Private Equity Excel essay paper

The Panera Bread LBO

Case

Author: David Stowell & Alexander Katz

Online Pub Date: January 04, 2021 | Original Pub. Date: 2019

Subject: Financial Investment/Analysis, Valuation, Mergers & Acquisitions

Level: | Type: Indirect case | Length: 5872

Copyright: © 2019 Kellogg School of Management, Northwestern UniversityPrivate Equity Excel

Organization: Panera Bread | Organization size: Large

Region: Northern America | State:

Industry: Food and beverage service activities

Originally Published in:

Stowell, D. , & Katz, A. ( 2019). The Panera Bread LBO. 5-219-250. Evanston, IL: Kellogg School of

Management, Northwestern University.

Publisher: Kellogg School of ManagementPrivate Equity Excel

DOI: https://dx.doi.org/10.4135/9781529741759 | Online ISBN: 9781529741759

© 2019 Kellogg School of Management, Northwestern University

This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2022 SAGE Publications Ltd. All Rights Reserved.Private Equity Excel

The case studies on SAGE Business Cases are designed and optimized for online learning. Please refer to the online version of this case to fully experience any video, data embeds, spreadsheets, slides, or other resources that may be included.

This content may only be distributed for use within CUNY Baruch College. https://dx.doi.org/10.4135/9781529741759

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 2 of 16 The Panera Bread LBO

Abstract

This case considers the buyout of Panera Bread from the perspective of a private equity fund. In early 2017, KLG Managing Director Tom Denning is considering a leveraged buyout of Panera Bread, a rapidly growing fast-casual restaurant company. A surprising Bloomberg News story signals that the deal process is broadening and KLG will have to act quickly if it hopes to buy Panera Bread. Students assume the role of Tom Denning as he prepares an investment recommendation for KLG’s investment Private Equity Excel committee. In doing so, students are required to consider a very large and expensive investment. Students are challenged to create an investment recommendation by performing due diligence, determining additional questions to ask, and pricing a buyout bid that incorporates an optimal capital structure and meets KLG’s return requirements. The Panera Bread case is designed to give students insight into the private equity investment process.

Case

It was early April 2017, and Bloomberg News had just broken the story that several major suitors were negotiating the possible take-private of Panera Bread, a rapidly growing company in the fast-casual chain restaurant industry:

Panera Bread Co. is exploring strategic options including a possible sale after receiving takeover interest, people with knowledge of the matter said.

The bakery chain, which has a market value of about $6.5 billion, is working with advisers to study the options, said the people, who asked not to be named discussing the private process. Potential suitors could include JAB Holding Co., Starbucks Corp., and Domino’s Pizza Inc., one of the people said.

There’s no certainty a deal of any sort will be reached for St. Louis–based Panera, the people added. 1Private Equity Excel

Panera Bread was a very attractive business within the struggling restaurant industry. The fast- casual operator had thrived in 2016 as the greater restaurant market shrank. Robust same-store sales and new restaurants drove Panera Bread’s revenues to $2.8 billion, growing by 4.2%. A spate of recent buyouts, such as the $1.8 billion purchase of Popeyes Louisiana Kitchen and the $525 million purchase of Checkers Drive-In Restaurants, had paved the way for further purchases in the sector. Restaurant operators seeking inorganic growth and financial buyers keen to put capital to work were actively considering acquisitions in the industry.

Tom Denning, a managing director at the private equity firm KLG, was caught off guard by the news from Bloomberg. After receiving a confidential investment memorandum from investment bank Morgan Sterling in February, Denning and his team had been quietly conducting due diligence on Panera Bread. The public news story meant that the deal process was broadening and KLG would have to act quickly if the firm hoped to prevail.Private Equity Excel

Picking up the telephone, Denning first called Susan Fowley at Morgan Sterling. The conversation confirmed that Panera Bread’s board and management were seriously considering several offers but were still open to timely competing bids. Panera Bread would consider a non- binding bid that exceeded a 12% premium to the 30-trading-day volume-weighted average stock price of $242.31 (which would be $271.38 per share/$6.6 billion enterprise value). Leaning back in his chair and considering the impact on his upcoming family vacation, Denning pondered whether a leveraged buyout of Panera Bread would be a good investment for KLG. The next few weeks would be grueling for both Denning and his team.

