Volume 23, Number 10 • Restaurant Finance Monitor, 2808 Anthony Lane South, Minneapolis, MN 55418 • ISSN #1061-382X
October 18, 2012
OUTLOOK
The Parlay Wager
Give me your tired company stores, your poor profit performers, your
huddled corporate managers yearning to breathe free, and through
the magic of refranchising, franchisors and franchisees can lift their
lamp beside the golden door. —Anonymous
When IHOP (now DineEquity) overpaid for Applebee’s
International in 2007, CEO Julia Stewart and then CFO
Tom Conforti devised a grand plan to sell all of the Applebee’s
company stores, some 500 of them, and create a 99% franchise
company—the first of its kind in casual dining and the biggest
parlay bet to date in the industry. The “stores on sale” plan
was desperately needed to pay down some $2.3 billion in debt
and preferred stock the company took on for the acquisition.
Stewart was in a unique position of assessing Applebee’s as
she once lead their operations and knew many franchisees.
She correctly identified the demand of larger franchisees,
such as Goldman Sach’s-backed Apple American Group,
Applebee’s largest franchisee, and others interested in adding
additional units. At IHOP, she transformed an unusual
franchise financing scheme to a more traditional franchise
sales arrangement, resulting in growth.
With the recent sale of 65 Applebee’s units to the Schostak
group in Michigan and 39 units to Potomac Dining in
Virginia, Stewart’s plan to sell all of the Applebee’s company
units is now “mission accomplished.”
Hats off to Ms. Stewart for accomplishing her goal to unload
the Applebee’s company stores. Hats off again to Ms. Stewart
(and chairman Bernanke) for bringing the IHOP/DineEquity
share price back to within $10.00 of its all-time high. Hats
off to the Applebee’s franchisees and PE firms for buying the
discarded Applebee’s assets on the cheap. And hats off to the
Restaurant Finance Monitor for predicting five years ago that
the combination would result in a mess for the IHOP brand.
More on that later.
Refranchising, or what used to be known as selling companyoperated restaurants to franchisees, has resurfaced as the latest
abracadabra for transforming restaurant chains. The belief that
a franchisee and local proprietor can run a restaurant more
efficiently than a large company is one of the sacred pillars
of franchising and is usually at the top of the talking points
memo when a company wants to sell franchised restaurants.
Consider me a skeptic on the “franchisee-runs-the-storebetter” theory, especially when you consider the size and
scale of most multi-unit franchisees these days. Ladies and
gentlemen, I want you to picture, in your minds, a private
equity chief, or large, multi-unit operator greeting customers,
closing the store on Sunday night and counting inventory just
like the Mom and Pops. Let’s get real: They hire managers just
like the corporates do.
The prime motivation of Stewart and other refranchising
devotees isn’t necessarily that stores will run better, but that a
sale of stores can transform the balance sheet or direct capital
investment elsewhere. Applebee’s needed cash to pay down
debt. Yum Brands sold company stores to finance its capital
spending in China. Jack in the Box had too many company
stores and used the sale proceeds to fund development for
Qdoba and new markets for Jack. Conversely, when companies
are flush and want earnings like Buffalo Wild Wings and
Panera, they buy back stores.
Refranchising isn’t new. It isn’t good. It isn’t bad. Franchisors
have actively traded and made markets in the restaurant
businesses of their franchisees for decades—buying and selling
when it makes sense to do so. Consider it to be a portfolio
approach to franchising.
In the late ‘70s and throughout much of the ‘80s, it was Pizza
Hut, Taco Bell and KFC, as divisions of Pepsico, that preferred
acquisitions of franchisee units to prop up their growth
rates. With Burger King, one of the earliest reacquisitions of
franchise units took place in 1985, when the then Pillsbury
Co., owner of the brand since 1967, launched a tender offer
for the publicly held Diversifoods, the largest Burger King
franchisee in the system.
