Restaurant Bankrupcy Crisis
It's not just Red Lobster.
In “Empty Tables and Rising Costs Push More Restaurants Into Bankruptcy,” WSJ reporter Heather Haddon highlights a problem that I was only marginally aware existed.
Americans love fish tacos, but not enough to keep Rubio’s Coastal Grill from joining one of 2024’s biggest food trends: the bankrupt restaurant chain.
The California chain founded around 41 years ago by a surfer hung on through the Covid-19 pandemic, and sales had been improving. But business never came all the way back, and as expenses climbed and customers grew fed up with the rising cost of eating out, Rubio’s filed for bankruptcy protection in June.
“You have locations that just aren’t viable. You have the Covid hangover, labor costs. There’s multiple problems,” said Jeff Crivello, president of Trew Capital Management, an investment firm that bought Rubio’s out of bankruptcy in August.
Restaurant chains and operators this year are on track to declare the most bankruptcies in decades outside of 2020, when the global pandemic upended the industry’s operations, according to an analysis of BankruptcyData.com records. The firm tracked chapter 11 filings of restaurants that are publicly traded, along with companies holding more than $10 million in liabilities.
Restaurants declaring bankruptcy this year include sit-down chains Red Lobster and Hawkers Asian Street Food, along with a string of fast-casual operations such as Tijuana Flats and Roti. More eateries on the edge are likely to file for bankruptcy in the coming year, according to restaurant executives, attorneys and lenders.
Nearly five years since the pandemic hit the more than $1 trillion U.S. restaurant industry, the sector’s health has improved on many fronts. Hiring is robust and an average of 3,700 new restaurants are opening monthly this year, according to market-research firm Datassential.
But some chains are still struggling because customers have pulled back on dining out, and high interest rates have hurt companies that gave priority to growth over profit.
Same-store sales traffic at U.S. restaurants was down by 3.3% this year through Oct. 6 versus the same period in 2023, according to market-research firm Black Box Intelligence. Visits to casual-dining restaurants fell 4.5%.
“These are things that have been bubbling under the surface for the last 15 years,” said Brett Schulman, chief executive of fast-casual chain Cava. Schulman said he has had more than a dozen distressed restaurant companies pitched to him to buy or invest in the past year.
Chains with fewer than 50 locations that can’t benefit from the scale advantages of bigger companies are considered the most vulnerable, industry officials said. Older sit-down chains struggling to cater to today’s consumers are also in tough positions.
I had noticed Red Lobster’s bankruptcy filing a while back but was unaware it was part of a larger trend.
An August Bloomberg Law report by Alex Wolf (“Casual Dining Chain Bankruptcies Highlight Industry in Flux“) adds more context:
America’s casual dining chain restaurants, struggling with operational costs and changing consumer habits, are rapidly going bankrupt in last-ditch efforts to rightsize or sell themselves to opportunistic investors.
The Chapter 11 filing in May by Red Lobster may be the most spectacular restaurant collapse of 2024, but the iconic seafood chain is just one of several brands forced into bankruptcy this year due to unsustainable debt and bloated operations. The trend continued earlier this month as Italian eatery Buca di Beppo and craft-beer focused chain World of Beer sought refuge in bankruptcy.
For many, the goal is to use the debt payment breathing spell afforded by Chapter 11 to close unprofitable locations and rework a number of vendor contracts to save money. Several are also using bankruptcy to finalize a changeover in ownership or solicit offers to buy the business at a discount.
In court filings, the bankrupt brands all say they’ve failed to make ends meet in the face of industrywide difficulties, including rising costs for food and labor and shrinking consumer demand. The Covid-19 pandemic is often cited as the genesis of despair, as many restaurants have struggled to adapt to changing consumer behavior, like spikes in delivery or takeout orders and diminished weekday lunch crowds.
Plus, pandemic-era guardrails have been removed and price-conscious consumers have shunned dining out due to higher costs. Even fast food brands are deploying value meal deals to reel customers back amid inflationary pressures.
“There’s an impending bust that’s on the way,” said restaurant industry consultant Aaron Allen, head of Aaron Allen & Associates. “We’re getting more and more calls these days for folks who need turnarounds.”
The cases illustrate not only how a global event affected a consumer market, but also how an entire industry is reckoning with broad, lasting changes.
“This is kind of a convergence of things,” Allen said. “There’s going to be a reconfiguration of the industry that will emerge out of this in the next two or three years.”
Pushed to the brink, restaurateurs like Mod Pizza—a fast casual chain with more than 500 locations across the country—have inked buyout deals before ending up in bankruptcy court. In other cases, Chapter 11 is being used to facilitate a business handoff to investment firms that acquired substantial amounts of the company’s secured debt.
