Season 3 Episode 2: KBP Foods & Grand Mere Capital - Franchisee Interview



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I'm really excited today to be here with Barry Dubin and Mike Cherney. These guys are special people in my life. At Unbridled Capital over the last, I'm trying to think guys, over the last couple three years I think we've represented sellers, and you guys have bought about 300 of restaurants that we've sold. Pretty much half one and half the other. Mike is a primarily pizza franchisee and Barry is primarily a KFC and Taco Bell franchisee. So they're going to have some dynamite perspectives here. I'm going to launch this little presentation and just kind of introduce them a little bit and then I'm going to turn it over to them in a series of Q&A format so that you get to know them and you'll love their personalities.

So hang on one second here. Let me see if I can share the screen and off we go. So there is a ... You can read a little bit about Barry and Mike. I mean, they're just excellent folks. Tremendous backgrounds in private equity and they operate some of the country's biggest restaurant brands. Great guys, really movers and shakers in the franchise industry, and so I'm excited to have them. Guys, welcome. Barry, Mike, welcome. Thanks for being here really.

Thanks, Rick. Happy to be here.


Thanks for having us, Rick. Enjoy.

Got it. Yeah, yeah, absolutely. I was just kind of teasing Barry because he looks like he's got this fancy background behind him and Mike and I are a little more boring than you are, Barry. I think Barry is on Colorado, and so we're all over the country today. I guess if we could just kind of start off, guys. Why don't you just tell us a little bit? I mean, I don't care who goes first. Maybe Mike here in my screen you're first.


And Barry is second, it looks like. So maybe you guys just throw around some of these questions. Let the audience know kind of what do you own and what's your role. Maybe take the first two questions, Mike, and then we'll throw it over to Barry and let him do the same.

Yeah, sure. So our business is called Grand Mere Restaurant Group and we own about 145 Pizza Huts in nine states. It's our primary business and we're not in any other restaurant brands. I'm the CEO of the business and I have a partner, Victor Heutz who is the president. We kind of have a fifty-fifty responsibility for running the business. Victor runs sort of the formal operations of the business as well as the middle back office and kind of keeps the train running in all aspects and has a long career and history in operations in the restaurant business, and I focus primarily on real estate, finance and growth, and sort of representing Grand Mere and the rest of the franchisees to the franchisor. So have focused on all of our M&A activities and optimizing our returns on the real estate.

This business launched in 2016, and prior to that I was in private equity for most of my career and kind of stumbled into the restaurant space after I met a second generation franchisee in New York who kind of told me about the business and it was sort of an intersection of operations, investing and real estate, and kind of piqued my interest as I looked to make a pretty major career move after spending 13 or 14 years in finance in New York.

We acquired our first business in mid 2017, we bought 23 units from Rick and that's how I got to know Rick. Actually, when I launched the business I flew down, it was in the nascent days of Unbridled, short but storied history already, and I spent two days I think in Rick's basement learning about the business and kind of talking through brands, and strategy, and things like that, and built a special friendship and business relationship with Rick through that process. Since then, as I said, we've grown to about 145 units in nine states.

Isn't that cool? I'll never forget it, Mike. We found each other on LinkedIn, right? We had a mutual friend, and sure enough I'm sitting in the basement with a marker in my hand, drawing out which brands to get involved in and why.


And you're thinking probably and you're not saying it, you're thinking, "Who on earth is this dude?"

You probably were thinking the same thing, I'm sure. What type of guy gets in a plane and flies to hang out in my basement for two days? But it's been a great run I think for both of us. Thanks for having me, Rick. Appreciate it.

I mean, yeah, your unbelievable story and unbelievable success, really cool. Yeah, and then thank you for sharing. Of course Barry, please do the same. I mean, Barry is a name that I'm sure most people on the call know and KBP Foods is, I don't know the number now, Barry, you probably do, the third or second or fourth largest franchisee in the country by store count, and maybe by revenues too, I'm not exactly sure. But Barry, please introduce yourself, yeah.

Yeah, sure. Thanks. So my name is Barry Dubin. Rick, thanks for having me here today. I look forward to sharing thoughts with the group. KBP, myself and a gentleman by the name of Mike Kulp co-founded KBP in 2011, in fact, on April Fools' Day, and I always joke [inaudible 00:05:18] that joke is on. But anyway, April 1st of 2011, so we're coming up on our 10 year anniversary. Mike at the time was working in our predecessor entity, it was primarily a KFC franchisee, approximately 60 restaurants, and the senior partner on that business was seeking to kind of transition and do something else, and Mike was [inaudible 00:05:44] grow the business from that point. So we partnered and over the course of the last 10 years have completed about 65 acquisitions in the KFC and Taco Bell space, spanning from one unit where we've done many one unit deals, all the way up to a 90 unit add on at one point in time. Today we have close to 800 restaurants. We're in 29 states. Again, KFC is our predominant brand and we're growing in Taco Bell as well.

My role within the business is actually quite similar to what Mike's is. I oversee kind of the financial part of the business strategy, M&A, real estate, having been as acquisitive as we've been, both the function of buying businesses and then also the buy and sell of real estate has been a pretty full-time role over the course of the last 10 years within our business. Additionally, we do spend a lot of time thinking about the planning of our business from a financial perspective. So the partners, whether it be equity or our lending syndicate who we spend a fair amount of time, working with them and making sure that we continue to cultivate that relationship. So, that's also a big part of what I do within our business.

