00:00:05 Rick Ormsby
Welcome to the restaurant builder, season five, Episode 9, I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the boiler room, I'll be talking about fast Act legislation, zombie PE funds selling to an operator.
00:00:20 Rick Ormsby
Versus a PE fund, recent deal Closings and a comment on the upcoming franchise M and a deal flow, the restaurant boiler Room is a one stop shop for multimillion dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry.
00:00:34 Rick Ormsby
We talk money deals, valuations and risk delivered to the front door of franchisees, private equity firms, family offices, large investors and franchisors on a monthly basis. Feel free to find all of our content at unbridled capitals website at www.unbridledcapital.com. Now let's enter the boiler room.
00:00:53 Rick Ormsby
Well, hello everybody and hope you're doing.
00:00:55 Rick Ormsby
Well, I've just come back from a couple of weeks of traveling. I was at the Sonic National Convention in San Diego and then swing by had a wedding and saw some, you know, some clients in the Nashville, TN, Middle Tennessee area also was down in the the Gulf Coast area a little bit too doing some work. So it's been a fun little journey here in the last couple of weeks. I've got a son.
00:01:15 Rick Ormsby
I've given him the disease of being a Tennessee Titans and AFL fan.
00:01:20 Rick Ormsby
I tell him I said. Son, you're going to be a Tennessee Titans fan. It's a long miserable Rd. with a lot of pain and suffering, but we got that, took him to his second and third game ever. He's about to be 16, but we went to.
00:01:31 Rick Ormsby
Watch the Titans.
00:01:32 Rick Ormsby
Get beat in New Orleans, and if you hadn't been to the New Orleans Saints Stadium, then those fans are crazy and loud. And I mean, I could barely hear myself think.
00:01:40 Rick Ormsby
You see those TV commercials where there's like 2000 people in the crowd and you're the only one, and you and your whoever's next to you with the opposing team colors, right. And you feel like your life.
00:01:50 Rick Ormsby
Is being threatened and so.
00:01:52 Rick Ormsby
We found ourselves in the.
00:01:54 Rick Ormsby
Like that, where there's like 2000 Saints fans and we're the Titans fans, the only two with our light blue shirts on, you know, and they all have their dark black and gold. And so it's hilarious. But they were very gracious, but loud fans. And then we went up to Nashville and watched the Titans play San Diego Chargers, which was a apartment Los Angeles Chargers now, which was a fun game. Titans won in overtime.
00:02:14 Rick Ormsby
So we've been traveling around a little bit and in upcoming weeks here I'll be at the Taco Bell Convention Popeye's event. Actually, the Burger King Convention is this week, and then we end up on the rotation with RFC, restaurant, finance and Development Conference in Las Vegas.
00:02:28 Rick Ormsby
This in November like I think it's 11th, 12th, 13th or 13th, you know, twelve, 13th and 14th of the month of November. So and that'll be kind of the end of convention season. And so I think I told you on a prior episode, I kind of up doing a panel out there at restaurants and development conference. I'm going to try to get that as a podcast later on this year, maybe in the December time frame. So you guys can.
00:02:50 Rick Ormsby
And listen to it. Last year I was told it was the most heavily attended panel at the conference and there's over 3000 people there that.
00:02:57 Rick Ormsby
Oh, so should be good stuff. And I'm going to be opining with a couple of other folks on the state of the M&A market. A lot of this, you will have already heard, but there'll be some other folks there with some good perspectives and opinions. So please tune in to later this year. I was going to do a webinar and make it a podcast too on the real estate world and had a couple of the decent folks lined up from the Reed.
00:03:18 Rick Ormsby
Community and the 1031 community to talk about cap rates.
00:03:22 Rick Ormsby
Honestly, as I started kind of digging into it a little bit, the news isn't all that newsworthy. I mean, you know, the reeds that that we're talking to are doing deals, but they're not doing a whole lot of deals in the franchise space right now because cap rates have come up a lot, their risk tolerances have dropped a, you know a lot. And as interest rates have moved up, I think the message from the REAP community is they're being conservative.
00:03:43 Rick Ormsby
You know, most of them are, and the big REITs that buy big swaths of real estate are very interest rate.
00:03:48 Rick Ormsby
Sensitive whereas smaller deals that are out in the marketplace where you have someone selling one or two or three, you know pieces of real estate that they might own and you've heard me say this before those deals are are tax motivated 1031 motivated and those tax motivations are very, very powerful from people, especially from California who are trying.
00:04:05 Rick Ormsby
To defer huge tax bills, so those are a little.
00:04:09 Rick Ormsby
Less interest, rate sensitive and.
00:04:12 Rick Ormsby
And are, you know, nonetheless, under pressure a little bit right now cap rate spreads have have come up probably between 60 to 100 basis points over this year. And I think that's a pretty modest number. I think it's going to look a lot worse going forward into 2024. I bet we will probably six months from now be saying that we're at 120 to 150 basis points.