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 3 of 16 The Panera Bread LBO

The Fast-Casual Industry Overview

Industry Description

Fast-casual dining emerged in the mid-1990s and achieved significant growth. The fast-casual model offers consumers quality meals, rapidly prepared. The dining experience falls between restaurants that offer fast food (e.g., McDonald’s) and those that offer standard casual dining (e.g., The Cheesecake Factory). Fast- casual menus often consist of tailored dishes built from quick- to-assemble basic foods. Upon entering the restaurant, customers place their orders either while waiting in line or at a main counter. Line cooks assemble the meal and might offer additional customizations. After paying a cashier, the customer then takes the meal to go or to eat at a table in the restaurant.Private Equity Excel

Fast-casual restaurants primarily aimed at affluent adults 18 to 34 years old. Shifting American eating habits had created a segment of customers who demanded bold and diverse flavor profiles. These consumers prioritized what they saw as healthy eating habits and authentic food with fewer frozen and pre-processed ingredients. The growing demand for quality and an increasing preference to eat out was expected to cause fast-casual restaurants to become more mainstream and the customer base to grow.

Fast-casual meals typically cost between $9 and $14, a significant price premium relative to fast food that was justified by the fresh and high-quality ingredients. Innovative fast-casual meal options, such as a steak and arugula sandwich, a soba noodle broth bowl with chicken, and bacon mac and cheese, reflected the quality of a genuine dining experience, but the meal was delivered faster and at a lower cost, compared with standard casual dining. In addition, the made-to-order nature of fast-casual meals allowed customers to personalize their foods.

A small store footprint allowed fast-casual restaurants to thrive in suburbs and cities where space was at a premium. The interior of a fast-casual restaurant was commonly a brightly lit, 2,000-to-4,000-square-foot space that featured modern décor. Focused menu offerings allowed a fast-casual kitchen to be smaller than a full-service operator. Often the kitchens operated in full view of the customer, inviting interaction and meal customization. The seating space for fast-casual restaurants was carefully gauged to allow guests to readily find a table but to give the impression the restaurant was busy. 2

Sales and Growth

Fast-casual restaurants represented a vibrant and growing portion of the limited-service restaurant industry. In 2016, this sector generated $291 billion in domestic revenue (Exhibit 1 and Exhibit 2). Fast-casual establishments comprised 18% ($47 billion) of the sector’s revenue. Among fast-casual operators, the top 20 brands accounted for more than half of that, $26 billion. The five-year compounded annual growth rate of 10.1% for fast-casual restaurants substantially exceeded the growth rate of the broader restaurant industry.

A significant portion of the fast-casual segment revenues came from taking market share from fast food companies. Industry analysts projected that, within five years, fast-casual dining would represent 22% of the expected $348 billion in limited-service restaurant revenue. Within this segment, cuisines such as pizza, seafood, and healthy foods were experiencing exceptionally rapid growth (Exhibit 3). Another key factor driving fast-casual restaurant growth was technological innovation. Restaurants adopted digital ordering systems to increase service speed and reduce labor costs. Many companies created phone-based loyalty apps to build their customer engagement further. 3

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 4 of 16 The Panera Bread LBO

Panera Bread Overview

Company Description

Panera Bread was a national chain of company-owned and franchise-operated fast-casual bakery-cafés. With 2,036 stores across North America, the business served approximately 9 million customers each week. Panera Bread aimed to provide tasty, flavorful, and wholesome food in a warm and welcoming environment. The company stated a commitment to using fresh and clean ingredients and instituted several company-wide policies to accomplish this goal.

The Panera menu was composed of year-round products and seasonal specials. Store bakeries offered a selection of pastries and other goods baked on-site daily. The café offered soups, salads, pastas, sandwiches, and specialty drinks. High-quality ingredients such as select antibiotic-free meats, whole grains, and organic components were used to prepare Panera Bread’s foods.

The company’s strong competitive position relied on providing first-rate food, superior customer service, and an elevated dining experience. Each bakery-café was designed to provide a distinct environment that blended with the local community. Specific fixtures and construction materials that complemented the neighborhood were designed to engage customers. Comfortable indoor and outdoor seating areas encouraged customers to use Panera as an oasis-like gathering spot. Store associates were trained to greet customers by name, display friendly personalities, and make each visit enjoyable. To differentiate itself from competitors, Panera Bread introduced the MyPanera loyalty program to encourage customers to build deep relationships with the brand by rewarding them for returning often. This program gave Panera Bread valuable insight into customer preferences.