During much of the Dave Thomas era, too, Wendy’s took
advantage of franchisee missteps, buying up restaurants and
territories, improving the operations, and then reselling them
at a profit. In 1989, Wendy’s acquired stores in Cleveland,
Akron and Youngstown, Ohio after a large franchisee filed
bankruptcy. They did the same thing in Minnesota after a
large franchisee defaulted on its loans.
The pendulum shifted back to selling stores when public
restaurant chains discovered the benefits of massaging
Continued on page 6
© 2012 Restaurant
Monitor
Page Finance
1
FINANCE SOURCES
BMO Harris Bank Launching Restaurant Finance
Group
Rick Thompson and Rick Meiklejohn have literally worked
together for 25 years. The two started with Citibank in 1987,
when restaurant finance groups weren’t so common. They
helped build that platform, leaving in 2006 to join Merrill
Lynch Capital, where they continued to finance restaurants
even as that group was acquired by GE Capital a couple of
years later.
So it’s probably not a big surprise they’ve been recruited to
build a franchise finance program by BMO Harris Bank. And,
BMO has tapped some of the members of the team that were
together at Merrill, who, as Thompson puts it, have years of
experience behind them financing restaurants, as well.
“They are people I really enjoy working with, and that’s fun,”
said Thompson, who will co-lead the group with Meiklejohn
as Managing Directors.
Joining them will be Mike Eagen, Director; Todd Maldonado,
Director; and Elizabeth Kurtti, Vice President. Thompson
says they will be announcing a few more additions to the team
in the next 30 days.
What’s also exciting to Thompson is “we are working with a
world-class bank with a very strong and sizable balance sheet.”
BMO Harris is part of the BMO Financial Group, one of the
strongest capitalized banks in the world, with approximately
$554 billion in assets and a 12.4% Tier 1 capital ratio.
The group will focus nationally on deals mostly $5.0 million
on up for larger restaurant operators, generally those with
more than 10 stores. They will offer senior debt that can be
used for acquisitions, development, remodels and refinancing
existing debt.
Meiklejohn says they’ve been given the task to grow in a
thoughtful and controlled way. He sees them helping to grow
the customer base with smaller operators inside the bank’s
regional footprint, and possibly other asset classes at some
point in the future.
He knows that adding another source of capital adds to the
competitiveness of the space, but he thinks there is room, and
still a need. “At the end of the day, you need to deliver the
product better than the competition, giving the customer the
best combination of a properly structured deal, on time, and
at a fair price,” he said.
And, for him, clients really care about “working with a bank
with a world-class balance sheet, getting products from people
they know, like and trust, and who have been in the business
a long time.”
For more information on BMO Harris Bank, contact Rick
Thompson, Managing Director, at (949) 413-3450, or at rick.
thompson@harrisbank.com; or Rick Meiklejohn, Managing
Director, at 949-351-8944 or by e-mail at richard.meiklejohn@
harrisbank.com.
Bank of America Leads Two Large Financings
Apple American Group, the largest Applebee’s franchisee,
closed October 10 on the acquisition of 99 Applebee’s
restaurants from AmRest, a global franchisee operating
restaurants in western and central Europe and the U.S. Apple
American Group is the second largest restaurant franchisee
in the United States, and the largest in the casual dining
segment, with 436 restaurants, $1.1 billion in sales and over
25,000 employees in 25 states. Founder/CEO Greg Flynn
and CFO Lorin Cortina led the work on the transaction
for the company, the most recent of several deals that Apple
American has completed.
To facilitate the transaction, a senior credit facility led by Bank
of America Merrill Lynch was increased to $415 million.
Additional Joint Lead Arrangers included GE Capital and
Sun Trust, and participating lenders included RBS Citizens,
Regions Bank, Cadence Bank, City National, Raymond
James Bank, First Tennessee, Capital One Bank, Fifth
Third Bank and Huntington Bank.
Bank of America has worked with Apple American on various
transactions over several years, including the recently refranchised Minnesota and New England markets and the
AmRest deal, reported Ted Lynch, Managing Director with
Bank of America. “Greg and Lorin and their team understand
the process and the lenders’ requirements for assessing due
diligence, business strategy, and acquisition rationale. Their
efforts help make for relatively smooth execution in terms
of both the financing and the acquisition and business
integration.”