00:04:33 Rick Ormsby
I mean, we have to.
00:04:34 Rick Ormsby
Be right. I mean, interest rates are almost to borrow any kind of money at almost 8%. I just saw some sort of a article on CNBC or somewhere or Bloomberg that was talking about, you know, home mortgages have hit 8% now for the first time in however long so.
00:04:47 Rick Ormsby
Just directionally, interest rates going up affects the borrowing power on real estate transactions, squeezes the cap rates and makes them less favorable. If you're a seller of real estate, it's a pretty stark deal, right? Like when cap rate goes from 6% to 7% and I'm just using just simple math, even you lose roughly 15% of the value of your real estate.
00:05:10 Rick Ormsby
So pretty huge swing in a short amount of.
00:05:12 Rick Ormsby
Time. So as you think about your real estate portfolio and your holdings, you know that that it's it's a germane time to be kind of considering your long term future. Obviously it's difficult to refinance right now at comfortable rates. And my guess is that the sale leaseback market is kind of taking some time to catch up to the real estate market. So maybe some deals and some.
00:05:33 Rick Ormsby
Some of you who have done real estate transactions might have found slightly more favorable sale leaseback terms than financing terms. If you are buying and borrowing for real estate.
00:05:43 Rick Ormsby
Instead, but, but my guess is that arbitrage is probably coming down as we start seeing just anecdotally from talking with friends and clients and brokers and things like that, start seeing inventory kind of pop up and price reductions on real estate, commercial real estate dropping or increasing is price reductions are are happening, so that arbitrage between.
00:06:03 Rick Ormsby
Going to sale lease back and borrowing money to finance real estate instead and holding it and owning it, that might be lessening as we move into 2024.
00:06:14 Rick Ormsby
OK, so with no webinar or podcast on real estate, I'm just going to talk about a couple of items this week that may be interesting to you. A couple of things that kind of caught my attention. There's been some quite a bit of the noise about AB 257, which is the California's fast legislation, right? You probably heard about it right about it, but I'm going to do a yeoman's job of.
00:06:33 Rick Ormsby
Walking through it with you, but essentially a nine person council was set up in California, appointed by Governor Newsom to fight for a higher wage in California for fast food workers. This is, for all I believe, you know, like, I think it's all chains that have at least 60 locations nationwide that are defined within a.
00:06:53 Rick Ormsby
Kind of a fairly narrow definition of, you know, fast food and QSR and the legislation is basically this minimum wage, I believe in California is $15.50 set to go up to $16.00 on January 1st. The legislation is, I believe it's sitting on Newsome's desk, right. I I think and it's.
00:07:13 Rick Ormsby
It says that April 1st of 2024, the wage floor for California fast food workers with at least 60 locations nationwide, that wage will be $20. And then from 2025 through 2029.
00:07:27 Rick Ormsby
I believe that the Council will will have the authority to approve hourly minimum wage increases annually at the lower of either 3.5% or the annual change in the CPI or consumer price index each year. So think about it. If you do 3 1/2% and they can do that through 2029, three and a half percent compounded growth of $20 to.
00:07:47 Rick Ormsby
00:07:48 Rick Ormsby
Get you to about 25 bucks, so it would be by 2020. Ninety $2020.00 for minimum wage starting soon within six months, and then probably around $25 or maybe a little.
00:08:00 Rick Ormsby
More, by the time we hit 2029 in the state of California, couple of things, you may say I'm not in California, I don't care disturbing legislation.
00:08:10 Rick Ormsby
Blah blah blah.
00:08:12 Rick Ormsby
If you do.
00:08:12 Rick Ormsby
Operate restaurant businesses or franchise businesses, not even restaurants, but other businesses. Right? Because you're.
00:08:17 Rick Ormsby
Going to have to.
00:08:18 Rick Ormsby
Compete for labor against, you know, increasing wages.
00:08:21 Rick Ormsby
My commentary is that this is a little bit of a domino effect that's probably going to find itself.
00:08:27 Rick Ormsby
Happening in some other dark blue states like.
00:08:31 Rick Ormsby
You know, who knows?
00:08:32 Rick Ormsby
I mean, it wouldn't be a.
00:08:33 Rick Ormsby
Surprise to see Oregon.
00:08:35 Rick Ormsby
And Washington and New York and New Jersey and Minnesota and some of these places that probably Illinois that just have notorious kind of policies like this. So it's kind of I'm hoping it's not.
00:08:46 Rick Ormsby
The tip of the iceberg.
00:08:48 Rick Ormsby
Or a domino effect kind of thing, but it's possible, right? And that's why all of us should be concerned about California because it sets a precedent that could move its way throughout the country to other states.
00:08:57 Rick Ormsby
And why do we care one way or the other? Now I I have.
00:09:00 Rick Ormsby
Always cited in many you know.
