1. Review from the Annual Pizza Hut Convention
2. Q1 Restaurant Same Store Sales Update
3. Preparing to Sell a Franchise Business
4. How to Build a Franchise Business
Welcome to The Restaurant Boiler Room Episode 16. I’m your host, Rick Ormsby, Managing Director at Unbridled Capital.
Today, in the Boiler Room:
Review from the Annual Pizza Hut Convention
Q1 Restaurant Same Store Sales Update
Preparing to Sell a Franchise Business
How to Build a Franchise Business
Tag Line: The Restaurant Boiler Room is a one-stop-shop for multi-million dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk – delivered to the front door of franchisees, private equity firms, family offices, large investors, and franchisors on an every-other-week basis. Feel free to find our content at Unbridled Capital’s website at www.unbridledcapital.com
Now, let’s enter the Boiler Room:
A. Review from the Pizza Hut Convention
Background: Unbridled just attended the annual Pizza Hut Convention in Nashville, TN. I have been attending this convention for almost 15 consecutive years, and it is a gathering of most of the domestic-based Pizza Hut franchisees, along with Corporate employees and vendors. By the way and as an aside, I am a Vanderbilt MBA alum from many years ago, and so I know the town of Nashville quite well. I am amazed at the number of cranes in the Nashville skyline – there must be 25 or more. It is shocking to see how much the city has grown in the past decade. Downtown now looks like a mix of Bourbon Street and downtown Dallas. There is a constant buzz of new people and new ideas. Someone on the street told me that 100 new people move to Nashville each day. But I digress!
Comments: Pizza Hut posted flat same-store sales growth in Q1 on the heels of a difficult 2018. The brand is dealing with declining transactions, a heavy mix of legacy assets, a very old franchise base, and a lack of menu innovation. However, much like the buzz in Nashville, you can feel the buzz of a hopeful Pizza Hut turnaround underway – just by walking around the convention this year and seeing the young faces, argyle socks, and tan dress shoes. In the past several years, no less than 5 new, young, family-office and PE-backed franchisees have entered the Pizza Hut brand. These new franchisees are optimistic, well-capitalized, young, and have fresh ideas to offer in terms of operations, marketing and strategy. Unbridled has been at the forefront of this trend and is honored to play a large role in ushering these new franchisees into the Pizza Hut system. And, I feel like the generational transition of the Pizza Hut brand from 70 and 80-year old’s to 30 and 40-year old’s will ultimately be one of the most important factors in the revitalization of the brand as it looks to inject fresh capital, better operations, newer assets and new energy into Pizza Hut.
Effects on M&A: Yum is a great company, and it has attracted the best and most sophisticated franchisees for many years. In my opinion, it remains the gold standard for restaurant franchisees. Most of the new entrants into the Pizza Hut brand also believe this to be true. They also see a bunch of operational upside in their acquisitions, and they are less fearful of abandoning mediocre dine-in assets for DELCO relocations. Finally, Pizza Hut remains unique across all franchise brands in having only about 100 franchisees and 6,500 locations – the average franchisee is large. This scale and the corresponding reasonable valuations for the brand – create a great platform investment for a first-time executive backed by outside capital who wants to have a large operation and healthy G&A structure to hire, train and retain a great management team. For these reasons, we expect Pizza Hut multiples to remain near their recent highs of 5.75 – 6.50X of EBITDA on a post G&A basis and before considering several years of future remodeling expenses.
Q1 Restaurant Same Store Sales Update
Background: Q1 restaurant earnings have been coming out in the past week or so. Here’s a small sample - Taco Bell was +4%, KFC was +2%, Pizza Hut was flat, Wendy’s was +2%, Wingstop was +7%, and Papa John’s was down 7%.
Comments: Generally, sales are looking strong across the industry in Q1 after a stormy February in the Midwest and Northeast. Real GDP growth was 3.2% in Q1 but is expected to lessen significantly in Q2. Unemployment has steadily remained near historical lows at 3.8%. The 10-year treasury has dropped substantially in the past several quarters to about 2.5%, now sitting 50 basis points lower than just a year ago. Finally, due to labor inflation, brands are increasing pricing by about 3%, which is creating most of the sales increases. All in all, the industry continues to appear healthy, noting that cost pressures in the business are increasing, as well as competition from new unit development.
Effects on M&A: For Yum, the story remains the same – Taco Bell is a darling, KFC is steadily producing strong results, and Pizza Hut is trying to regain momentum. Wendy’s appears to be having transactional success with its Biggie Bag. Wingstop has been a name I continue to hear frequently in the franchise community – many friends and clients want to buy Wingstop units because of their unit growth potential, low development costs, digital ordering growth, and high IRR – just be careful on the wild swings in chicken wing prices. And finally, Papa John’s had some big news in announcing that Founder John Schnatter may sell some or all of his stock in the company. With the addition of a new loyalty program, Shaq as a board member, franchisee, and spokesman, and the upcoming roll-over of the public reaction to Schnatter’s comments last year, we hope to see same-store sales improve in the Papa John’s brand in the next quarter and throughout the year.