[…]
A number of large restaurant brands like California Pizza Kitchen and Le Pain Quotidien filed for bankruptcy at the height of the pandemic, but the vast majority limped along hoping that business would return to normal before government relief dried up.
With the backing of landlords that couldn’t quickly find new tenants and lenders that didn’t want to take over their businesses, operators were largely spared.
“Some companies filed during Covid but there was definitely a trend of kicking the can down the road,” said Mette H. Kurth, chair of Culhane PLLC’s bankruptcy practice. “Mid-Covid nobody was going to buy it.”
Government assistance and creditor patience has since waned. Consumer demand in many respects has also not returned.
One Table noted upon filing for Chapter 11 in July that the ripple effects of the pandemic have devastated its businesses, “as they no longer enjoy the same volume of lunch-time workers as they did pre-pandemic.”
The operator of New York-area restaurant chain Sticky’s Finger Joint told a Delaware bankruptcy judge in April that it has similarly seen reduced workday lunch crowds and has had trouble adjusting to “the ‘new normal’ of shorter work weeks for employees who previously commuted to work in New York City five days a week.”
Kurth, who last year guided fast casual chain Corner Bakery into Chapter 11 and through a bankruptcy sale process to SSCP Management, said rising debts and interest rates—coupled with inflationary effects on food prices and worker wage costs—have made it “very difficult for these companies to keep their doors open.”
The problems are acute in California, which in April raised the minimum wage for fast food workers to $20 an hour.
“The restaurants have record levels of debt,” Allen said. “We expect to see an acceleration of bankruptcies in the fourth quarter and into 2025.”
Our family dining patterns haven’t changed radically since COVID but we’re more affluent than most and were already largely eschewing weekday lunch out and fast casual dining. We get takeout for the family two or three times a month, and my wife and I go out for Saturday “date night” every couple of weeks. But, for example, I’ve largely quit grabbing a late lunch at Five Guys when I’ve neglected to pack leftovers because I find the $20+ price tag ridiculous. Can I afford it? Yes. But, come on.
Checking the archives to see whether I’d posted about Red Lobster (I had not), I stumbled on a post from way back in February 2014 titled “Middle Class Shopping Less at Lousy Stores, Eating Less at Lousy Restaurants.” Even then, Red Lobster was struggling—as were other middlebrow restaurant chains (Olive Garden, Longhorn Steak House) and department stores (Sears, J.C. Penney, etc.).
Certainly, the pandemic and post-pandemic economic shakeup were impactful. People discovered that, if it was simply food and not a dining experience one was after, getting the food to go and eating at home was considerably cheaper and more convenient. And the combination of rising prices and staff shortages has made dining out considerably less attractive; you’re literally paying more for less.
Restaurant-like establishments have been with us for centuries, although the variety that would be recognizable to modern consumers is roughly the same age as the United States. I don’t see them going away, as they serve a legitimate need. But it may well be that those outside the most affluent will revert to dining out less frequently rather than on the routine basis that had evolved in the last quarter century or so.
One key detail being left out here is the role leveraged buyouts and asset stripping by private equity played in so many of these bankruptcies. That is, the reason they’re going bankrupt is because someone sucked all of the equity and capital out of the companies and didn’t care if what remained was still a going concern because they’d already made a large amount of money.
In Red Lobster’s case, for example, after Golden Gate Capital bought the chain in 2014, they sold off the land under their own restaurants for a quick $1.5 billion payout that saddled the chain with $200 million per year in rent expenses while also drastically increasing the interest rates they paid on their hefty corporate debt because they had no collateral securing it.
How private equity rolled Red Lobster
The reality is that a lot of private equity is really just an elaborate form of check kiting and really should be considered fraud.
@Stormy Dragon: Yep. If you read all the articles the common theme was these chains were carrying a lot of debt. How did the debt get there? I bet if you peeled that onion back you would find a pattern of investment firms buying chains out and loading them with debt while skimming off assets.
I think this is a problem we’re going to see more and more of. Private Equity aside (which is a major problem), a lot of stores/industries rely on large amounts of relatively cheap, abusable labor being readily available, and for a variety of reasons (but especially the aging populace/retiring baby boomers), that’s changing. But a lot of our society is built around that assumption. I live in a relatively small town, north of New York City. We have 5 CVS pharmacies, 4 Walgreens, and 4 Rite Aids within 10 miles of me. That doesn’t include the non-chain pharmacies, nor the pharmacies that are embedded in grocery stores or Target. That’s really convenient for their customers, but each one of those stores requires 1 pharmacist and 2 or 3 people to be there for them to be open. And those stores are empty most of the time. I’m pretty sure several of those will be closing in the next year or two.
My wife is a pediatric hospitalist; several of her colleagues have quit recently because they can get jobs that are less stressful, pay more, and allow them to work remote. This is bad for patients, but I can understand why they do it, especially since so much of what they’re asked to do these days is nonsense for insurance coverage.