So myself and Mike are both on the board of our business and we have a large family office that is the largest shareholder of our business, that's the other board members. So we are continuing to grow the business and seeking to find opportunities both within Yum! and also selectively looking at some things outside of Yum! as well.

65 acquisitions, Mike Cherney, think about that. I mean, he has all his hair and it's not that gray either. I don't know how he does it, man.

It's pretty gray.

Yeah, it's incredible. I mean, what an incredible story, 65 acquisitions over ... I mean, what's the number of years, Barry, would you say? I mean, I'm throwing a number out there, 2000 ... You may have said it and I missed it, 2008, 2000 ....



So our 10 year anniversary coming up in about 60 days.

Yeah, wow. Congratulations.

Thank you.

It's a tremendous growth story. What we'll find out, I mean, if you don't share more about it, I mean, KBP has started getting into the Taco Bell space in the last year kind of more meaningfully outside of the KFC Taco Bell multi brand stores, a base brand Taco Bell business. For those of you who aren't familiar, that's kind of a separate entity than being a KFC Taco Bell multi brand franchisee. So that's been an area of growth for them in the last year. But yeah, I mean, Mike, back to you the next couple of questions. How did you choose Pizza Hut? I mean, I think this is a really interesting one. I spend a lot of time talking with people about the different brands they want to get into, people who might come to me as an investor, or as a family office, or a private equity group. But how did you guys choose the brands and then maybe give us a little high level, as much detail as you'd like, about how you're financed?

Sure, sure. Yeah, so when we got in the business we kind of had a criteria of brands that needed to fit the mold of what we were trying to accomplish. So they had to have enough scale in the US where we could own a business that had five, 10, $15 million of earnings eventually without being too big a piece of a pond. Had been through multiple recessions and kind of withstood them. So all the brands we were focused on had over 20 years plus of existence. Some opportunity for consolidation and kind of as we sort of filtered down opportunities within those brands and met with management teams, geography became more important and sort of brand legacy in the markets we were focused on, and ultimately wanted to make sure the first business that we bought was enough of a platform that we could kind of scale off of it versus sort of just dipping our toes in. As I said, we probably had eight or 10 brands that fit that criteria, and then you start looking at valuation multiples and what you're trying to accomplish, and all the brands, the major brands have sort of positives and negatives about the brand, the brand equity, the value as an investor versus as an operator, kind of how customers and consumers perceive the brand and various factors that kind of I think allow you to hone in on sort of the sweet spot.

So I think one of the things we said is we don't really want to be paying more than five and a half times earnings as an entry point at the start because we want to feel like if we're buying a business and we can just keep the wheels running as are, it should generate a pretty decent return without sort of creating any incremental value. We've really focused on what are our cash flows, not sort of what are our earnings as we buy into businesses and think about businesses that have no capex versus a lot of capex. I think the Pizza Hut brand and the first opportunity we had was in the heartland of Pizza Hut country, which was right around Kansas City, and we ended up building our entire footprint and our main office actually down the street from Barry's in Overland Parks in Kansas City. We bought 23 units in Kansas and Missouri, and Pizza Hut had been founded in Wichita. The owner we had bought it from had been in the business close to 50 years and there was a lot of low hanging fruit from an ops perspective. Ultimately because of the dynamics both around valuation, geography and that specific brand, that became a great opportunity for us.

We also had looked at a Burger King business in Kansas City also that didn't check those boxes, even though that was in the same market. It's just an example, and ultimately started with that. We were talking to a number of lenders at the beginning. My partner is primarily family office and myself and Victor, so that's our investor base. It's very sort of family ownership style, and I talked to a number of lenders, kind of two floated to the top and our lender since the beginning has been Texas Capital Bank and Brian Frank. He's been a tremendous partner to us. He had a legacy in the franchise space and kind of went to Texas Capital as they were launching their business, and he was sort of at the same starting point, almost like you, Rick, when you were launching your business we kind of got in at the same time and have grown with him versus kind of some of the larger banks where we'd be the lowest guy on a huge totem pole, and that relationship has been great through the years and we've expanded, as you can imagine, the syndicate, and so now we have three other banks that are a part of our group and it's been great so far.

Yeah, it's great. I'll probably add for your business, particularly with Pizza Hut, the numbers aren't exact, but there's somewhere a little less than a 100 total franchisees for 6,500 restaurants. So when people look to get into a brand from the outside, Pizza Hut might not have initially fit some people's criteria, but they quickly weave themselves through these different brands and say that it's hard to find a 50 unit acquisition or a 30 unit acquisition in some of these other tier one brands that are out there. [crosstalk 00:12:50].

I think the other thing I would add, it was important that real estate was part of the strategy. We were not interested in sort of pure play ops investment at the beginning. So I think in our first acquisition we acquired 13 fee simple pieces of real estate and through the years we have bought over 80 and have done a variety of sort of strategic activity related to those, either redevelopments, some sale-leasebacks, some we're holding and we'll in the future redevelop. So that was important because there had been some opportunity on the real estate side to really take advantage sort of some spread in valuation. A lot of the Pizza Hut franchisees historically had owned a lot of their real estate, especially those had been in the brand a long time.

Yeah. Yeah, no doubt. No doubt. What about you, Barry? I'm dying to hear what you have to say. How did you get into these brands? A little bit different than Mike, but a unique story too.