00:09:02 Rick Ormsby
Me. Well, enough. If you listen to this podcast right, like my personal views are I side with franchisees. You know, that's kind of where I make my bed every day. I've always loved franchisees and and the franchisees have helped make the American dream happen across the country. I respect them.
00:09:17 Rick Ormsby
And I respect the entrepreneurship and zeal that they have for the businesses. And so I see things through their eyes. This is obviously a bad situation for our franchisee and I would submit to a very bad situation for a consumer too. Now the winners of.
00:09:31 Rick Ormsby
These of the fast type of legislation are the worker, so the worker gets more money, right? The franchisor is also a winner and that's why they're really, in my opinion, not a fair person to be sitting at any table in any negotiation over labor, because guess what happens to a franchisor that doesn't actually operate company locations in those markets.
00:09:51 Rick Ormsby
They actually get a fixed percentage of the gross revenue right of the gross revenue or net revenue depending on the brand. But let's just say the gross revenue that a franchisee brings in. So if a franchisee brings in, let's just say $100 in rent.
00:10:05 Rick Ormsby
New they get, let's say if they have a 5% royalty, they get $5. Well, if a franchisee now has to pay their employees more and so they have to raise their prices and they raise their prices just and they still can't be as profitable as they were prior to the big wage increase. So now they raise their price as 10% and now they have $110.
00:10:26 Rick Ormsby
Where they used to have $100.00 of revenue. Well, the franchisor gets $5.50 instead of $5.00. So they actually are pulling more profit. So their incentive, if we assume that franchisors act in the best interests of the franchisees, which I think is a wild.
00:10:40 Rick Ormsby
Question then we would say that the first obligation is going to be to keeping their brand, their trademark and their franchisees healthy enough to continue to pay them royalties, right? So they do have some incentive to make sure our franchisees profitability stays there because they don't want to franchise you, not paying them royalties, right, but.
00:10:58 Rick Ormsby
Other than that, they want.
00:11:00 Rick Ormsby
Higher royalties and more profitability and the ones that are public can can say hey.
00:11:04 Rick Ormsby
Our stock, you know, our our incomes rise.
00:11:06 Rick Ormsby
And so. So unless, of course, they are actually operating those stores themselves, which in many brands and this is a topic for another conversation and many brands you know 90% is a round Number or 95% franchised in many systems, you know some systems are 100% franchised, others are 95% franchise, the model and you know young brands.
00:11:26 Rick Ormsby
Somewhere collectively in the mid 90s, some brands are closer to 100% franchise think like A.
00:11:33 Rick Ormsby
Like a Jimmy John's or like an IHOP or something like that. Those brands are more heavily franchised and then you have, like, Arby's, which is more of like a brand that's, I mean, these are rough.
00:11:41 Rick Ormsby
Numbers, right? But more be.
00:11:42 Rick Ormsby
Like 5050 franchise.
00:11:44 Rick Ormsby
Owned or company operated. And then you have.
00:11:46 Rick Ormsby
Like you know.
00:11:47 Rick Ormsby
Darden, some of you know their concepts are almost all 100% Chipotle is 100%. Chipotle is going to take a a whacking.
00:11:53 Rick Ormsby
There with this fast sack legislation, because they're headquartered in California, they're publicly traded stock and they operate 100% of the restaurant. So they're going to feel the burden of.
00:12:01 Rick Ormsby
This legislation but.
00:12:03 Rick Ormsby
Let's make that known to you. So like the franchisor and the worker are the big people who benefit from these policies. And then I guess also the politicians and the ones that do not benefit are the.
00:12:14 Rick Ormsby
Consumer and the franchisee and we've talked about the franchisee, right, say a little bit more. There was someone I just saw something come across my feed talking about.
00:12:23 Rick Ormsby
McDonald's somebody at McDonald's or or someone doing the calculations saying that this is going to cost average drop of $250,000 of EBITDA per restaurant per McDonald's in the state of?
00:12:34 Rick Ormsby
California holy cow.
00:12:36 Rick Ormsby
I can only imagine if the McDonald's is doing, you know, on average 3 1/2 to $4 million in sales and they have maybe like, you know, 12 or 13% margins. Let's just say that they're doing that having 400.
00:12:46 Rick Ormsby
$1000 in EBITDA.
00:12:48 Rick Ormsby
Right or cash flow at the store level and they're saying that it's going to drop by $250,000. I can't confirm whether that's accurate or not, but that's losing like 60% of their EBITDA.
00:12:58 Rick Ormsby
Overnight, you're not.
00:12:59 Rick Ormsby
Going to be able to price yourself into a higher Big Mac in that situation, right? So what's going to happen is price.
00:13:04 Rick Ormsby
Goes up immediately, but it can.
00:13:06 Rick Ormsby
They go up like to, you know.
00:13:08 Rick Ormsby
Big Mac might be.
00:13:08 Rick Ormsby
Selling for what, 350 might not in.
