Private equity firm Roark Capital agreed on Thursday to buy Subway, in a deal that people familiar with the matter said values the US sandwich chain at up to $9.55 billion, including debt, subject to targets in its financial performance.

The deal marks the conclusion of a drawn-out auction that started in February and attracted interest from several private equity firms. Reuters reported on Tuesday on a so-called earn-out agreement that was key to Roark clinching a deal for Subway.

For the full deal price to be paid, Subway’s cash flow would need to reach certain milestones over a period spanning two or more years after the deal closes, according to the sources. Without the earn-out, the deal is worth $8.95 billion, the sources said.

Earn-out structures, while uncommon in the consumer and retail sector, are increasing in frequency in a challenging market for mergers and acquisitions as a way to reconcile price differences.

The sources said the arrangement helped bridge a gap in the valuation expectations between Roark and the DeLuca and Buck families that own Subway, which started up nearly 60 years ago in Connecticut.

The families were hoping to fetch more than $10 billion for Subway based on its strong brand and international growth, but the private equity firms countered it was worth less because they deemed its US business saturated.

Roark prevailed over a rival bidding group led by buyout firms TDR Capital and Sycamore Partners, whose final offer was for $8.75 billion including an earn-out, and $8.25 billion without, the sources said.

Roark, which owns other restaurant operators and franchises, including rival sandwich chain Jimmy John’s, will pay Subway’s owners a break-up fee equivalent to 4 per cent of the deal’s value should antitrust regulators thwart the deal, one of the sources said.

The deal contact allows for 12 months for the transaction to be completed, according to the sources.

Roark took the view that the restaurant market is too fragmented for the deal to raise competition concerns, the sources added.

Jimmy John’s has more than 2,600 restaurants in 43 US states. Subway has more than 37,000 restaurants in over 100 countries.

Roark and Subway, which announced the deal on Thursday, declined to comment on the terms.

Roark currently controls Inspire Brands, the owner of restaurant chains including Jimmy John’s, Arby’s, Baskin-Robbins and Buffalo Wild Wings.

Its experience of helping restaurant brands grow will be helpful, “especially in the U.S. market where it remains well below the peak it hit a few years ago”, said Neil Saunders, managing director of market research firm GlobalData.

Revamping operations

Tax considerations were part of the calculus to sell Subway. This is because the estate of co-founder Peter Buck, who passed away in 2021, donated his 50 per cent stake in the privately-held company to his philanthropic foundation under the terms of his will. This offers a shield from taxes on the sale of the stake.

Founded in 1965 by 17-year-old Fred DeLuca and his family friend Buck, Subway has been owned by the founding families since its first restaurant opened as “Pete’s Super Submarines” in Bridgeport, Connecticut.

The Milford, Connecticut-based company has been revamping its operations to deal with outdated decor and $5 deals on foot-long sandwiches that eroded franchisees’ profits. In 2021, the chain launched a menu overhaul and splashy marketing campaign as it embarked on a turnaround plan that has helped sales grow.

Subway, which has closed thousands of US locations since 2016, said a year ago that it wants to shift away from its current base of small franchisees that own just one or two shops, which tend to be family-run and sometimes barely scrape by.

The company saw a 9.85 per cent increase in same-store sales in the first half of 2023. Its 12-month earnings before interest, taxes, depreciation and amortization are around $800 million, according to the sources.

JPMorgan Chase and law firm Sullivan & Cromwell LLP advised Subway. Paul, Weiss, Rifkind, Wharton & Garrison LLP advised Roark Capital, while Morgan Stanley led the acquisition financing.

• Reporting by Anirban Sen and Abigail Summerville in New York and Deborah Sophia in Bengaluru;Editing by Greg Roumeliotis and Marguerita Choy, of Reuters.