Yeah, that's right. I think, so a lot of the core criteria that Mike mentioned are similar to the way I and we think about the business. We love the fact that our brands are nationally scaled with large media budgets and have stood the test of multiple economic cycles over the last 30 or 40 years. So that's a critical part of what is our thesis in what we're doing, and in particular over the last years. This coronavirus is all that I don't think anyone could've ever predicted of course that outcome, but meaning the event of a major and national pandemic, but the result of that and the resiliency of the sector and in particular large brands I think is in retrospect not that surprising, given the history of these brands have sort of produced over the last 30, 40, 50 years, depending on the brand. So a lot of what Mike says, or said I should say, is similar to kind of how we think about the world and why we are in the brands that we're in. One thing I would add to our thesis as we, Mike Kulp and I met about 10 years ago or really 11 years ago, and we're thinking through what does KFC at that time look like and how do we feel about buying a business in today's world.

These brands tend to cycle, and when they're down they can be down for a couple quarters or a couple years, but there is a historic track record that these national brands do almost always recover. There's very few examples of any national brands going out of business. There's a couple out there that you could point to, but one of the things that was attractive to us at the time, 10 years ago, was that there was some challenges that were being experienced organically within the KFC brand. So as you think about entering in and establishing a platform, doing it so at the point where you're in more a cyclical trough in performance and earnings causes you to buy a business at a basis that, as you look back, hopefully will end up looking like it was a good timing, was good timing for having made that decision.

So those are kind of effectively the main things, the main additional things I would add to what Mike had mentioned. In terms of thinking about the scalability as well, and Rick, you mentioned there's 100 KFC franchisees, there's several 100 KFC franchisee ... I'm sorry, Pizza Hut franchisees, there's several 100 KFC franchisees, and certainly as someone's considering a strategy to enter in and become a franchisee if a portion of their strategy and thesis is to be acquisitive and be a consolidator, certainly understanding the fragmentation of those franchisees and the nature of those franchisees, whether there's a lot of institutionally backed folks that have private equity partners or alternatively if there's a lot of second and third generation franchisees who may be seeking some sort of generational transfer to their family or otherwise they don't have that option to them and may be seeking liquidity I think is an important criteria to understand as you're considering what brand you may want to enter.

Yeah, it's a great point. It's a great point. For example, if you are going to a Taco Bell convention you could probably, it would take you a couple of hands to count the number of Gucci shoes you saw walking around with no socks, right? So in other words, there are more institutional investors in the Taco Bell space as an example than there might be in another brand where it's not quite so prevalent and you might develop your strategy around that. What I thought was interesting, and I mean, as we just talk about this, couple 100 people on this webinar now, there's probably, I don't know, we just kind of characterize it as maybe a third are franchisees of different sizes, maybe a half, and then you've probably got a third or two or so of family office private equity folks, and then maybe a third or so of others.

For the private equity folks who may not know that point, it's a really good point about momentum in these brands, and it's just something that is hard to describe, but these brands go through. They do have a tremendous record of success over a long period of time, not only at the store level but at the brand level, but they do go through these peaks and valleys. You can get and lose momentum in this business in kind of strange ways. It's sometimes kind of hard to predict, it's hard to see while it's happening. It's easy to see in arrears, you know? But that's kind of like a weird thing in this business that happens in cycles. I think it's a really good point.

Yeah. The one thing I would add to that [inaudible 00:18:25]. There's varying reasons that you see those cycles happen, right? So for example, you may have a series of new product introductions that are unsuccessful and you just kind of slowly lose momentum. You may as an alternative have a food safety issue where there's a belief, or in today's world social media there's something posted online that there was some sort of foreign object in food and all of a sudden that hits national press and the brand is down for some meaningful amount for some period of time. So there's a whole variety of reasons why that can happen.

I think it's fair as you're thinking about entering a brand you always need to consider the fact that if you're going to have let's say a five to 10 year hold cycle, there's almost inevitably going to be a down year and certainly down quarters time and making sure that ... The other question here is who's your partners? We have a large family office as our partner as well, and making sure that you've got the appropriate partners that can understand the cycles and the likelihood that the brand will revive and not overleverage yourself such that you're forced into a corner to make a decision that's unwise at the time and almost time yourself the wrong way. There's an importance of timing on the way in and also making sure that your timing is you're considering the exit as well. So having those partners both from a lender debt perspective as well as some equity perspective I think are critically important within the space.

Great answers. Yeah, great comments really. Great comments. I think there's all kinds of meat and potatoes we could get into. I'm going to pivot a little bit here and go to another slide if you guys don't mind, and just kind of throw around some different questions. How generally has your business been doing, guys, during COVID? How do you think about that? How have you been? Maybe give us a little bit of a timeline. Around March 11th or 12th we all just kind of thought the world was going to end, right? And then started coming back. Your various brands have performed better because of just the circumstance. Tell us how it's doing. I'm not asking for any inside information, but so you don't have to speak overly specific.

Yeah. Mike, you want me to go first or you want to ...

[crosstalk 00:20:48], yeah.

Yeah, great. So I think it's probably not a secret to most on the phone that the QSR sector has performed very well. Kind of once the dust settled a little bit around the initial shock of COVID, without getting into specifics for our business but having spoken to a lot of other franchisees and lenders and others, and the industry generally speaking the first four to six weeks when COVID hit was very, very challenging for the industry. The anecdotal word on the street you hear from a lot of people, which I think makes sense, is that people were hunkering down at home, they were going to Costco or the local grocer and spending two or three times what they were typically going to spend at a grocery visit and saying, "I'm not leaving my house for several weeks." And our business, not just KFC or Taco Bell, but I think the entire sector is largely dependent upon the mobility of our consumers, although now with digital and delivery that's becoming a little bit less the case, but still, very dependent upon that. As people become less mobile, as they did very much so during that first four to six week period, the entire sector as well as our business took a very substantial hit.