As transaction syndications go, working with both specialized
and non-specialized lenders to the restaurant industry has
become less challenging, said Lynch. “While we think we’ve
done a good job of working with traditional restaurant lenders,
we’ve also been tapping into more and more non-specialized,
regional lenders on transactions, and it is fair to say that the
overall capital availability to restaurants has improved.” Bank of
America has brought these regional players to the deal table by
sharing both expertise and access to owners and management,
though Lynch added that leading restaurant operators usually
have local bankers calling on them, and the opportunity to
participate in a deal for an industry leader like Apple American
often encourages pursuit of both smaller and non-syndicated
restaurant financings.
“Every one of the lenders to Apple American has participated
in at least one other restaurant syndication with Bank of
America,” he said, “and many are also direct competitors
to originate loans. The competition and enhanced industry
knowledge is net-net a win for restaurant operators in terms
of both capital availability and turnaround time on deals.”
Bojangles’ transaction refinances higher priced debt
In another major transaction, Bank of America Merrill Lynch
was the lead left arranger on a $200 million senior debt
financing for Bojangles’ Restaurants, Inc., the franchisor of
the Bojangles’ restaurant chain. Other lenders in the financing
included Fifth Third Bank, Regions Bank, Wells Fargo
Bank, KeyBank, Cadence Bank and Royal Bank of Canada.
The financing included a $25 million revolver and a $175 million
Page 2
term loan and was used to retire more expensive debt from
when the company was sold by Falfurrias Capital Partners to
private equity firm Advent International about a year ago, said
Cristin O’Hara, Managing Director and Market Executive
with Bank of America Merrill Lynch. Since that time, the
company has performed well, she said, and Bank of America
was able to use that to its advantage as it priced the deal.
“We were able to go to the pro-rata market to lower the
company’s cost of capital. We priced it at the right time as
banks continue to be hungry for assets, and it’s safe to say the
company was happy with the interest rate it received,” O’Hara
said. “And I think all of the banks are happy with it; the deal
was sufficiently oversubscribed.” For more information on
Bank of America, contact Ted Lynch at (617) 434-2351 or
Cristin O’Hara at (617) 434-1897.
Kowalske Joins Capital Insight
As former CEO of GE Capital, Franchise Finance, Darren
Kowalske has looked under the hood of many restaurant deals,
developing relationships with restaurant brands and operators
along the way. In fact, those relationships were a reason to stay
in the industry, coupled with the opportunity to join and work
with the other principals at Capital Insight, a financial and
operational advisory firm within the restaurant space.
“As I was transitioning out of GE, I took the time to work with
different investment banking groups,” said Kowalske. “And,
while at GE, I sat across the table from Capital Insight (as they
represented various operators). I could see them dig into the
deal—they weren’t scared off by complexity, and I respected
the way they approached that. That was important to me.”
Greg Landry, Managing Partner of Capital Insight, says he’s
been recruiting Kowalske since his departure from GE. For
Landry, it’s about putting together a team that can approach
deals from a holistic approach. Landry is joined by the firm’s
co-founder and head of financial advisory, Brett Bishov, as
well as recent addition, Frank Sbordone (former CEO of
Peter Piper Pizza) who heads the firm’s operational advisory
business. Both Landry and Sbordone have retail and restaurant
operations experience, as well as financial backgrounds. Bishov
comes from finance and investment banking before joining
Landry at Capital Insight.
“Darren has a stellar resume that he put together at GE as
he rose through the ranks,” said Landry, “with tremendous
experience in the capital markets and real estate segment.” In
fact, he lead the efforts to acquire and assimilate the restaurant
lending and real estate groups from Truststreet, Merrill Lynch
and CitiCapital into the franchise finance group after GE
acquired them.