00:13:11 Rick Ormsby
The other probably.
00:13:12 Rick Ormsby
Put it up to 425, but they can't put it up to $5 immediately, but they'll, but they'll do it. It'll be $5 in a year or two and they'll keep.
00:13:18 Rick Ormsby
Raising the prices.
00:13:19 Rick Ormsby
As they're able, so really what happens is the franchisee takes a massive whack.
00:13:24 Rick Ormsby
The franchisees business is certainly.
00:13:26 Rick Ormsby
Sellable, you know, right until the, at least in the short term, until they can stabilize the EBITDA, right, raising prices enough. And then the third thing that happens is is clearly the the consumer pays way more money, right? I mean you all of a sudden you have a $5 Big Mac.
00:13:41 Rick Ormsby
00:13:42 Rick Ormsby
Big Mac, whatever the whatever the price is. So.
00:13:45 Rick Ormsby
And those are the kind of the seesaw effects. Now it is interesting that once here's some hope in the state of California. Once these franchisees take the lashings for their dropping, crashing EBITDA and all the issues associated with it. And once they raise their prices, you know so much. And once the consumers adjust to having to pay.
00:14:06 Rick Ormsby
Way more for their food, so much so that they can't really afford to eat it right. Once they do that, then there's a lot of certainty and then probably valuations in California will normalize quite a bit. You know what I mean?
00:14:20 Rick Ormsby
And there and it could be optimal.
00:14:21 Rick Ormsby
Stick. So I just kind of make that commentary that it's not a long term negative view if you can get the labor increases to stop and you can price yourself to hurdle those labor increases over the medium term. And longer term, it might actually be fine and buyers are typically of anything or typically myopic.
00:14:42 Rick Ormsby
What I mean by that is like probably heard me say this before, like think about someone who's buying like a house. You have this beautiful house and a wonderful location, great layout. But the countertops are yucky looking, right. So they walk in, they see the countertops in the kitchen, and they say I don't like the house. You know what I mean? But they can't envision.
00:14:59 Rick Ormsby
And just replacing the countertops in the house is perfect, right? So buyers typically are myopic and if they don't have full information, they don't act and react in positive ways affecting the price typically. So that certainty will need to come in the form of higher prices and stabilized EBITDA for those businesses that try to transact in that state. But watch to see the next domino that falls.
00:15:20 Rick Ormsby
The next day. OK, a lot about that. You know, I can get a little fiery about it because I see the effects that my brethren franchisees.
00:15:28 Rick Ormsby
I have to.
00:15:28 Rick Ormsby
Bear by these political things that happened.
00:15:32 Rick Ormsby
OK, #2 zombie PE funds. You're like, what the heck is a zombie PE fund?
00:15:39 Rick Ormsby
A zombie? I just caught this story on Bloomberg, maybe.
I don't know.
00:15:44 Rick Ormsby
Five or six days ago and I read it, I was like a small business. People are. I was awake at 3:00 in the morning, and I'm just like, trying to find some peace and just.
00:15:52 Rick Ormsby
Reading some Bloomberg articles and that.
00:15:55 Rick Ormsby
Was what popped up and.
00:15:56 Rick Ormsby
I was like, oh, this is interesting. Never heard.
00:15:58 Rick Ormsby
For so I'm going to do a yeoman's job of it, but it has some tentacles into the franchise space, so that's why I want to talk about it. Do your own research, you know, read up on it if you want to. But private equity firms, it's a $12 trillion industry, evidently. And some firms growing percentage of them are lumbering on years and years without.
00:16:18 Rick Ormsby
Any new fundraising insight because their existing funds are full of investments that have not been able to be sold because they either bought it too high or maybe they bought it and they ran it into the dirt and can't.
00:16:33 Rick Ormsby
Sell it. Maybe they actually have just owned it a short amount of time and interest rates have caused these funds to be unable to unload them at the price that they bought them at because valuations have changed or the debt situation is bad or, you know, might be some like consumer demand that's caused the particular industry they're invested in or the particular company they're invested in to like not perform over a longer term.
00:16:54 Rick Ormsby
And these are called evidently zombie private equity funds. And now it sounds like there's going to be a shake up as these money managers continue to operate these funds, they want to get out of and they can't raise more money through a new fund because their existing fund can't be shut down because they can't sell the assets out of.
00:17:11 Rick Ormsby
And then the people who own these assets, you have the limited partners in these private equity funds, which are typically like pension funds and you know think.
00:17:20 Rick Ormsby
About like the.
00:17:20 Rick Ormsby
Whoever Nevada Teachers union, you know that invest 5% of their teachers union pension fund into a private equity company, right? So they're faced with a hard choice. So they continue to keep their investment.
00:17:32 Rick Ormsby
In these zombie private equity funds are just open year after year after year, but not growing and not returning money to shareholders. Or they just sit there and wait indefinitely. Or do they sell these assets at a disco?
