Don't Get Sucked In by Fast-Food M&A

Burger King finally made good on its plans to go public again last week, by using a back door to the stock market. The company, Burger King Worldwide (NYSE: BKW  ) , began trading through a reverse merger with a special-purpose acquisition company owned by private-equity firm Justice Holdings.

Set aside the fact that the transaction was structured as a deal between investment companies and not a "true" public offering. Even if the deal were far more transparent, I'd walk away from BK's counter -- and away from most fast-feeders.

There is no shortage of deals in the restaurant space right now, both at the quick-serve and casual-dining ends of the spectrum. But even if international expansion can help the more global fast feeders (open for debate, since even China is seeing some economic slowdown), the macro trends have turned iffy back home. Domestically, the market is overstuffed with "restaurant concepts" -- as seen in the bankruptcies of Friendly's and Sbarro, among others -- at a time when consumer spending looks about to tighten again.

A recent survey from NPD Group found that traffic at fast-food chains grew 2% in the spring, thanks to a push to sell breakfast and snacks. But the report warned that traffic will slow down for the rest of the year. Indeed, according to the Conference Board, consumer confidence dropped this spring and consumers are less confident about the future ahead. And other polls show consumers are cutting back on fast-food meals.

The only thing that comes out of this level of competitiveness is a war of attrition, which turns costly for everyone. Competitors try to top each other with more and cheaper menu items to boost sales at the expense of margins. If you happen to own McDonald's, that's fine -- it never hurts to own the sector leader. But I'd stay away from the rest of the pack.

Burger King will join a flowing pipeline of restaurant deals announced in the past two months. CKE, the parent of Carl's Jr. and Hardee's, filed for an IPO in May under the ticker CK; Outback Steakhouse's parent, Bloomin' Brands, also announced last month it will go public under the ticker BLM.

On the other hand, P.F. Chang's China Bistro (Nasdaq: PFCB  ) agreed to be taken private by Centerbridge Partners last month, and Einstein Noah Restaurant Group (Nasdaq: BAGL  ) , parent of the bagel chains Noah's and Einstein Bros., topped a healthy first-quarter report and news of a dividend with word that it was exploring "strategic alternatives" -- such as a merger or sale of the company.

Even with lower gas prices giving households a breather, recent economic indicators all point to more of the tight discretionary spending we've seen the past four years. And that's making consumers agnostic about eating out; the recent American Customer Satisfaction Survey found diners were just as happy with quick-service restaurants as with the experience at casual-dining eateries.

So tight budgets have given rise to a whole hybrid category of "fast casual" eateries to trade down to, such as Panera (Nasdaq: PNRA  ) , Chipotle (NYSE: CMG  ) , Cosi, and Pret-a-Manger (the posh British sandwich-shop chain majority-owned by Bridgepoint Capital. Technomic found this group grew sales by 8.4% in 2011, more than twice the 3.5% growth rate for the industry.

The hybrid eateries make for a better macro play and are still small enough to be in growth mode, not in the defensive crouch of mature competitors like Burger King. But some of the more up-and comers, such as Five Guys Burger & Fries and chicken chain Zaxby's are not public, and most of the strong public players have already been discovered.

We've previously recommended Panera in this space, and Chipotle got a vote of confidence from Fools until it was recently judged to be overpriced. Sadly, Cosi hasn't gotten its act together, judging by its disappointing first-quarter loss of $0.02 per share; that was less than the expected $0.04 consensus, but it was still a loss despite 7.3% comparable-store sales growth.

So there's very little in this sector that would whet an investor's appetite right now. But in case you want to order in later, add these stocks to your free My Watchlist and keep an eye on them.

Fool contributor Mercedes Cardona owns no shares in any of the companies mentioned in this article. Follow her onTwitter and on her website. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill, McDonald's, and Panera Bread and creating a bear put spread position in Chipotle Mexican Grill. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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