What’s critical to the principals of the firm is that as a client
“you don’t just get one of us,” said Landry. Each of the four
principals are part of an “open forum” and look at every
engagement based on the vantage point of their expertise to
sift down to the best solution for the client. As for Kowalske,
he’s glad to be “putting deals together and working with the
operators. That’s the most fun part of this industry, for me.”
For more information, contact Darren Kowalske, Managing
Director, at Kowalske@cidfs.com or 949-415-7111.
STORE Completes $19 Million Deal with Taco Mac Parent
STORE Capital Corporation, a real estate investment trust
formed to invest in single-tenant operational real estate such
as chain restaurants, supermarkets, health clubs, education
and other retail, service and distribution facilities, recently
completed a $19.2 million sale-leaseback with Tappan Street
Restaurant Group, Inc. (TSRG). TSRG is the parent company
of Taco Mac, a Southeastern casual-dining restaurant chain
with 28 restaurants across metro Atlanta, Georgia; Charlotte,
North Carolina and Chattanooga, Tennessee.
The transaction occurred simultaneously with an equity
investment by CIC Partners, a Dallas-based middle-market
private equity firm, in TSRG to help Taco Mac continue its
expansion. Under the terms of its agreement, STORE Capital
purchased six properties, including five Taco Mac restaurants
located in Georgia and North Carolina and TSRG’s corporate
headquarters located in Alpharetta, Georgia. STORE then
leased the properties back to TSRG under a long-term, triplenet lease.
STORE Capital is a REIT principally backed by funds
managed by Oaktree Capital Management, L.P. STORE
has funded or committed to fund more than $750 million in
sale-leaseback transactions since its inception in May 2011. For
more information contact Mary Fedewa, EVP–acquisitions
at 480-256-1107 or by e-mail at mfedewa@storecapital.com.
GE Funds Sale-Leaseback for Wendy’s Franchisee
GE Capital, Franchise Finance recently provided $16.1
million to WendPartners, a Wendy’s franchisee. The facility
is being used for the sale-leaseback of nine locations in Texas,
New Mexico, Ohio, Georgia, and Alabama. WendPartners is
a Wendy’s franchisee with 331 locations in 20 states.
GE Capital, Franchise Finance is a lender for the franchise
finance market via direct sales and portfolio acquisition. The
company specializes in financing mid-market operators with
multiple stores in the restaurant and hospitality industries.
First Franchise Capital Funds Denny’s Franchisee
First Franchise Capital Corporation, a national lender to the
restaurant franchise industry, recently funded another Denny’s
acquisition for Dawn Lafreeda of Den-Tex Central, Inc..
As the brand’s second-largest franchisee, Lafreeda owns 71
Denny’s franchises, and counts on her long-time relationship
with First Franchise Capital to help drive her success.
“I have lost count of the number of years and number of
transactions I have done with First Franchise Capital because
I keep going back. They have been instrumental in my growth
of the Denny’s brand and have financed a large portion
of my portfolio,” Lafreeda said. “When I am looking for
financing, First Franchise Capital is always my first call.” First
Franchise Capital Corporation offers financing solutions to
the restaurant industry to include senior debt for acquisitions,
refinancing, remodels/re-images, new builds including real
estate, refinancing and buy out partners. For more information
call Karen Johnson, Director of Sales, at 402-562-5111 or by
e-mail at Karen.Johnson@FirstFCC.com.
Page 3
Making Sense of the Market Multiple
When J. Alexander’s agreed to sell itself to Fidelity National
Financial in June, the company got what it thought was a good
deal at the time: $12 a share, or $72 million. The per-share
price gave shareholders a 33-percent premium, and about
double the share price of a year earlier.
Yet few deals we’ve covered have proven to be as controversial.
The deal almost immediately came under intense scrutiny from
activist investors who thought the price was too low.
The reason? The multiple of the deal was 6.7x EBITDA. The
Nashville-based J. Alexander’s was worth more than that.
Investors pay close attention to that multiple as a guide
to the value of a deal. Indeed, few numbers are as closely
scrutinized, yet it’s also a number notoriously difficult to pin
down. Numerous factors go into the final price to be paid for
a business—so many, in fact, that some consider the multiple
virtually useless as a measuring stick.
