparing them. The implied multiple for the Scott Dunn deal was 9.6xEBITDA, based on the July 2023 forecast. “How are the multiples being affected?” asks Jones rhetorically. “There is pressure, of course, but that’s still a healthy multiple.”

And, of course, private equity-backed groups remain determined to focus on expansion. The RedCat Pub Company, for example, was set up by former Greene King boss Rooney Anand in February 2021; he raised £200m from Oaktree Capital to invest in pubs, betting on a post-pandemic recovery. Major acquisitions in 2021 – including Coaching Inn Group and Stonegate Group – continued last year with two significant hotel purchases in the South West.

KSL Capital Partners is pursuing a similar strategy. Last year, it invested in The Pig Hotels, co-owned by Jim Ratcliffe, the billionaire founder of petrochemicals group INEOS, as part of a push into the travel sector. KSL has also launched Mission Hill Hospitality, aimed at the extended-stay segment of the market.

A variation on the theme is for real estate investors to partner with operating businesses to make acquisitions. Last year, for example, Tristan Capital Partners’ European Property Investors Special Opportunities fund acquired Point A Hotels in a deal that will see it work with co-investor and hotel operator Queensway.

Given this level of interest from both trade buyers and investors, advisers are hopeful that M&A activity might be stronger than expected this year. “I’m optimistic; 2022 was a very difficult year, but the early signs are that 2023 will be a little easier and that we will see more deals,” says Hemington.

There are risks on the downside. Many hospitality groups find themselves facing refinancing deadlines in a very different interest climate to when they last took on debt – funding will be more expensive, assuming it can be secured at all. Equally, it is possible that the economic outturn will be worse than expected; a sharp rise in unemployment, for example, or inflation that proves more stubborn, would clearly hit a consumer-facing sector. A poor Christmas trading period for many businesses – not least as rail strikes hit large parts of the country – has not helped either.

Still, Deloitte’s Scriven is also inclined to be optimistic. “Activity is now trending up from a very low base,” he says. “The market has been so flat that even a modest acceleration will feel like a recovery.