Panera Bread operated three business segments: company-owned bakery-café operations, franchise- contracted bakery-café operations, and fresh dough and other product operations. As of December 27, 2016, the company’s bakery-café operations consisted of 902 company-owned bakery-cafés, 1,134 franchise- operated bakery-cafés, and 24 fresh-dough facilities. In addition, the company’s Panera Catering delivered breakfast and lunch entrees (see Exhibit 4).

Panera Bread viewed innovation and technology as a major differentiator in the restaurant business. The Panera 2.0 initiative was an ongoing investment to provide customers with a greater degree of convenience through technology. Digital ordering and rapid pickup for to-go orders allowed customers to interact with Panera Bread bakery-cafés in new ways. As of December 27, 2016, approximately 70% of the company- owned bakery-cafés had transitioned to Panera 2.0. 4

History of Panera Bread

Panera Bread began as a Boston bakery called the Cookie Jar in August 1980. Ron Shaich, the founder, initially subleased a 400-square-foot storefront from a jewelry store. To expand the Cookie Jar’s food selection, Shaich became a licensee of Au Bon Pain, a chain of three French bakeries struggling under enormous debt. In 1981, Shaich and his father purchased Au Bon Pain. The merged company took the Au Bon Pain name and slowly grew the restaurant franchise over the next decade. The company leveraged its croissants and bread as a platform to sell soups, salads, and sandwiches. By the time it completed an IPO in 1991, Au Bon Pain had 125 stores.

In 1993, Shaich met the founders of a 19-store chain called the St. Louis Bread Company, which focused on serving lunchtime soups, salads, and sandwiches to suburban markets. Up to this point, Au Bon Pain franchisees primarily were located within city centers, and Shaich viewed the St. Louis Bread Company as a gateway to expand into the suburbs. As a result, Au Bon Pain purchased the business for $23 million and renamed it Panera Bread.

While the Panera business grew, Au Bon Pain stagnated. By 1995, half of Au Bon Pain’s stores had closed,

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 5 of 16 The Panera Bread LBO

and the company’s stock had fallen from a high of $27 to $6. The company’s aggressive expansion into the Midwest was undermined as store sales sharply declined and operating costs increased. Furthermore, the company struggled to repay expensive senior subordinated debt interest used to fuel its Midwest expansion. Viewing Panera as a diamond in the rough, Shaich suggested to the board that the company should divest everything but Panera. In 1999, the Au Bon Pain division was sold to private equity firm Bruckmann, Rosser, Sherrill & Co. The sale erased $65 million in debt that Au Bon Pain had accrued and left Panera with about 180 bakery- cafés and a surplus of cash. 5

Management Team

Ronald M. Shaich: Founder and CEO

Ron Shaich, the founder and current CEO, oversaw six major iterations of the firm as it evolved from the Cookie Jar into Panera Bread. Shaich demonstrated an uncanny ability to anticipate consumer preferences and scale franchise businesses. He initially guided the business to success as a niche purveyor using French baked goods as a platform to sell soups, salads, and sandwiches to the urban market. As growth stalled, Shaich rebuilt and re-scaled the company as a gathering-place business. When he expressed an interest in stepping away from being CEO of Panera Bread to focus on creative initiatives and other interests, such as politics, other key Panera executives, including Blaine Hurst and Chuck Chapman, became candidates to succeed Shaich. 6

Blaine E. Hurst: Chief Transformation & Growth Officer, President

Blaine Hurst joined Panera Bread in late 2010 to oversee the Panera 2.0 initiative. His career had focused largely on assisting restaurant and distribution companies in seeking innovative ways to grow by leveraging new technologies in their operations. Prior to Panera, Hurst served as president of Restaurant Technology Solutions and vice-chairman and president of Papa John’s International. At Papa John’s, he oversaw the development and implementation of a proprietary point-of-sale restaurant operating system throughout the company. In 2014, Hurst launched Panera Bread’s delivery initiative, a successful and rapidly growing portion of the business. 7

Charles J. Chapman III: Chief Operating Officer

Chuck Chapman joined Panera in November 2011 and was promoted to chief operating officer a year later. Prior to Panera, he had worked as the COO of Dairy Queen and of Bruegger’s Bagels Inc. At each position, Chapman demonstrated an impressive ability to build sales. Skilled at rolling out concepts and developing best-in-class operating systems at national restaurant companies, and with a background in consulting, Chapman oversaw company and franchise operations at Panera Bread. 8