For those that are in the industry, recognize that the industry is a relatively low margin on a percentage of sales basis with a relatively high degree of fixed costs. So the tolerance for [inaudible 00:22:12] in revenue and maintaining positive cash flow, not just profitability but also cash flow more importantly, is not that substantial. So you started hearing that businesses were down 15, 20, 30, 35, 40%. I mean, it ran the gamut, but call it 20 to 40% is probably about the average of what you'd hear. I know it's a broad range, but some brands were faring better than others. In a business that being down three to 5% a year is sort of like code red, big problem. So it was extremely concerning for I think all of the industry for that period of time. Kind of as the pandemic settled a little bit, what transpired is that there was a significant amount of stimulus of course pumped into the economy both to consumers as well as directly to businesses. We found over the course of the last nine or so months since that initial trough transpired is that the sector is really an indirect beneficiary of stimulus as it's been put into the economy.

So very recently the trend in the industry tends to be at the beginning of the year that people have stretched themselves financially heading into the holidays, and so heading into January sales really do take a significant hit, in particular in a lot of brands you see a reduction in the check size, because people have less money. So they're coming in a little bit less frequently but when they're there they're spending a lot less money. This year what the industry is seeing is they're seeing really no winter because stimulus checks hit essentially at the first of January. So whereas people would typically be in a position of losing, or I'm sorry, being sort of at a point of exhausting their financial wherewithal, they've received a stimulus check right at the perfect time relative to that holiday season. So the industry tends to be performing very, very well right now, which is really kind of if you look at sales dollars, the industry tends to be selling as much product as we would typically be in say in October, but you're comparing that to a traditional January from last year. So percentage increases look outstanding. Dollar sales look like there just isn't going to be a winter this year.

So from a sales perspective I think the sector's seen that from a margin perspective many people have shut down their lobbies and in many cases continue to have them closed. When you combine higher average check, as mentioned, that people are spending more money when they come into the restaurant with closed lobbies, with an increase in digital sales, which carry higher check and higher margins, the industry is seeing kind of a renaissance in terms of margins that are being generated. An industry order of magnitude, average brand probably at a scaled franchise is 10, nine to 12% EBITDA margins is probably a good range, depending on the brand and the size of the business and volumes. I think people are generally seeing two to 300 basis point lifts. So when you think about it on a percentage basis, order of magnitude 25-ish percent growth in margins as a result of what's going on with COVID. So it's been certainly a complete ... It's been a windfall both from a sales and a margins perspective for the business.

I think, and it's beautiful because I say the exact same things. For those of you who listen, it's like I just dropped the mic. Great job, Barry. It was excellent. I mean, if that wasn't rehearsed, it doesn't need to be for the future. That was perfectly laid out. The only little funny thing I'll say is I remember at the beginning you talked about the lockdown that started happening and I had to start mailing toilet paper from our office out to Derek Ball in Colorado because he didn't have any. Because remember how no one had toilet paper back in March and April? I mean, I don't know, man. That was crazy, it was crazy. But that was great, fantastic overview and absolutely 100% what we're seeing in business too.

Mike, let's say you. I mean, I guess I'd say before I transition to Mike, you're heavily invested, Barry is heavily invested in KFC, less invested in Taco Bell but growing. There has been some difference in the different segments within QSR, right? So I've personally seen in burgers in many cases, some burgers, depending on the delivery mechanism and the type of brand, I won't name which ones, have been doing really well and others haven't been doing well. Chicken as a segment has typically been really outperforming maybe because it carries well and can be delivered and can feed a whole family pretty easily. Pizza has been one of those big beneficiaries of this renaissance that Barry is talking about. Mike, so what say you about your business, about the pizza business?

Yeah, sure. The only other sort of macro things I would add, and Barry touched a lot of it and was very eloquent in what he described. I think for the non pizza brand, sort of the businesses that weren't focused on off-premise or delivery, it definitely accelerated the prioritization of technology and kind of the intersection between delivery and how do our customers want to eat going forward. All of the sort of non pizza brands had been dipping their toes probably in a casual way into rewards programs and who are our customers and technology, and I think when COVID ends, which hopefully is soon for everyone's mental health, that will be one of the areas that this will have catalyzed for all of the major brands and will continue to have an edge over either mom-and-pops or small chain restaurants because that has become an important part of the business and figuring out how to do that economically long-term is kind of a big frontier for just the chicken, burger or the taco space. So I anticipate that being ... There's probably a raise on that front. An example is Chipotle invested a huge amount of money into their technology, and from a standing start only a couple years ago now have this wide open lead on their app and mobile, having things like that.

So, that's one piece. I think the second piece is customers want in a time of crisis, whether it's economic or in this case health, people want safety and reliability and what they know, and it's another reason this asset class has performed well is because you don't know the safety protocols of John's pizza at the corner, or who he is hiring, or what they're doing in the kitchen, but you can be sure a brand like Yum! or Inspire Brands is cascading down safety protocols and things to keep the employees and customers both safe and reliable and is at the forefront of safety for its people and its customers. So I think people go to what they know and what is safe, and you would see that probably in various businesses as well as ours, where people they don't want to try some generally in our business not a crazy new product. It's a lot of pepperoni pizzas or meat lover pizzas are things that they order that is a regular normal thing and they're ordering bigger tickets.