I don’t know what the answer is; people expect to get paid more to work unpleasant jobs, but that raises prices and reduces the number of customers, who are used to being genuflected to, and tend to have meltdowns if they don’t get the service they think they deserve. Part of me thinks we’re seeing the death spiral of a lot of industries, and we’re heading for a new equilibrium, but I don’t know what that will look like.
@Stormy Dragon: I was just going to point this out and you beat me to it. Another way to say this is that Restaurants/Stores/Manufacturers who get loaded up with debt and pursue “efficiencies” (primarily screwing employees and lowering quality) so they can pay out venture capitalists are significantly less able to weather storms.
I live in the heart of Baltimore and if I walk on the main streets pass 30 restaurants and bars on my walk to the supermarket – 15 if I go the back ways. Certain of them do really well, and more struggle. And the for the ones who have a tough go, they go out of business, someone new comes in, and then they go out of business in turn. I can’t really explain it, other than to say that of the four places my wife and I like best and go to most often, three seem to be doing really well and have been around for years. The fourth is a labor of love brewpub that can’t serve their own food. I think they are making some money, but no one would invest in it because of the balance sheet. What do these four places have in common? They are, very much, neighborhood places. They aren’t chains. None are on the main drags. If you give local people a sense of community and good food and drink, you’ve got a shot*. Except in really small towns, no one is going to Red Lobster for community.
* Of course, you also have to understand what it takes to make money in food service, a business where you have something like 90% of the same costs whether one customer walks through the door or a hundred, and put that knowledge to practical use.
I suppose there isn’t much insight in that last piece, and Stormy captured what I said in the first part.
Reminds me of Toys R Us. As I understand it, it didn’t go out of business because it wasn’t profitable. It went out of business because of the way venture capital screwed around with it.
@Steven L. Taylor:
Something along these lines may be brewing up at Southwest, with a heavy helping of chutzpah.
TL;DR: a group of activist investors called something like Elliot Management, acquired a large number of shares in Southwest, and have since then complained about the low valuation of their stock. Now they want a multitude of changes to bring the value up; I assume so they can sell for a profit and walk away, very likely leaving a mess behind.
Really, if they were so concerned about the price of Southwest’s stock, they could have easily avoided potential losses by not buying a large number of shares.
Retrenchment and closures appear common in this business segment. Denny’s, Applebees, and Olive Garden come to mind. I don’t know enough about their business structure to make a useful comment, but I suspect some fundamental issue with their model. Any insiders to these businesses out there?
Chains are one problem, but independently owned restaurants are closing at a fair clip around here too, even places that have been around for a while.
We go out several times a month, and what has jumped out at me is the decline in quality. I can handle smaller portions. I can handle higher prices (to a certain extent). But when a formerly good restaurant starts to decline in quality, we start to look elsewhere.
@Stormy Dragon: @Scott: Ayup. It’s not called “vulture capitalism” exclusively for the play on words.
@Jen:
Back when I ate out with friends often (80s-90s), we had a rule: if we liked some new non-chain restaurant, we visited it often because it would certainly be gone within a couple of years.
This wasn’t true of all of them. Our favorite Chinese restaurant remains at its original location and is still family owned. But a hell of a lot of others vanished.
I dunno, it just seems to me that the pandemic changed people’s habits, and a mediocre chain restaurant is just not going to be interesting enough to pull people back. Labor costs, and a big interest rate spike are probably collateral, as well. But I would make the change of habits primary. If you go out, you spend time driving there, parking, getting a seat, waiting to order, waiting for your order, waiting to pay, and driving home. If you order takeout, or delivery, you don’t spend any of that time, and you can spend that time doing something else, with friend perhaps.
Or if you’re cooking, you can make it interesting. Maybe you like cooking. Maybe that’s how you connect with each other – cooking and then eating.
My favorite local restaurant is doing ok, and it’s a local chain, too. It has always been insanely popular in the area. It has a ton of personality, and that’s probably got a lot to do with why it does well. I’m really not interested in the polished, gleaming blandness that is so common among many of these chains.
@Jen: The only time I’ve seen a real decline in quality was when the local one-off that we loved changed hands. They kept the names on the menu, but the food was not the same. We went a couple times, then stopped. It was closed a year later.
Kevin Drum had a chart last week of grocery and restaurant food sales over the last ten years.
The venture capital explanation looks good to me.
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@Stormy Dragon:
Yes, this. For whatever reason, Rubio’s seems to be the poster child in all articles about restaurant bankruptcies, and they almost never mention the private equity acquisition and the debt that the chain was carrying as a result.
@just nutha: Yup. Several years ago, I published a short story titled “Vulture Capitalist” which pointed out that the profit-maximizing ways of some humans and some predatory avians are remarkably similar.