Michael J. Bufano: Chief Financial Officer and Executive Vice President

Mike Bufano joined Panera in 2010 as the vice president of planning. In April 2015, Bufano was promoted to chief financial officer, responsible for the finance, accounting, and investor relations departments. He previously had worked within PepsiCo’s soft-drink and bottled-water business. As director of strategic and financial planning at PepsiCo, Bufano helped build the sales strategy and analysis function. During his nine-year tenure at PepsiCo, he was involved in various strategic, financial planning, and business-analysis roles. Bufano also worked at Accenture and consulted for clients in the telecommunications, banking, and pharmaceutical industries. 9

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 6 of 16 The Panera Bread LBO

Competition

The restaurant industry was extremely competitive. Large chains competed with independent local operators across a spectrum of cuisines, price points, and service types. As a bakery-café concept with fast-casual service, Panera claimed a unique niche within the restaurant market, stating that no specific competitor matched Panera Bread’s scope, culinary expertise, and service concept.

Bakery-café menus include flour-based foods and complimentary items, such as pre-made sandwiches, salads, and soups. The gourmet and healthy nature of these dishes meshed with recent changes in consumer tastes. Panera Bread commanded a 68% share of this segment’s revenues. Einstein Noah Group, the second-largest bakery-café operator, held only an 8% market share, followed by Corner Bakery Café (4.8%) and Au Bon Pain (4.6%). A majority of bakery-cafés were located in major metropolitan areas. 10

Panera Bread’s closest competitors were other fast-casual restaurants, including those with different menu types, such as Mexican, Asian, or burgers. With fast-casual restaurant companies expanding rapidly within the United States in the 2010s, Panera as a pioneer in the segment enjoyed significant success. The firm’s scale and revenues ranked with such other leading fast-casual brands as Chipotle and Jimmy John’s Gourmet Sandwiches. Although several major chains dominated the industry, savvy independent companies developed profitable niche businesses. Strong market fundamentals resulting from high consumer spending and disposable income created a profitable operating environment. Many fast-casual restaurant brands found success in city centers as well as in suburban markets. As geographic expansion becomes saturated, fast- casual operators expected to pursue the less-competitive breakfast market.

The growth of fast-casual restaurants came at the expense of traditional fast-food companies. To remain competitive, larger fast-food companies responded by leveraging their marketing and pricing strengths. In a 2016 Fortune feature article entitled “Free Bird,” McDonald’s proudly announced its commitment to high- quality ingredients and cage-free eggs. 11 Taco Bell took advantage of favorable beef costs to aggressively price meat-heavy menu items such as burritos for as low as $1. 12 As fast-casual restaurants continued to capture market share, larger fast- food operators were likely to redouble their efforts to compete vigorously and win back their customer base.

Table 1: Comparable Public Competitors

Logo Chain Name Segment Menu Type

2016 FYE

Revenue ($ M)

US Restaurants

Panera Bread Fast Casual Bakery- Café

$2,795 2,036

FAST CASUAL RESTAURANTS

Chipotle Fast Casual Mexican $3,904 2,198

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 7 of 16 The Panera Bread LBO

Noodles & Company Fast Casual Asian/Noodle $487 530

Pollo Tropical Fast Casual Chicken $402 182

Taco Cabana Fast Casual Mexican $310 173

The Habit Burger Grill Fast Casual Burger $284 172

Zoës Kitchen Fast Casual Burger $276 204

Shake Shack Fast Casual Burger $268 71

Wingstop Inc. Fast Casual Chicken $91 922

Freshii Fast Casual Bakery-Café $18 N/A

MULTINATIONAL QUICK SERVICE RESTAURANTS

McDonald’s Quick Service

Burger $24,622 14,155

Starbucks Quick Service

Coffee Café $21,316 13,172

KFC Quick Service

Chicken $3,232 4,167

Tim Hortons Quick Service

Coffee Café $3,001 683

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 8 of 16 The Panera Bread LBO