Obviously Pizza Hut was about 10% dine-in pre-COVID, and for most of COVID the dining rooms have closed. So we generally lagged, and it's publicly disclosed, roughly our competitors who are 100% delivery and carry-out about 10 points from a same-store sales basis during COVID, but it's been one of the sub sectors of QSR that has really performed quite well. Prior to COVID, and probably this was starting to change in the middle of 2019, definitely in Papa John's and for sure in Pizza Hut towards the end of the year where there had been a chase to value, and I think people had stepped off the throttle of value and were slowly moving away from the focus on Domino's had been on 7.99 for 10 years, and that was catalyzed during COVID as well because the new constructs that Papa John's and Pizza Hut had launched, coupled with sort of the lack of local options, the lack of dine-in really accelerated the business in the pizza sector. I anticipate 2021 being another very, very good year for QSR broadly and definitely for pizza.

Obviously the equity that pizza brands have with their customers of being one of the historic go-tos for delivery and carry-out where we really do it well. We and Papa John's and Domino's get your pizza there faster and hotter than any aggregator could that's out there, and we employ our own drivers, and it's a seamless integration of ops and delivery, and I think that's something that has become more and more important, that the long-term story on the aggregators is unknown. I think Domino's has come out and said it, we basically, Pizza Hut has said that if we're going to do it, it's very cautiously, but we're really focused on delivering our own food because the economic model for the aggregators themselves is a tough unit economic model. I anticipate continuing to see strong performance this year and putting aside some of these wacky laps where there's no March Madness, and then to various point every restaurant was closed for some period of time. I think the numbers if you look back on a two or three year lap will be very, very strong.

Yeah. You and I were talking about this with Barry last week, and it's interesting. Mike, you're a pretty, well I'd say generally knowing you, both of you guys, I'd consider Mike to be pretty conservative in your views. You're not going to be out there saying things that are overly aggressive, but I get the sense that you're pretty bullish actually, pretty bullish, and Barry, I liked your point too about what's going to happen in 2021. I mean, we're going to talk about politics, and taxes, and minimum wage and all this stuff in just a minute, but just generally speaking about the sales and performance profitability performance of these brands going forward. I mean, a lot of people might be saying, "Oh crap, as soon as we get to May or June we roll over next year, last year's numbers, everything is going to be falling apart from a same-store sales basis." But you don't seem to feel that way. I don't know how Barry you feel, but tell us, give us a little perspective on that.

Yeah, sure. I mean, I'll give mine and I'd love to hear Barry's. I mean, I think what's happened in COVID is that there's been way more stomachs to fill at home, but there's also been way more restaurant supply to do it. I know for myself, I'm willing to have a mediocre Italian meal delivered to me or a mediocre steak during COVID, but I can assure you the minute that it's over I may have that less frequently, but I'm only going to have it outside of my house. I'm not longer going to get Gibsons delivered and have an okay $50 steak or something like that. I think so there is this sort of expectation in my mind that some of these businesses, and obviously all of QSR was moving more off-premise prior to COVID, is that people are really going to leave the house and want to have an experience, and that while there will be some off-premise that comes from some of the casual dining chains or others that's sticky, I think the likelihood of that being anywhere near the levels it's at right now is fairly low, and you have sort of prior to COVID two things are happening.

One was there were clearly way too many restaurants in the US, whether it's QSR, fast casual, casual dining or fine dining, and everyone was expecting a correction, which I think post government stimulus and PPP sort of the jury is out on what's going to happen with restaurants. So my expectation is there's going to be long-term closures and less restaurants out there. So I think that's pretty important to talk about that that was going to happen before, and I think kind of coming into this there's just going to be this year a continued knowing what I want, I want to have it home and I want it to be good, and that's why I'm pretty bullish on pizza.

What say you, Barry?

Yeah. We were actually going through, we do a five year plan every year and we really spend a lot of time focusing on the first two years of that plan and year three, four and five are I guess why not do it if you're going to put together a multiyear plan, but we spend less brain damage on that. There's been a lot of analysis, discussion happening over the last couple of weeks within our business about what do we feel like 2021 and 2022 will look like as a result of that process. More globally I think the way I would describe it is that if you consider we're really looking at 2021 and comparing it to 2019 for the most part, especially in 2022 because we believe that kind of towards the end of this year, fall to winter, with the vaccine rolling out, one would I think suspect that the odds are the world will become a little bit more normalized, although I do think that the sort of the psyche of the consumer will likely take longer to return back to be an absolute norm.

Things like pent-up demand we're a little concerned about. So for example in our business your competitor may very well be am I going to go to Applebee's for dinner on Friday night or am I going to order KFC? And I think there will be some pent-up demand of I haven't been able to go to Applebee's or name another casual brand that's a competitor of ours for some time, and so there may be some periods of softness. The question is how quick it comes and how deep and long it lasts. Now, the answer from our perspective is that the benefit of COVID, the outcome from COVID will be somewhere between good and very good, depending on how much of sort of the uptick was retained. We think some of it will be, certainly not all of it as the world reopens a little bit.

The other thing I would notice is that hopefully a lot of scale operators have done this, but one thing that our business has been fortunate to be able to do is given the cash we've generated we really positioned our balance sheet in a way that's quite favorable. I think a lot of operators out there have that same dynamic going where they've delevered to the paid out of debt or are sitting on a significant amount of cash. So I think there's a feeling amongst the sector in general that, again, it's sort of somewhere between it will be we'll look back in three to five years and say that was good or it was really good and the juries have been out, but the good news is that people at this point in time, I mean generally, are very well positioned from a financial perspective to weather some of that uncertainty that inevitably is going to play itself out over the next 18 to 24 months.