00:17:43 Rick Ormsby
And then evidently, there's a secondary market for other managers and other funds, private equity funds to buy these assets or to buy these funds themselves. From these quote, quote zombie private equity firms, which is an informal name and buy them at a discount, which could be 50% or more, which I think is what we may start to see maybe as an alternative to bankruptcy.
00:18:05 Rick Ormsby
In cases where.
00:18:06 Rick Ormsby
For private equity, funds are looking to unload their assets so they can start afresh and start a new fundraising effort and not have to continue. And this article goes on to say that private equity groups that have these long assets that they can't sell for whatever reason are obviously unable to raise new funds. And as they're unable to raise new funds, they don't generate enough fees.
00:18:26 Rick Ormsby
To keep the talent pool of executives there. And so it's a retention thing as well. If this is a trend that Bloomberg's talking about and it may be a growing trend in a.
00:18:36 Rick Ormsby
Difficult market, how does?
00:18:38 Rick Ormsby
This affect us in our in our franchise business.
00:18:41 Rick Ormsby
I mean, I don't know. You know what?
00:18:42 Rick Ormsby
I mean, I'm.
00:18:42 Rick Ormsby
Not a doom and gloom or as a matter of fact, I'm. I'm friends with many of the private equity and family office groups that have been the biggest acquirers of these businesses over the last five to six years. But it is notable that we do have a big intrusion of those types of firms in the franchise space. And this isn't just restaurant.
00:18:57 Rick Ormsby
Franchising, it's all across the board, right?
00:19:00 Rick Ormsby
So, like anything in life, I mean, you know, no one's going.
00:19:03 Rick Ormsby
To be 100% correct so.
00:19:05 Rick Ormsby
So I mean, like, what was it like? President Reagan had 70% of the vote and those are like the highest ever in the 80s, I don't know. But that means 30% of the country hated him, right? And didn't vote for him. So like, it's the same thing with investing not going to hit 100% of the time. If there have been 50 insurance, private equity insurance into the franchise space over the last five to seven years, it would.
00:19:25 Rick Ormsby
Not be a surprise.
00:19:27 Rick Ormsby
That 10 to 15 to 20% of them, you know, aren't performing well and maybe half of those maybe 5 to 10 of those can't sell their assets or trying but can't sell their assets. And what are they going to do with those, those franchise assets that they.
00:19:38 Rick Ormsby
They have that.
00:19:39 Rick Ormsby
Presumably they followed A playbook of like selling all the real estate, cutting costs, trimming overhead, delaying major CapEx, maybe even delaying new store development and remodeling. And then it kind of starts to spiral if then they get into a brand that that's not performing well for whatever reason at the top end, maybe the leadership at the franchise or level is not good or maybe.
00:19:59 Rick Ormsby
There's been some trends or maybe.
00:20:01 Rick Ormsby
There's a competitor.
00:20:02 Rick Ormsby
Like it's in the chicken space and there's like two or three new up and coming chicken concepts that are taking share.
00:20:07 Rick Ormsby
From you, whatever the.
00:20:08 Rick Ormsby
Places I know that they're out there. There are some of these franchisees, private equity franchisees and family office franchisees that are, I don't want to say upside down on their assets or investments, but or in a having to be in a long game because they've got a business that's not performing the way they thought it would or it was performing a lot of it could be a macroeconomic and they're forced to continue their.
00:20:30 Rick Ormsby
Management of those funds beyond their initial expectations and it's raising and making it difficult for them to raise new money to buy new franchise businesses.
00:20:41 Rick Ormsby
It's probably not a pronounced trend right now, but it may just keep an eye on it because it what it may do and I'm going to dovetail this into my next kind of idea for today, what it may do is it may make private equities offers in a down market, a little less attractive than it was in an up market.
00:21:02 Rick Ormsby
Because there are a few of them less right? Because they can't make offers because they can't close on their new funds because they have assets and their old funds. Maybe that's the case or their limited partners are becoming more and more conservative because the general temperature of the environment we're in right now isn't the best.
00:21:21 Rick Ormsby
And I think we are starting to see that there's even though there's plenty of liquidity for selling these franchise assets.
00:21:27 Rick Ormsby
There may be fewer private equity pure.
00:21:29 Rick Ormsby
Private equity players making aggressive offers on these businesses.
00:21:32 Rick Ormsby
Than there used.
00:21:32 Rick Ormsby
To be and so that's kind of a just a general possible observation. It shouldn't be a surprise to anyone, right?
00:21:41 Rick Ormsby
Like, who are the people that are the most likely to buy things at reasonable but not high prices, regardless of the environment? It's usually independent operators, multi generation franchisees who don't have outside investors.
00:21:56 Rick Ormsby
People who see an asset and they like it because it's nearby and they grew up in that hometown and they want to acquire it. They have a longer view and they say, hey, I've seen the ups and downs and I'm not wed to A5 year selling horizon, I'm going to.
