One helping too many

The saga of Buffets Inc., the largest steak buffet restaurant chain in the U.S., is a timely reminder that the leveraging binge can sometimes prove too much of a good thing. Crippled by acquisition-related debt and other economic factors, Eagan, Minn.-based Buffets, known for its all-you-can-eat smorgasbord outlets including Old Country Buffet, HomeTown Buffet and Fire Mountain, filed for Chapter 11 bankruptcy on Jan. 22.

It was a sharp reversal for the 25-year-old business, though not an altogether disastrous outcome for the private equity sponsors -- CI Capital LLC, then known as Caxton-Iseman Capital LLC, and Sentinel Capital Partners, both of New York -- which had generous helpings of dividend recapitalizations early on.

Buffets, founded in 1983, went public in 1985, making numerous acquisitions. At the time of the buyout in June 2000, Buffets had just posted the most profitable quarter in its history. At that point, it was generating $114 million of Ebitda on $973 million of annual sales.

The sponsors, which took it private for $665 million, were banking on Buffets to overcome the recession, as well as increased fuel and meat prices. They were proved right. The company performed well, allowing it to pay down part of its senior debt and mount a recap less than two years later. Just as the junk bond market began to retrench in mid-2002, the investors pulled off a $525 million recap arranged by Credit Suisse Group that gave shareholders $142 million in dividends.

The high-yield market evidently was happy to go along because, as Frederick Iseman, president and managing partner of Caxton-Iseman, explained at the time, the debt markets "came to understand that we are not in business to invest $130 million and take out $142 million after 20 months but rather to invest in building future revenues and profits as the basis for a large future capital gain."

Encouraged by robust credit markets, Buffets launched a second leveraged recap in January 2004, allowing the sponsors to collect another $75 million in dividends, according to Sentinel's Web site. CI Capital, which holds 77% of the common, took the lion's share.

That same year, the company filed to go public while putting itself up for sale, but neither happened. Moody's Investors Service warned in 2005 that its debt protection measures were weaker than expected.

Instead of downsizing, however, Buffets supersized. Hoping for economies of scale, it bought rival Ryan's Restaurant Group Inc. in November 2006, creating the country's largest buffet chain, with $1.7 billion in revenue and more than 36,000 employees. The $834 million merger included $184 million in debt that was repaid at closing, according to an affidavit by Buffets' CFO Keith Wall.

The merger was funded in part by a $566.8 million sale-leaseback transaction involving the sale of 275 Ryan's restaurants and seven Buffets restaurants to Fortress Investment Group LLC.

But it came amid a steep spike in commodity prices as well as higher energy and labor costs. "A lot of things went wrong at the same time," says William Fahy, a Moody's analyst. "The costs associated with the acquisition, with both higher rent expenses and higher leverage, resulted in a liquidity crunch." Moreover, the economic downturn limited the chain's ability to raise prices.

Early this year, Buffets, which had a $634 million credit facility, missed an $18.75 million interest payment on a $300 million loan in 12.5% senior unsecured notes. Wall's affidavit acknowledged "a variety of economic external factors" that led to the company's troubles, which "significantly hampered" its ability to service its debt.

Company executives and the sponsors declined comment. The creditors' and debtor counsel did not return calls.

Even assuming they lose all equity, the investors are still ahead, chalking up a 1.7 times return multiple. Not exactly a stellar return, but a return nonetheless that's always welcome.

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