So this is the podcast and everything we do is related to buying and selling things, so it's interesting to hear your perspective. So this means that you guys, if I'm just hearing this, you guys are optimistic. That means you'll be buying stuff, right? And paying high prices for it, because the future is looking fantastic. Is that what I thought I just heard from both of you? Maybe not, maybe so. What do you think?

My personal opinion is the next six to 12 months of restaurant M&A are going to be very interesting to watch because there's a discussion around what's the appropriate EBITDA and what's the appropriate multiple. Ultimately of course what matters most is what's the purchase price someone's willing to pay for a business. As I noted earlier, I think the average brand is probably seeing a 25-ish percent organic EBITDA growth number last year, maybe even a little low. I don't know, Rick, you've seen more a broad-based side of information than we do, but that's my hunch, is in that range. So if you take a business that last year or 2019 was doing let's say 10 million of EBITDA and it's now doing 12 or 13 of EBITDA, and if you apply let's say a multiple of six times for that business you've all of a sudden gone from paying 60 million to, everyone can do the math, 72 to 75 million for that business. If all of a sudden the EBITDA reverts all the way back to 10, a pre-COVID number, you just paid seven and a half times for a business based on its pre-COVID earnings.

So I think it's going to be quite interesting to watch and I think there's going to be more launch processes that fail than typical on the industry because there's going to be expectations from sellers that may be a little bit disjointed from where buyers are willing to pay for assets. So it is going to be very interesting to watch what happens I think in the near term from an M&A perspective.

Yeah, [crosstalk 00:38:30]. Yeah.

Yeah. I mean, so I think obviously one factor is whether lenders are willing to lend, and they're not paid to take risk and to take bets on what are the normalized earnings of these businesses. I think at the same time we have a historically low equity yield environment and we have a huge amount of cash sitting on the sidelines, particularly high net worth families, family office capital, even private equity to some respects. For guys like Barry and I that have purchased probably strategically and because we have existing infrastructure and bought some small deals, et cetera, we're paying six times or something for these businesses. Seven and a half times may not sound too expensive if they can still generate at 12 or 15% cash yield, where the leverage levels are. So I think a lot of it will be determined by the types of buyers that are out there.

To our original question around why did we get in this space or why was it an interesting investment asset class is you can sort of add pandemic, not just resilience, but sort of almost like negatively correlated to it. We outperformed during the pandemic is another positive characteristic of the asset class. So if people are looking for yield or a 30 year treasuries are at a point, and you can't get any yield out there in any asset class, it really does become an interesting one because it's been around for decades and decades, and broadly speaking to various point, I mean, it wasn't until only recently that sort of this margin war took off that had some issues for franchisees on their P&Ls from a margin perspective. If your worst year is down two or three points of same-store sales and a grand slam year is two or three points up, I mean, there's really no other industry out there that has these little movements and has just broadly over a long period of time been within such a narrow bandwidth.

So there were a lot of people interested in this space prior to COVID. I think guys that are already in this space are going to sort of have different expectations than people that are looking to get into it, and I think ultimately lenders will impact people's ability to grow. The last thing I'll say is the performance of these businesses are good, and I think you hear from Barry and I that we're pretty bullish on our businesses. I'm not sure if we're going to be guys in meeting other people halfway that are saying, "Well, that's not normalized EBITDA." I can continue to drive cashflow to our partners, have paid on debt and reinforce the balance sheet for the next couple of years, and see how it plays out and be positive about the direction of the brand versus compromising. I'm going to assume that this is going back to where it was in 2019. So those are some other dynamics with it.

Yeah, and you say ... I mean, all great points. I think the M&A market for 2021 will certainly be an interesting one. I mean, I've been character, I've been asked that a lot in the last couple of days and weeks and I guess I would say from our little microcosm of what we're doing I would say that we're seeing probably an overall increase in activity in Unbridled from sellers con as well into seller businesses, maybe up 15 or 20% maybe year over year, which would ... Our deal size is growing too, and we're working off of a base that's kind of wonky and weird, but my sense is that you're probably going to have more people selling obviously this year than last year, maybe about the same or less than were selling in 2019. Our deal size and our market share is increasing and that's a blessing. I think you're probably going to be seeing an inordinate amount of smaller franchisees and maybe franchisees located in the Southeast potentially in some of the Midwest areas that have low minimum wage potentially selling.

Those franchisees who may own five, to 10, to 15 locations just don't have the breadth to be able to handle all of the massive, everything that's going on while you all may be happy with PPP loans and all the protocols, and closing down the dining rooms and the EBITDA lifts and all these things that you're doing. It's really taxing on a smaller operator. So the continued consolidation has to happen I think in 2021, and there are some headwinds at play too, but I see the same thing here too with a lot of franchisees who are now sitting on businesses that are, in their minds, whether it's worth 25% more than it was worth or not, it's always worth what someone's willing to pay. They're making 25% more in EBITDA than they were before, and that I think is creating an expectation that all of a sudden my business is better, materially better than what it was. That's something we're going to have to see how that plays out between what a seller is going to sell something for and what you guys are willing to buy it for. Usually the answer is it's somewhere in between, depending on the [crosstalk 00:43:26].

Yeah, and I think one of the things you bring up, Rick, is interesting from an investment perspective, which is most of the people that have had success investing in this space, it's not because some people walked into a brand that grew eight or 10% same-store sales for 10 years and they grew their top line and their bottom line organically without sort of acquisition or meaningful development. Most people have been able to get relatively attractive leverage. They've paid down debt and they use business's cash flow consistently year after year, after year, and if you look at them you know top line isn't really growing that much, bottom line isn't growing, but because you can get very inexpensive attractive debt and you can buy these at very attractive multiples, you are generating a meaningful amount of cash flow. So I think that is a consideration.