Domino’s Quick Service

Pizza $2,217 5,371

Taco Bell Quick Service

Mexican $2,025 6,278

Burger King Quick Service

Burger $1,144 7,161

Pizza Hut Quick Service

Pizza $1,111 7,689

Potbelly Quick Service

Sandwich $407 454

Popeyes Louisiana Kitchen

Quick Service

Chicken $269 2,067

DOMESTIC QUICK SERVICE RESTAURANTS

Wendy’s Quick Service

Burger $8,964 5,739

Papa John’s Quick Service

Pizza $1,714 3,331

Jack in the Box Quick Service

Burger $1,599 2,255

Dunkin’ Donuts Quick Service

Coffee Café $662 8,828

Sonic Drive-In Quick Service

Burger $606 3,557

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 9 of 16 The Panera Bread LBO

Bojangles’ Quick Service

Chicken $532 713

Del Taco Quick Service

Mexican $452 551

El Pollo Loco Quick Service

Chicken $380 460

Baskin Robbins Quick Service

Frozen Desserts

$167 2,538

Source: Restaurant Business Technomic Top 500 Chain Restaurant Report (2017), company FYE 2016 10K SEC filings, and company websites.

Table 2: Other Selected Competitors

Logo Chain Name Segment Menu Type

2016 FYE

Revenue ($ M)T

US Restaurants

Subway Quick Service

Sandwiches $11,300 25,908

Chick-fil-A Quick Service

Chicken $6,743 2,261

Jimmy John’s Gourmet Sandwiches

Fast-Casual Sandwiches $2,220 2,819

Five Guys Burgers and Fries Fast-Casual Burger $1,437 1,500

Einstein Bros. Bagels Fast-Casual Bakery- Café

$381 707

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 10 of 16 The Panera Bread LBO

Corner Bakery Cafe Fast-Casual Bakery- Café

$376 185

Au Bon Pain Fast-Casual Bakery- Café

$352 212

Peet’s Coffee Quick Service

Bakery- Café

$272 246

Bruegger’s Bagels Fast-Casual Bakery- Café

$197 220

Blaze Pizza Fast-Casual Pizza $185 150

Note: TTechnomic estimate.

Source: Restaurant Business Technomic Top 500 Chain Restaurant Report (2017), company FYE 2016 10K SEC filings, and company websites.

The 2017 Private Equity Industry

The private equity industry performed robustly and grew increasingly crowded in 2017. Strong economic growth propelled the value of buyouts and exits to new heights around the globe. As private equity outperformed other assets, a tidal wave of capital flooded the industry. During that year, 7,775 funds raised $701 billion in new capital, a five-year peak. (See Exhibit 5 for previous annual totals.)

The search for attractive buyouts grew more difficult as competition escalated. Many private equity funds began to explore a wider range of investment opportunities. A number of firms combed portfolios of competitors to find new assets to buy. Other private equity investors introduced funds with extended holding periods of up to 15 years. These funds charged lower fees but benefited from lower transaction costs and more flexible exit timing. Other common buyout activities, such as add-on and growth investments, continued to be popular (Exhibit 6).

Despite the creativity in sourcing deals, valuations continued to soar. During 2017, the average EBITDA purchase price multiple climbed to a three-year high of 12.1× (Exhibit 7). Flush with cash, many funds began to buy larger businesses to deploy greater amounts of capital. Although the total number of buyouts remained flat, globally invested capital (including add-ons) swelled $440 billion during 2017, up 19% from the previous year. The US market experienced a similar 9% growth in deal value, whereas the number of transactions remained relatively stable compared with those in the previous year (Exhibit 8 and Exhibit 9). High purchase prices in the market were partially mitigated by accommodating debt markets. The average debt multiple exceeded 6×, and covenant-lite loans dominated three-quarters of the overall loan volume (see Exhibit 10 for previous years’ figures).

Add-ons were an increasingly important source of value in 2017. Funds stimulated portfolio growth by purchasing smaller companies to combine with existing portfolio companies. Small businesses had comparatively lower purchase premiums, and anticipated portfolio company synergies helped to justify

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 11 of 16 The Panera Bread LBO

purchase prices. Despite accounting for only 25% of total deal value, add-ons comprised nearly half of all investments during the year.

During the previous twelve months, US private equity exits were accomplished principally through sales to strategic buyers and financial buyers (Exhibit 11). Increased activity in the secondary market, where sponsors sold to one another, became a more common option for PE funds. Dividend recapitalizations, which were dependent on an accommodating debt market, saw some measure of success, as did partial exits, where funds sold a stake in portfolio companies. The overall IPO market cooled as investors shied away from taking companies public because of the length of time an IPO took to translate into a full cash realization. 13

KLG Overview

Fund Description

KLG, Tom Denning’s firm, was a private equity fund founded in the early 1990s. The firm regularly engaged in leveraged buyouts of upper-middle-market and large-cap companies located in the United States. Each partner of the firm specialized in a particular sector, including a focus on consumer businesses. The firm was investing a tenth fund, of $8.8 billion, largely undrawn since its inception in late 2016.