00:22:11 Rick Ormsby
Own this for 30.
00:22:12 Rick Ormsby
Or 40 years. I can see my way into the changes in this business.
00:22:17 Rick Ormsby
That are going to have to occur to be more profitable in the future. I can overlook some of the the current environment. So those types of buyers, which are generally first or second generation, non equity controlled franchisees have largely over the last four or five years.
00:22:34 Rick Ormsby
Been losing out on deals and transactions to the private equity groups who were very financially savvy family offices too, but they are very savvy with real estate. They're very savvy with borrowing money. They are getting big assets under their belt and by doing that, they're doing term B loans and getting loans that don't amortize that they have.
00:22:54 Rick Ormsby
Interest only loans right for an indefinitely.
00:22:57 Rick Ormsby
At really low rates and so.
00:22:59 Rick Ormsby
They use the sale leaseback market very.
00:23:01 Rick Ormsby
Wisely and from a financial perspective, they're able to pay 10 to 15% more than maybe an operator would be comfortable paying because they can squeeze, they can squeeze the lemon a little harder than a franchise he can from a financing perspective. And so that's what's happened over the four or five years and you know leading up to maybe last year and this year. And I think what we're seeing now.
00:23:21 Rick Ormsby
At least on our limited scale and and look, my viewpoint is not perfect, but.
00:23:26 Rick Ormsby
I've started to.
00:23:27 Rick Ormsby
Be it like.
00:23:28 Rick Ormsby
I think that the reemergence of the operator as a viable buyer for some of these businesses is something that I think we may continue to see and may see we I think we're going to see lenders also become a little less warm to the private equity family office community and more warm to the idea of backing a family operator of scale.
00:23:49 Rick Ormsby
I've had a couple of lenders already kind of intimate that to me, so I think that's coming. I think also you're going to see franchisors have already said that they're looking for those types of operators right in their systems now where it was totally private equity in the past.
00:24:02 Rick Ormsby
I think you're going to start seeing that a little bit more too franchise or supporting the 50 unit operator who owns his or her own business. So it's a bit of a change for the moment, maybe not permanently, but my encouragement to you if you are one of those types of operators, a family operator who's got a nice sizable business and you've been frustrated over the last few years because you've.
00:24:22 Rick Ormsby
Been losing out.
00:24:23 Rick Ormsby
By 10 or 15% on the value of these deals, a lot of them unbridled has been selling, I would say hang in there. This may be your time to to to get more competitive, there's another item at play here. Not only do limited partner investors get more conservative, the private equity funds that invest their money are also very heavily tied to interest rates.
00:24:41 Rick Ormsby
Right. But the other thing is they get decidedly more defensive because they're dispassionate investors and you'd expect them to be. So their contracts become more difficult. The terms of their agreements are more difficult. They probably seek to retrain the deals that are under due diligence. If they can't get the financing terms that they initially expect, which may or may not be reasonable.
00:25:04 Rick Ormsby
Since they're so aggressive on their financing terms, their demands of the franchisor are heavier.
00:25:09 Rick Ormsby
The indemnification clauses and the escrow agreements and.
00:25:12 Rick Ormsby
All you know and.
00:25:13 Rick Ormsby
The professional buyers also have typically quality of earnings studies that they do where they bring in a third party, usually accounting firm to come through the numbers even if they're audited, P&L's and make sure that their investors are comfortable with the financial assets that they're buying, all of which is great and wonderful.
00:25:28 Rick Ormsby
That adds time and complexity and risk to deals.
00:25:32 Rick Ormsby
That a lot of these conditions and operator doesn't have. Now the operator may not the equity and except for in their existing business to buy an asset, they're not on a $50 million deal the amount to have $20 million of equity just laying in the bank they have that equity typically in their existing business and they put it up as collateral.
00:25:52 Rick Ormsby
To borrow the money in order to do an acquisition. So in a sense they they have the equity there maybe not huge equity risk, but they clearly don't have a bucket of money like a professionally run group does. And so that's typically the trade off you feel like you have.
00:26:05 Rick Ormsby
Less financial risk, typically, but in a down market where it's raining and stormy, the financial buyer is a private equity buyers of family office buyers. I would submit to you without having a full scope of this, but they may be more risky in the trenches during due diligence, they are going to be more scrutinous the times are going to be longer, the deals are going to take longer to do and an operator.
00:26:28 Rick Ormsby
At the same price.
00:26:28 Rick Ormsby
Case may be a much easier transaction to do because they're invested with their heart and soul into the business as opposed to just their pocketbooks. So these are some things that we'll see one's not better than the other, but I just wanted to give that encouragement, and it's also an encouragement to the professional investors that are listening to this podcast, right?
00:26:45 Rick Ormsby
Like if you.
00:26:46 Rick Ormsby
Are a family office or private equity group and you're looking at buying?