I think there's obviously other things you mentioned, changes in tax code or minimum wage or things like that, and one of the things that we've talked a little bit about is people that have been in this business a long time have no basis in their business, so things like long-term capital gains, if you're a small business owner, can have a meaningful difference in your retirement and things like that. So I think I agree that some of the smaller operators this may be an opportune time, particularly if you think long-term capital gains is going up in 2022 or thereafter.

You've been given a shot in the arm too, right? I mean, the problem there always is with the smaller operators is most of, I mean, I don't want to characterize everyone in the same bucket, but a lot of them don't have the foresight to see that when you have just gone through an event, as unfortunate as COVID is, but if you've gone through an event that's really strong and has strengthened your business, the time to sell a business is to sell it when it's at the top, not to kind of ride the horse until it's back down or times are ... As I see it and I hear it all the time, why would I sell my business is going great? I'd sell it when it's not doing well anymore. I think oh, man, that's not the right way to think about that. What about politics? I see a lot of ... Barry, go ahead and answer that. I know you probably have some comments, yeah.

One quick thing to add to that point, Rick, is I think the majority of people are going to see their earnings peak around Memorial Day of this year, right? Because that's when COVID had hit and people sort of were rolling those very weak results from call it middle of March to middle of April, or late April for most people. So by Memorial Day you're going to get to that point. I think the majority of brands are going to see some compression on earnings from call it June to the end of this year. The question is, and this is where the big debate will be, is what's that compression in earnings. Your earning's going to be they went let's say plus 25 all of last year, they're going to be down 5% in 2021 or are they going to be down 25%? I think the answer is probably somewhere in between that. I think there will be some meaningful hit to the majority of brands out there.

So, Rick, to your point, the question just becomes if you're a seller and you're thinking about selling, or you're an operator so you're saying you're thinking about selling. To add to Mike's point, you've got capital gain risk cutting into 2022. If you start thinking say, "Well, let me launch a process in September and hopefully get this thing closed by the end of the year." Well, the problem is is that in September you're going to have probably more benefit, depending on how bullish you're on the brand, but in September you're going to have a pretty good idea as to how this year is going to shake out. If you wait that long and it's not a very strong summer, given the strength of the rollover you're facing, I think there will be some reconciliation to what valuations look like as a result of that. So it's kind of an interesting bet if you're an operator thinking about selling your business. Do you try to do it soon or do you wait and do it over Labor Day once it's proven out that the rollover is going to be pretty strong in 2021?

Yeah, no doubt. No doubt, 100%. Let me jump in and ask a couple questions, say a couple questions. Let's see if I can bang out some of these questions really quickly. I saw one like how do you find investors like you guys for your businesses? Well, that's a plug for Unbridled Capital. You call us. You call Unbridled Capital. We help you find that kind of an investor for your business. You go to the trade shows, you attend industry events like this, you get to know people through networking. It's hard to do in a virtual environment, which is how we kind of jumped into these podcasts and webinars and things. Let's talk about that. Here's a question from a dear friend. $15 minimum wage, cap gains increases. What say you guys on how that will affect your business and whether we'll see it in 2021 or when we'll see it?

Yeah, I mean, there's not a short answer to that, I don't think. From my perspective, going there nationally, I mean, I think it hurts mom-and-pop either operators, mom-and-pop businesses initially and drives up unemployment, which is fairly high right now. If it's rolled out nationally it's going to impact everyone, competitors and others alike. So you can see that there's going to be some inflation related to it, and ultimately it generally is sort of tough to see how it's a benefit obviously to our business. But I mean, if you can look at it over a medium or long-term horizon, if everyone's wages are going up, you're going to see price increases, and I think once again, you're going to see an acceleration in investment and technology and ways to sort of mitigate the need for labor.

The other thing, and Barry would have a much wider survey of this, but we're operating in nine states, and even many of those states have an $8 minimum wage. Our effective minimum wage is whatever Walmart or McDonald's is paying their employees in our towns. So while you might say $8 and you might think, "Oh my gosh, we're going up such a large amount." The actual impact to many of us, I mean, we don't want to hire employees that are going to be on minimum wage that long. We want to be hiring people that want to grow in our organization. So ultimately the length of time that someone's on minimum wage is hopefully not going to be that long and we're going to be paying them more because they're going to be doing more. I would say lastly almost two thirds of our employees are delivery drivers who make tips and generally make above $15 as it is. So a big piece of our labor force, well, I think it will have a trickle down effect to other folks as it's implemented are already above that level. So I think if you have a medium, long-term view on it, it'll be okay. Obviously the bigger chains with the bigger technology budgets and things like that will have tools that mom-and-pops and local operators won't to sort of offset some of those.

Yeah. The two things that I would add to that, I agree with all of Mike's point. First of all, I think there'll be a lag effect. Minimum wage will increase in a stairstep and there's always going to be a lag effect of the ability to pass along pricing. We've done studies in our business. We own restaurants everywhere from New York City, to on the Mexican border of Texas, to Miami, to Detroit, Michigan and in a lot of places in between. So we've got all kinds of different wage environments. Generally speaking, if you go into a restaurant in New York City versus a place that's got a $8 minimum wage and you look at the pricing you'll see that the pricing will more or less make up for that. So while there may be a lag effect, I don't believe the long-term impact will be that substantial. I believe that's an overadvertised risk of this industry personally. The second thing I'll note is more globally I think that the new administration in Washington will provide tailwinds in 2021 to our industry, primarily as it relates to supporting the consumers. So the initiatives that will be brought on right away will be supportive to the consumer and the sector has very clearly displayed being an indirect beneficiary of that support to the consumer.