Preparing to Sell a Franchise Business
Background: I am often approached by operators who want to sell their franchise businesses. They commonly ask – how do I prepare for this? I think it is a great question – as it suggests the franchisee is planful and recognizes that selling a company is complex and requires a plethora of analysis from all angles – price, risk, legal, leases, taxes, legacy, and family, just to name a few. As such, here are a few ideas to keep in mind:
Review your P&Ls and pay for someone to give you an opinion of how your expenses compare with other franchisees in your brand and geographically. Take the temperature of your business and work on any improvements.
Do a thorough review of your leases to make sure they are solid. Where appropriate, try to extend lease terms or options. Buyers want long lease-lives and flexibility if any store’s performance is poor.
Consider your remodeling obligations and their timing. You’ll need help from someone like Unbridled to give you thoughts on when to remodel or build new units and the pacing/sequencing of doing so if considering a sale. The last thing you want to do is spend too much capital on a remodeling project and not get credit for your hard work and dollars spent through the sale process.
The franchise M&A industry has changed a ton in the past few years. You likely do not currently know the ultimate buyer of your business because of the big increases in family-office buyers in the franchise space. You certainly don’t know how to negotiate with them either. Just go ahead and convince yourself of that.
M&A has gotten much more complex – franchisees are exposing themselves to unnecessary risk and leaving money on the table. You need a good attorney with transaction experience. Most franchisees have a good attorney relationship, but many of those attorneys are great at overall business issues but don’t have much specific franchise M&A experience. From our standpoint, an inexperienced M&A attorney will create headaches and sub-optimal results in a sale.
Deals take hundreds of hours of time, so you need to be prepared for the journey. Doing it alone is an impossibility unless you neglect your operations, your family, or your health. You will need the support of your family and a competent team – including an M&A advisor who is excellent, doesn’t have conflicts with buyers, and is trustworthy.
Recent tax law changes necessitate a CPA who knows M&A and has buy/sell experience. This is like the attorney comment from earlier.
I recently chatted with a founder of a very successful law-firm that is now almost 40 years old. I was doing an interview with him and afterward asked for his advice in building a sustainable business. He offered the following:
Don’t be too broad. Stay focused and excellent at doing fewer things.
Always be innovative – never stop coming up with new ideas.
Hire good thinkers – you can always teach someone about a particular industry, but good thinkers are hard to find.
I thought these were great points to consider when building a franchise business too. Many of you listening are younger – this Podcast tends to attract young 30’s with MBAs who are looking to acquire franchise assets by partnering with family offices. As mentioned earlier, we have put several groups like this into a few restaurant brands in the past year. My advice to you is very similar to what I was told from the founder of the law firm:
Get narrow and focused immediately – too many investors and franchisees start their journey by wanting to look at every deal and every brand. That is a bad idea. Step back, take your time and really develop a strategy. Learn about the Top 50 brands in the country. Get to know their stories. Watch and read the news about these brands. Talk with experts. Watch their trends, sales results, unit growth, size of the franchise base, age of the brand, new product promotions, etc...Once you have done this, you will start to naturally develop a thesis on 2-3 brands that will make the most sense for you.
Start looking at deal flow – the big mistake here is that most would-be business owners look at deal flow too early, and that deal flow starts developing their strategy for them, instead of their strategy developing from market research and continual thought. Don’t look at deal flow closely until you have narrowed the brands you want to pursue
Go to the Franchisor to Get Approved – unless one of your brands is struggling badly, and there is little demand in the M&A market, you are never going to win a bid on a franchise acquisition target if you are not approved in the particular brand. In this environment, there are always several other buyers. Most sellers will take a substantial reduction in price, all things equal, to deal with an approved buyer instead of one who isn’t.
Set a goal for making an offer – it is usually reasonable to look at a few deals before making your first offer. On the other side, I have rarely seen anyone become a new franchisee who hasn’t made at least 2-3 offers in the first 6 months of starting their search. There are many, many tire-kickers who go for months or years of looking at deals and never win one. This is a likely outcome of not setting your strategy and focusing early on.
Start Looking for an Operator – The time to start looking for an operator is once you start planning your meetings with franchisors. If you are dependent on an excellent management team in order to acquire a franchise business, you are likely not going to win the deal unless your price is much higher than everyone else’s. Why? Existing and well-capitalized franchisees nearby want those deals and can typically offer a better assurance of closing. Also note that without an operator, most brands will not fully- approve you.
Go Get ‘Em – If you are prepared and have followed these steps, you should be ready to buy a franchise business. Good luck and Go Get ‘Em!
Thanks so much for entering the Boiler Room today. You can find our podcasts on iTunes, Google Play, Stitcher, TuneIn, and Spotify. If you like these podcasts, please listen, rate, and review! I also encourage you to visit our website at www.unbridledcapital.com for the best franchise M&A and financial resources in the industry. Our website includes podcasts, videos, white papers, and a list of our M&A transactions.
Disclaimer: Please note that neither Rick Ormsby nor Unbridled Capital LLC give legal, financial, or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information, errors therein, or omissions therefrom.