00:26:50 Rick Ormsby
Assets please know that whereas you probably have rightly felt like you weren't concerned about strategic buyers in the past few years because of your ability to close and your you know your financial terms and pricing and all these things.
00:27:06 Rick Ormsby
Please know that they are becoming a more attractive offer than that. You know type of buyer than they used to be because of the market conditions that we find ourselves in. So you need to structure your offers accordingly and you need to probably present yourselves to sellers of these businesses.
00:27:26 Rick Ormsby
As in a little more earthy and grainy fashion, when instead of a Harvard MBA in a tall building, someplace with a financial calculator.
00:27:34 Rick Ormsby
If if that makes sense.
00:27:38 Rick Ormsby
So anyway, that's a comment here. Let me let.
00:27:40 Rick Ormsby
Me. Look at a couple of other things here.
00:27:42 Rick Ormsby
Yeah, I have a comment here about valuations.
00:27:44 Rick Ormsby
Potentially dropping. Yeah, I mean.
00:27:46 Rick Ormsby
And my rhetoric has been, and I'll talk about this.
00:27:48 Rick Ormsby
A little bit more at.
00:27:49 Rick Ormsby
RFC and you'll hear it if.
00:27:50 Rick Ormsby
You tune in in the next month or so.
00:27:52 Rick Ormsby
But I mean it.
00:27:53 Rick Ormsby
Has been our observation at unbridled capital.
00:27:56 Rick Ormsby
And I think we're running on.
00:27:57 Rick Ormsby
Now just so.
00:27:57 Rick Ormsby
You know, I think we've we've got a closing today, which was a a nice business, $2,000,000 AV business, Burger King business up in Connecticut area in the northeast.
00:28:06 Rick Ormsby
And last about a week and a half ago we had.
00:28:10 Rick Ormsby
Greg Blankenship had a probably the best Pizza Hut business in America, really on an AUV perspective in West TX mostly. And our friends at Flynn Restaurant Group or the buyers of that business, I haven't worked with Flynn in a while. So it was nice to see them acquire the business and we have those two deals recently completing which which is great, but my comment.
00:28:29 Rick Ormsby
Really is. We hadn't seen a whole lot of whole lot of transactions happening, right, it's been slow.
00:28:35 Rick Ormsby
Been slow and because of that my comment on is our evaluations up, down or sideways. Gee, Rick, they have to be dropping because interest rates are higher, that kind of stuff. What I was saying over the summer and certainly over the spring and over the summer was there not a lot of deals on the market and even though.
00:28:52 Rick Ormsby
Interest rates are going up. There's.
00:28:54 Rick Ormsby
Way more demand than supply.
00:28:56 Rick Ormsby
And that's kind of holding these brands in check as well as kind of decent same store sales and decent EBITDA or profit rollovers on a month to month basis or period to period basis over last year. And so my comment was that we're not really seeing much degradation in multiples at all and this was over 13 brands.
00:29:14 Rick Ormsby
Of about 800 locations that we're selling or doing valuations on in like I think 5 new assignments over a 60 day period with call it 300 stores and mind you in those thirteen Brands 3 two or three of those brands are non restaurant brands, OK. So like my perspective here is not like.
00:29:34 Rick Ormsby
Just one or two restaurant brands, but we weren't.
00:29:38 Rick Ormsby
Seeing really any.
00:29:38 Rick Ormsby
Much of A drop, but I think now as I'm talking to you today in the early part of October, we have like several larger deals on the marketplace. I'm starting to notice a little.
00:29:48 Rick Ormsby
Bit of a change.
00:29:50 Rick Ormsby
I would say a far average deal had, you know, throw a number.
00:29:54 Rick Ormsby
Seven offers on.
00:29:55 Rick Ormsby
It maybe now we're getting 5 if our average offer was X times EBITDA on a brand now and we might be seeing X minus half a turn. That being said, we don't we sold 5 Taco Bell companies.
00:30:09 Rick Ormsby
This year, at crazy prices, one of them in historic record-breaking price, we sold a wing stop business this year at a crazy price. Both of those closed, you know, about 60 to so days ago.
00:30:21 Rick Ormsby
If you're in an.
00:30:22 Rick Ormsby
Unbelievable brand. Maybe there isn't much degradation yet, unless it's a really big deal.
00:30:29 Rick Ormsby
And you're selling to a financial?
00:30:31 Rick Ormsby
Higher, but otherwise I think I have three or four now examples of deals where we're getting offers where I think there has started to see a shift in downward valuations. Don't be shocked of course that was going to.
00:30:44 Rick Ormsby
00:30:46 Rick Ormsby
Even though the.
00:30:46 Rick Ormsby
Correlation isn't exact. Probably not as exact, even as cap rates dropping because.
00:30:52 Rick Ormsby
Interest rates go up, but still EBITDA multiples are going to go in the opposite direction of interest rates, right in some regard because it's just more expensive to borrow.