“If you use a rule of thumb,” said Jerry Thissen, CEO of
California-based National Franchise Sales, “you’re going to get
your thumb cut off. There’s no Zillow to go to for a business.”
Still, we wanted to get a sense of how much business owners
can expect when they go to sell their restaurants, and what
went into their calculations of the multiple. So we asked a
bunch of experts, including consultants, brokers, lenders,
buyers and sellers, to get an idea of the multiple that sellers
can expect when they put their business on the market. And
how the multiple is used to determine that price.
Franchisee Multiples
Sellers routinely bombard business brokers with questions
about the multiple, and what kind of multiple they can get
for their franchise business. So here it is: 4x to 5x.
Of course, it’s not quite that simple. But that’s the starting
point of a restaurant franchisee, a number that is fairly
consistent, say business valuation experts. Rob Hunziker,
principal at Advanced Restaurant Sales, said this kind of
multiple should provide buyers the 20- to 30-percent return
that makes a deal worth doing. “When things get out of that
4 to 5 range, they don’t last long,” he said. They eventually
go bankrupt.
Concepts with good sales trends and unit economics will get
larger multiples. Weaker sales trends and unit economics will
get lower multiples. “Most of the labor is in the analysis of sales
trends, margins, franchise agreements, lease agreements and
other issues impacting value on a unit-by-unit basis,” said Scott
Roehr, a restaurant valuation consultant based in California.
“Dollars follow strong unit economics,” he added. “If the unit
economics are strong, chances are the system is growing. If
they’re poor, the concept is probably shrinking.”
Earnings stability is also a big deal, and concepts with stronger,
more active franchisors fetch higher multiples. “McDonald’s,
no matter what happens, is going to make sure you’re
profitable,” Hunziker said. “That cash flow is more valuable
than, say, Checkers, which doesn’t have as strong a parent
company and can’t support franchisees as much.”
Still, as Hunziker said, the multiple is a starting point. Other
factors are applied to the business that affects its ultimate value.
One big factor is real estate. Appraisers will give a business a
multiple as if they’re leasing space, even when they own their
real estate. The real estate value is then applied on top of that
multiple, and it could double the multiple paid for a business,
Hunziker said.
Franchisors also more directly influence the price of a business
by making requirements of a seller in a transaction. Burger
King, for instance, has been notorious over the years in forcing
facility improvements before a restaurant could be sold. “They
can devastate a sale overnight,” Hunziker said.
The remodels themselves also can throw a wrench into a sale,
and influence its ultimate price, often triggering negotiations
over who is responsible for paying for a remodel. If a reimage is
expected to increase sales, Hunziker said that the buyer would
be expected to help fund that remodel. But if the facility needs
improvements because of deferred maintenance, that cost will
more likely come out of the seller’s pocket.
Demand is perhaps the biggest wild card in valuation. And in
a franchisee’s case, location is perhaps the biggest influencer
of that demand. Restaurants on the coast and in the Sun
Belt states will fetch higher prices than those in the Midwest.
Bigger markets fetch good prices, in part because they’re rarely
sold. “You never see substantial franchisees turn over in places
like Atlanta, DC, or in desirable places to live like Dallas,”
Hunziker said. “When they do come available, you have a
lot of bidders. But if you’re out in some place like Idaho, you
might have one to two bidders instead of 10 to 20, and you
get 4.25 instead of 5 plus.”
Several factors helped drive up the price of some bankrupt
El Pollo Loco locations in Los Angeles earlier this year. The
locations were along the coast, in a market the franchisor
closed off for development, which lured franchisees eager to
add more restaurants to spread their administrative expenses
across more units. National Franchise Sales held an auction,
and the bidders drove up the prices into the double digits. “It
was a unique situation,” Thissen said. “But all sales are unique.”
Brand Multiples
Restaurant brands are even tougher to predict than are
franchisee multiples. They’re higher, in general. Markets tend
to value growing restaurant brands at 8x to 10x EBITDA.