KLG described its investment approach as flexible and opportunistic. The firm focused on pursuing deals for high-quality businesses with strong prospects and experienced leadership teams. KLG principally took a control position when it invested, but sometimes a minority position. In the past, KLG executed smaller deals on its own and syndicated larger investments with its peers.

Transaction Process

As at many other private equity firms, KLG’s new-deal transaction process could be broken up broadly into five major steps: deal sourcing, due diligence, closing, ownership, and exit. Each step of the process represented a distinct phase of work with different responsibilities and goals. A managing director and vice president were responsible for shepherding the investment process and keeping a fund’s investment committee abreast of the progress. The investment committee, a formal panel, judged the merits of an investment and either accepted or rejected use of the firm’s funds for a transaction.

Deal-sourcing occurs through a variety of structured and unstructured processes. Many firms leverage proprietary resources and use business relationships, industry analysis, and cold-calling to identify investment opportunities. A larger firm, such as KLG, also can source potential deals from investment banks that conduct auctions on behalf of selling companies. A confidential information memorandum (CIM) is developed by the investment bank advisor to the seller, and it is provided to both financial sponsors (PE firms) and strategic buyers (companies in the same industry as the selling company) to increase competition and to bid up the price of a company. Of the hundreds of deals a PE firm looks at, only a handful warrant serious consideration by the investment committee.

When an investment was worth a closer look, a KLG deal team would begin the due-diligence process. The broader goal of due diligence is to understand the key risks and to verify the health of a target business. The qualitative portion of initial due diligence focuses on building a detailed overview of the company and on broader market dynamics. Quantitative due diligence is used to build a leveraged buyout (LBO) model and to project the potential returns of an investment. The culmination of research is the creation of an investment thesis that articulates the rationale that justifies an investment. The investment thesis and supporting information is then transcribed as an investment memorandum for the consideration of the investment committee. The due-diligence process generally lasts between one and three months.

In a private deal that did not involve an auction conducted by an investment bank, KLG might approach an investment target directly. In a direct approach, the KLG deal team would try to hold an introductory meeting with the management team and ask initial due-diligence questions about the business. Topics often

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 12 of 16 The Panera Bread LBO

included financial information, major customer detail, competitive positioning, sales strategy, management and personnel, and key drivers of future growth. Additional due-diligence meetings would be held with management as KLG further refined its understanding of the target company. This would enable the firm to create a comprehensive LBO model and an investment memorandum that summarized the transaction for the investment committee. Upon the investment committee’s approval, the deal team would make an initial non-binding offer to the target’s board of directors (often provided as a valuation range).

If the non-binding offer appealed to the target company, another round of due diligence would begin. Given access to a virtual data room, the KLG deal team would examine detailed confidential information. Further due-diligence meetings would be held with management as KLG continued to refine its understanding of the company. This due diligence would be used to create a more comprehensive LBO model and investment memorandum summarizing the transaction for the investment committee. If the committee maintained its support for this investment, the deal team would provide a binding offer to acquire the target company. If the offer was accepted, KLG would enter the final closing phase of the transaction, which sometimes took several months.

The closing phase of a deal would be dedicated to confirming all financial information and other relevant data and to establishing the legal framework for the transaction. Often, an independent third party would be hired to prepare a quality-of-earnings report to assess the quality and accuracy of the company’s historical financials. Key legal documents, such as the merger agreement, and the purchase price would then be finalized before cash was wired to pay for the acquisition.

The ownership phase of a transaction began once KLG acquired the target. This phase focused on building the acquired company’s value by increasing revenue, reducing costs, considering add-on acquisitions, paying down debt, and enhancing the management team. Over a typical investment holding period of four to seven years, these initiatives usually resulted in a substantial increase in the company’s value.