00:31:02 Rick Ormsby
So that's my kind of commentary and I like I.
00:31:04 Rick Ormsby
Said that's probably.
00:31:05 Rick Ormsby
This is a commentary over probably 3 or 4 transactions, 300 stores. It feels like maybe we're seeing on average brands that don't have incredible amounts of like attractiveness, but are just kind of average brands in the marketplace, but decent sized deals. I think we're seeing somewhere around 1/2 turn of EBITDA drop now that the thing, the thing that could make it worse.
00:31:25 Rick Ormsby
Is if we get into early 2024 and if we see that there is.
00:31:30 Rick Ormsby
A huge pickup in supply.
00:31:32 Rick Ormsby
Of franchise businesses for sale.
00:31:35 Rick Ormsby
And then it could make it even worse is if we start lapping over fairly strong numbers that have pricing increases in them and then we start seeing sales and traffic drop a little bit or precipitously. So those are kind of the levers, right, if you see the businesses dropping on it, you know on a trailing 12 month basis, as we move forward.
00:31:55 Rick Ormsby
If you see a lot of deal flow in the marketplace and you see more zeroing in on interest rates, I think you could see another who knows quarter to half turn drop of EBITDA in the next three to six months. I mean it's definitely a a possibility.
00:32:09 Rick Ormsby
Keep an eye on deal.
00:32:11 Rick Ormsby
Low. Just keep an eye on it. Like I said, I mean, last two years, I mean, you know, we've been down eight, 2022 and 2023. We've probably been down obviously like 40 to 50% versus 2021 and over a five year period down like maybe 15 to 20%, right. So you had been the strongest year in 2022 and now 2023. My guess is though that.
00:32:32 Rick Ormsby
With the phone calls coming in to me, we're probably going to have.
00:32:35 Rick Ormsby
Twice as much deal flow next year as we had in 2023. That's just a guess. I'm not sure all that will close. You never know with the financing markets being a little jittery, but still you know still OK, but a little jittery. But I do think it's going to pick up some and how does that affect you as you might be selling and buying things. It's just important to know, it's important to know. It's a lot of it's.
00:32:55 Rick Ormsby
Brand specific, I can tell you right now we're.
00:32:57 Rick Ormsby
Probably of the seven or eight new assignments we're considering, one brand is like 3 of the 8 assignments, right? So you're starting to see particular to one specific brand. I don't see anything happening really right now in terms of geography like geographically focused like everyone is from.
00:33:13 Rick Ormsby
The state of, you know, whatever. Oregon, who's selling? No, I'm not seeing that. But I do think that the phone calls are picking up. So I think 2024 will be a busy year. If you are a seller of something, you may want to consider moving your timing up or delaying your timing by a year or year and a half. But I like personally and this is just one man's opinion. I like the idea of selling something in the next three or four months.
00:33:34 Rick Ormsby
Or selling something two years from now, but maybe not in between, like six months and two years. That may be a window where we're met with high interest rates, declining sales and increasing.
00:33:45 Rick Ormsby
Deal flow and that that's gonna be a triple whammy. If so, I could be totally wrong though, right? It could go to the opposite. I mean, if I had a nickel for every time I was wrong be.
00:33:55 Rick Ormsby
Rich man, right?
00:33:56 Rick Ormsby
So anyway, those are just some thoughts. Overall though I I would say a.
00:34:00 Rick Ormsby
Little bit of a job but.
00:34:01 Rick Ormsby
You know fairly good. You know, things are.
00:34:03 Rick Ormsby
Moving along, I think that's.
00:34:05 Rick Ormsby
Going to be mostly it, if you are looking at deal flow and you do not get like unbridled capitals emails, we send out all of our deals over e-mail. If you've told us that you're a buyer of a certain brand.
00:34:17 Rick Ormsby
And if the seller wants to do a broader auction process, it's important maybe to know that you know, many sellers say I don't want a broad auction process when I sell my business, I only want to, you know, reach out to 10 people, right. Another seller may say, I want to go to thousands and thousands of people and some other seller may say, you know, let's limit it a little bit because all of this stuff affects the confidentiality of.
00:34:34 Rick Ormsby
My business and my employees, so it's important.
00:34:38 Rick Ormsby
That if you listen to this and want to buy something or sell something, you got to communicate with me. Because if I don't know your intentions, I can't know how to.
00:34:46 Rick Ormsby
Keep you apprised in mind of opportunities or what valuations are or what pricing looks like, or what your neighboring franchisees might be doing with their businesses. Like all these things are dependent upon us having good communication, so make sure to reach out and you can always find our content online at unbridledcapital.com too. So thanks so much and we'll catch up with you.
00:35:06 Rick Ormsby
After RFC for an exciting episode, take care.
00:35:10 Rick Ormsby
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00:35:30 Rick Ormsby
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00:35:33 Rick Ormsby
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