Then as you head into 2022, not that it's necessarily [inaudible 00:51:13] on year, but I do think there'll be more of a headwind that will switch in terms of regulatory issues, wages, which again, I think will be in terms of a lag effect more of an issue than a permanent impact. But I do, my opinion is 2021 is going to be quite strong as it relates to the consumer, given the support that we're going to see pushed out in the form of stimulus 3.0 and maybe 4.0 and then kind of the reality is going to settle in a little bit more as you head into next year.

Yeah, I couldn't disagree at all. I think you're exactly right, Barry. The only thing we didn't really talk about is taxes, and clearly if you're in our job doing sale side M&A and the clients and the deals that you're looking at, that's a motivator as well, right? You think you might have to pay higher capital gains taxes, whenever that might be, whether it's delayed until 2022 or retroactive for January 1st, 2021, which most people think won't happen, it's still a factor. But I agree with you, I think we're going to see a good year this year and we're going to see some pretty severe headwinds in 2022 that maybe they're more severe than what people really realize, but a lot of that's macroeconomic too, some of it regulatory.

Okay, we've got just a few minutes. Let's go rapid fire. So any brands and segments you're not operating in that you really like right now, Mike then Barry?

I have a bit of a [inaudible 00:52:37]. I'm interested in casual dining, as we speak, and I've been spending some time on it trying to get a better sense of the landscape. So broadly speaking I'm looking at both brands as a franchisee as well as sort of mid-size, maybe sleepy brands themselves, besides sort of continuing to look at other QSR opportunities.

Interesting, yeah. What about you, Barry?

A challenge for us is just given the size of our business, and if we [inaudible 00:53:09] any individual segment to be let's say at least 20% of EBITDA when you're 800 restaurants, people can do the math, you effectively need to be in a place where you probably can get to the equivalent of a profitability of 250 QSR outlets, which may be on the higher volume concept, 100 to 150. So we really are limited in the brands that might be of interest to us just based on that reality of scale. We were at one point a franchisee of a brand that we were larger than the franchisor in terms of its EBITDA and that happened just we grew at such a clip. So I think our filter is pretty limited just based on our scale.

Casual dining is interesting, I think there are some people, I've heard others, and like Mike said, that they're given where they are in the cycle, similar to my comment when we got into the business about 10 years ago, there are some ... Casual dining, there will be some ongoing ... Casual dining is not going to die altogether and there will be some winners, and this is probably pretty close to a cyclical trough one would think. So it's an interesting play I think to think about casual.

Geography too. I'm starting to hear more and more people reconsider the higher wage states because they already have enacted a lot of the minimum wage legislation that would already lead them to believe that they're buying a P&L that is largely already accounted for higher wages. So I thought that was interesting. People talking about specifically the Northeast and West Coast in a way that's much less unfavorable than it has been in the past.

[crosstalk 00:54:44] on that. I think some of the challenges are not directly economic in some of those as well, there are policies beyond just a minimum wage, as far as just protections and difficulty to be in business. It's something we've thought about that too, Rick, and it's a very valid point, and I think you have to weigh those risks in conjunction with the actual $15 because there's just other things that have happened as well or that have been tough to look at.

Yeah, yeah for sure. For sure. Nice comment. Okay, a couple minutes left here. Let's say we'll do one question on this slide and then I'll jump into some of the Q&A and bang that out and then we'll end up here. So any longer term trends or anything that you guys would see? I mean, let's maybe make it specific to buying and selling franchise restaurants. Any comments about what you think might change coming out of COVID from an M&A perspective in the franchise space? Anything that may jump out at you?

Yes. So Mike mentioned this earlier, and I agree with his point, which is if you look back 10 years I feel like the franchise space was considered somewhat of a specialty industry, almost like healthcare to a generalist investor, where it's hey, you either have to have an expert or don't touch it. I think prior to COVID I believe it was becoming more of a mainstream category for institutional investors to consider, and I think coming out of COVID that will even be greater given the lack of ... How do you get access direct to the US consumer here with the Amazon impact on a lot of businesses and the resiliency that the sector displayed during COVID? So I anticipate that there will be even more offices and funds that are considering this sector that had not been prior to COVID.

Mike, anything up your sleeve? Any thoughts?

No, I think that's right. I mean, I think the ... It's not like investing in apartment buildings where if you miss one there's one down the street. So I think there will be continued demand for this because there are high barriers to entry, and once you're in the cash flow profile historically across just the average across the 10 brands we were kind of talking about is very stable and very robust. So just anticipate that growing as time goes on.

Yeah, yeah. Well, fantastic. I'd love to get into the last question because you guys are both brilliant and you see what I see, which is an inflated stock market and fully blown asset classes. So where do you put your money personally or if you're a business investor I think that's one of the reasons why this business and this industry and franchising may, like you all say, become even hotter than it has been, but we don't have time for it. I wanted to thank both of you, man. What a tremendous time. Here's their contact information if you guys are amenable to a phone call or a reach out from someone who's listened. We're just really thankful and I think it's going to be an exciting next few quarters for us all. I wish you guys, man, and just great guns in your businesses, and thank you so much for your time. For everyone who listened and joined in today, thank you all for joining and look forward to the next webinar that we send out here in a couple of weeks.

Thanks Rick, thanks Barry.