The exit of a portfolio company investment is a major event that needs careful planning. Many portfolio companies are sold to strategic buyers (companies operating in the same or adjacent industries). Strategic buyers often provide the highest purchase price because they benefit from synergies that can justify a higher price. Sales to financial buyers (i.e., other PE firms) is another popular exit method. However, these buyers are not always as willing to pay as high a purchase price without the benefit of synergies. Initial public offerings (IPOs) are an alternative exit strategy, but this market is difficult to forecast, and sometimes pricing and demand are too low. Furthermore, an IPO usually results in the sale of less than 35% of the company, which means that the balance of at least 65% needs to be sold over a multiple-year period through follow- on public or private market transactions. As a result, this liquidity event takes more time compared to other exit methods, and during this period, the company’s value might increase or decrease, which then affects the overall return of the investment.

Denning’s Due Diligence

Tom Denning and his team had been performing initial due diligence on Panera Bread since receiving the CIM from Morgan Sterling. With rumors of Panera Bread’s buyout leaking to the public, KLG needed to submit a bid fairly soon if it wanted to compete for this acquisition. Due diligence on Panera Bread had yielded a number of encouraging facts about the fast-casual industry and the company itself. During the past three years, Panera Bread had deftly navigated several public-relations problems and had laid the foundation for more growth (Exhibit 12). A review of recent equity analyst reports revealed that Panera 2.0 and a new delivery initiative had eroded Panera Bread’s profit margins, and the company had yet to reap the full economic benefit of these projects (Exhibit 13). However, analyst models projected significant future gains (Exhibit 14). Furthermore, the management team appeared confident in the company’s capabilities, as demonstrated in its financial forecasts and in the following summary of expected performance for fiscal years 2017 to 2021 (Exhibit 15):

Revenue growth in the low double-digits each year as a result of our efforts to become a better competitive alternative through innovation in food, operations, marketing, and store design, and our initiatives to build

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 13 of 16 The Panera Bread LBO

expanded runways for growth by pursuing an omni-channel strategy that leverages our brand credibility into new sales channels such as catering, delivery, high return on investment unit growth, and consumer packaged goods.

Modest operating margin expansion as a result of the cresting of our investments in “Panera 2.0” and delivery, margin improvement efforts in our bakery-cafes, and disciplined general and administrative spending. 14

Same-store sales growth was viewed by both Panera Bread’s management team and by industry analysts as a key indicator of sector performance (Exhibit 16). Major investments in value- improving services, such as Panera 2.0 and deliveries, were designed to improve the performance of existing stores. White-space mapping had revealed that delivery was a quickly growing component of the fast-casual industry space. Yet many other companies relied upon third-party services such as Uber Eats or Postmates to fulfill customers’ unmet delivery needs. As these services were rolled out, management expected to see resulting industry growth. Sales would likely increase, and as the company gained experience and improved its costs, profit growth was predicted to follow. However, the capital investment in these services had reduced the rate at which Panera Bread could expand its geographic footprint by opening new stores. Additional management insight on key topics was available in the most recent earnings-call transcript (Exhibit 17).

Pricing

To support KLG’s bid, Denning and his team gathered information to help determine an accurate market price for the company. Comparable public companies (Exhibit 18) and precedent transactions (Exhibit 19) indicated the range of sales values and premiums to be considered for the fast-casual and broader quick- service restaurant markets. Other data, such as the mean Wall Street consensus stock price targets (Exhibit 20) and earnings predictability (Exhibit 21), could also be considered. Panera Bread’s historical EBITDA multiples (Exhibit 22) could be used to examine the company’s past performance. In addition, a significant factor affecting the price KLG should offer depended on the debt that Panera Bread could support.

Debt-Financing Terms

KLG’s banking partners were eager to finance a Panera buyout. Panera Bread was viewed broadly as a company with a particularly bright future. Multiple banks sought to offer competitive financial terms to deploy a large amount of capital and collect high interest and financing fees. Denning anticipated that his team would be able to negotiate a total debt amount of $3 billion with a covenant of 7.44× FYE 2016 EBITDA. The capital structure would likely consist of a revolver, a term loan, and subordinated debentures. The revolver would likely limit the total amount to $1.5 billion, an amount Denning would not want to draw down fully. A term loan of up to $2.25 billion would comprise the bulk of the senior debt financing available to KLG. A tranche of subordinated debt was also available to KLG, with usage limited at most to $120 million (Exhibit 23).

