Elephant Bar Restaurant: Mezzanine Financing
Professor Shelly Canterbury
Finance 441-001 Spring 2016
Elephant Bar Restaurant is a California based company founded by Chris Nancarrow in 1979. The restaurant started as a test concept of Carrow’s Restaurants, a chain of more than 150 full-service restaurants. Elephant bar was sold to W. R. Grace in 1985, and repurchased in 1993. The company aims to differentiate itself through innovative culinary concepts. On a product level, the company provides an “elephant-sized” culinary experience to the customer. In order to support innovation, the menu featured complex dishes that included “one unusual ...view middle of the document...
Mezzanine’s hybrid characteristic made it an attractive type of financing for Nancarrow.
As a result of SKM’s efforts, John Fruehwirth, a principal at Allied Capital, was considering an injection of $20 million worth of mezzanine debt/growth capital in E-bar. Fruehwirth was aware of the fact that a restaurant with significant growth opportunity like E-bar could either be the next Cheesecake Factory, or flop and take the debt injection along with it. E-bar has shown initial success in California, but Allied’s investment committee needed to evaluate if this continued success can be applied outside the state. Areas of main concern included if the E-bar concept was sufficiently strong to visit and be a nationwide brand or if it had been merely a “California concept.” And in the case of success, would Allied Capital be able to meet is underwriting standards? Based upon the Black-Scholes formula and the financial information provided in this case, it is recommended that a current stock price of $6.18 be used and the warrant agreement be increased to 3.9% of total shares outstanding to yield an IRR of 18%. This report will support and examine E-bar’s ability in generating the required return on invested capital from Allied Capital and conclude by providing a recommendation on the deal alterations based on Allied Capital’s needs. The next section examines AC’s due diligence on E-bar’s growth potentials and the industry it operates in.
Allied Capital: Due Diligence
A champion of mezzanine investments, AC was founded in 1958 and has created a long history of providing both debt and equity capital to private and middle-market companies. The company became public on the over-the-counter market in 1960, and later listed itself on the NYSE in 2001. Allied Capital is legally a business development company (BDC), business structures created by congress to primarily increase the availability of long-term growth capital to companies that had limited access to it. AC generated an average total return of 18.3% for its shareholders since its inception and as of 2003; its portfolio consisted of 122 companies with a balance sheet topping $3 billion.
The firm primarily allocated its injections in less cyclical industries such as business services and consumer products. However, its committee were proactive in considering investments of all kind, including buyouts, acquisitions, growth capital, and recapitalizations. Debt provisions typically ranged from $10-$100 million and buyout investments from $50-$250 million. AC’s due diligence started with a brief overview of the restaurant industry. There are several important points that make the industry a very attractive industry:
* The restaurant industry accounted for 4% of U.S. GDP or $300 billion in sales annually.
* Between 1981 and 2001, nominal sales had grown at rate of 7.3%.
* Between 2001 and 2006, it is anticipated that sales will grow at a nominal compounded annual growth rate of 5.2%,...