“The Operational Consequences of Private Equity Buyouts: Evidence from the Restaurant Industry,” by Shai Bernstein, Stanford Graduate School of Business, and Albert Sheen, Harvard Business School – Finance Unit, a study paper dated October 6, 2013, addresses the question of whether PE firms add operational value to their acquisitions.
Are PE transactions just glorified financial engineering stratagems that focus on ruthless cost cutting and near-sighted financial goals such as ‘strip-and-flip,’ as commonly alleged and believed?
Bernstein and Sheen point out that, contrary to popular opinion, a large body of research work says PE buyouts improve productivity and profitability, and that “PE firms mitigate management agency problems through the disciplinary role of debt, concentrated and active ownership, and high powered managerial incentives, which lead managers to improve operations.” [Jensen (1989)]
What’s the practical reality?
Post PE impact on the restaurant industry in Florida
The authors adopted an innovative means to study this issue. They analyzed 101 restaurant chain buyouts between 2002 and 2012 through the lens of health inspection data (see table below), which gives insight into restaurants’ compliance with operational practices as recommended by the FDA.
Statutory and surprise inspection records covering over 50,000 locations yielded valuable clues to the questions (1) Whether PE firms added operational value to their buyout targets, and (2) What were the levers PE firms applied to improve operations?
- Restaurants showed fewer health related violations after being acquired in a PE transaction, and this reduction was especially apparent in the more serious (‘critical’) violations that could affect customers dangerously.
- Moreover, this improving trend was visible as long as five years post-buyout.
- There was a strong correlation between violations and adverse customer reviews posted on Yelp.com.
- Deteriorating health practices went on to impact profitability, and, ultimately, restaurant closure
- The beneficial impact of PE ownership was starkly visible when comparing (within the same chain and zip location) a ‘chain-owned’ and ‘franchised’ restaurant.
- Franchisees were driven to improve their health practices due to competitive pressures, a phenomenon described as a ‘spillover effect’ by the authors.
What levers did PE management pull?
- The authors noted that, on average, PE owners reduced manpower marginally.
- PE backed chains reduced menu prices in the same cuisine segments to be more competitive.
- PE owners improved management practices, particularly human resource management (HRM).
Conclusion for PE firms
PE firms are more actively involved in the management of the firms they take over, and through better operational practices such as capital budgeting, HRM (training, monitoring and alignment of worker incentives) and reduced health violations, are able to lower both menu prices, as well as employee headcount. At the same time they improve management practices across the firm.