Additional Due Diligence

An area of due diligence that Denning’s team had yet to explore fully was potential value- creation initiatives, including add-on acquisitions, the ramping up of new-store openings, expanding to new markets, better management of raw materials, and the application of cost efficiencies across the store base. Demonstrating how Panera Bread could be leveraged as an investment platform could make the investment more appealing. Adding a smaller company to Panera Bread could create value for the combined firm in a number of ways, including potential future multiple expansion. In addition, expanding the sales footprint, increasing product offerings, and/or eliminating duplicate management could improve Panera Bread’s return on investment and drive incremental EBITDA growth.

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 14 of 16 The Panera Bread LBO

The Case Assignment

This case is designed to simulate the private equity investment process from the perspective of a private- equity-fund managing director. The case provides a pathway to 1) understanding how to evaluate an investment opportunity by gathering information, analyzing risks, and identifying opportunities; 2) determining what additional information is needed to make a good investment decision; and 3) developing a viable exit strategy (including interim strategic decisions) to 4) make a compelling investment recommendation.

You will take on the role of Tom Denning, a managing director at KLG, as he prepares to present a recommendation to his firm’s investment committee regarding a potential buyout of Panera Bread. An analysis of the buyout opportunity should be completed in preparation for the upcoming investment committee meeting. The following outline may be used to help organize the PowerPoint presentation:

• Executive Summary (Situation overview, investment thesis, key merits/risks, and recommendation) • Company Overview (Company description, product overview, management team) • Industry Dynamics (Industry description, historical/future trends, major competitors) • Investment Merits and Risks • Value Creation Potential (Key drivers of ROI and multiple of invested capital, growth strategy) • Transaction Overview (Transaction summary, enterprise value multiple & leverage summary, and

sources & uses) • Historical Financial Summary (Income statements) • Projected Financial Summary (for Base, Upside, and Downside Cases) (Summary financial results,

case income statements, including assumptions) • Returns (for Base, Upside, and Downside Cases) (Income statements, cash flow, sensitivity analysis

based on EBITDA multiples) • Follow-up Diligence Questions • Investment Recommendation (Expected exit strategy, recommended acquisition price range,

sensitivities based on purchase premiums to unaffected price) • Appendix (Attach financial models to support your presentation)

You should project expected financial results for Panera Bread after considering content in the case, including potential value-creation opportunities, and use the provided financial model to determine the key inputs that drive IRR and multiples of invested capital. Your analysis should support the determination of a proposed acquisition price range.

Notes

1. Ed Hammond et al., “JAB Is Said to Be in Advanced Talks to Acquire Panera Bread,” Bloomberg, April 4, 2017, http://www.bloomberg.com/news/articles/2017-04-04/jab-holding-said-in-advanced-talks-to-acquire- panera-bread.

2. Darren Tristano, “Fast-Growing Fast Casual.” CCIM Institute, CIRE Magazine, November 2013, http://www.ccim.com/cire-magazine/articles/323313/2013/11/fast-growing-fast-casual.

3. Darren Tristano, “Technomic State of the Fast Casual Industry,” National Restaurant Association Show 2017, May 20, 2017, Chicago, IL.

4. Panera Bread FYE 2016 10 K SEC filing.

5. Panera Bread, “Our History,” http://www.panerabread.com/en-us/company/about-panera/our-history.html; Beth Kowitt, “A Founder’s Bold Gamble on Panera,” Fortune, July 18, 2012; Morgan Stanley 1996 Q2 “Au Bon Pain (ABPCA): When Will It End?” Research Report.

6. Ron Shaich, http://www.ronshaich.com/meetron.php.

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 15 of 16 The Panera Bread LBO

7. Panera Bread, “Management Bios,” http://www.panerabread.com/en-us/company/about-panera/ management-bios.html.

8. Ibid.

9. Ibid.

10. IBISWorld Industry Report OD4319 – Bakery Cafes in the US.

11. Beth Kowitt, “Inside McDonald’s Bold Decision to Go Cage-Free,” Fortune, August 18, 2016, http://fortune.com/mcdonalds-cage-free.

12. Brad Tuttle, “Taco Bell Sells Beef Burritos to $1, Ground Beef Prices Drop,” Time, May 23, 2016, http://money.com/money/4344687/taco-bell-cheap-burritos-ground-beef.

13. Bain & Company Global Private Equity Report 2018.

14. Company Schedule 14A SEC filings.

https://dx.doi.org/10.4135/9781529741759

SAGE © 2019 Kellogg School of Management, Northwestern University

Business Cases

Page 16 of 16 The Panera Bread LBO