Weaker brands that need some improvement will get 6-8.
Notably struggling brands will get even lower multiples, while
surging concepts can get bigger multiples.
Page 4
To be sure, these multiples are the source of considerable
debate. “The range of multiples is going to be much broader
in evaluating a brand,” Roehr said. “That’s really a function
of unit economics. Some concepts are just licenses to print
money.” Others are not.
Roehr often had to go over multiples with franchisors during
his days working with the financial advisory firm Deloitte.
“There’s nothing less pleasant than sitting down with a
franchisor and telling him his baby’s ugly,” Roehr said.
Indeed, in an analysis of 16 restaurant deals in recent years,
J. Alexander’s said the enterprise-value-to-EBITDA multiples
ranged from 5.3 to 20.2—though the median multiple
was a mere 7.2. Pierre LeComte, managing director of San
Francisco-based private equity firm TSG Consumer Partners,
the group that just fetched a 12.5x multiple for Yard House,
called the multiple a “gut check” on the chain’s intrinsic value.
“I want a low multiple when I’m buying and a high multiple
when I’m selling,” he said.
The multiple, LeComte said, is “an output of the valuation you
create on a company based on (its) intrinsic value. The rule of
thumb is a check against what that output is.”
For instance, TSG values a firm based on its cash flow or
EBITDA, its growth potential and the unit economics and
whether they can be replicated. It then examines the payback
following the up-front investment in a single unit, and the
four-wall cash flow. It uses these numbers in a model that it
can run forward a few years, depending on the cash flow, and
can come up with a valuation. “Then comes the gut check,”
LeComte said. “Is it an 8x multiple, a 10x, and how do I feel
about that? The market tends to trade around there. It’s another
way to check your number, basically.”
Franchisors can more easily run up large multiples, because
they have lower capital costs and thus buyers can put more
debt on a company from the get-go, rather than preserve
its capital for future restaurant expansion. This is how Bain
Capital, Thomas H. Lee & Partners and the Carlyle Group
were able to run up a multiple higher than 13x on its 2005
purchase of Dunkin’ Brands—the company had no units of
its own, and thus no capital needs.
Lenders also play a big role in the price a company can get
on the open market, because the more they’re willing to lend
in a deal, the more that a buyer will pay for a property. And
lower interest rates have cheapened debt, which can inflate
multiples, too. (Lenders wouldn’t speak on the record for this
story, noting that multiples are tough to pin down.)
And much like the sale of a franchisee unit, brand multiples
depend heavily on demand and the way a company gets sold,
though that is less dependent on location and more dependent
on the product being sold and the buyers themselves. Highgrowth chains with development white space don’t reach the
market all that often, and when they do the scarcity of supply
drives up price.
Consider the Darden deal. TSG had numerous possibilities to
cash out of its investment in Yard House this year, including
a potential IPO, or it could have simply stayed the course
and watched the value of that investment grow. To get the
company, Orlando-based Darden had to pay a high premium.
But it had the cash to make such a deal, the desire to obtain a
growth brand, and the infrastructure to make that high price
work. The result: 12.5x EBITDA.
“You only do that for concepts that have a good probability of
generating a return for that price,” LeComte said.
Darden could easily turn it into a $1 billion brand, and it
could take advantage of economies of scale to make it work
financially.
“The value of a restaurant is going to be different to different
buyers,” LeComte added. “Darden, with its resources to
expand nationally, was able to pay a different price than
a financial buyer that doesn’t have that infrastructure or
expertise.”
On J. Alexander’s
So why wasn’t a 6.7x multiple good enough for J. Alexander’s,
when stock investors hadn’t been giving the chain that kind
of value? And, after all, Fidelity had paid roughly the same
level for O’Charley’s.
Yet that level suggests the company was in need of changes,
perhaps significant ones, to get back in customers’ good
graces. O’Charley’s has been struggling for years now, but J.
Alexander’s, though much smaller, has had some success. It
hasn’t added units in a while, but the company’s sales trends
have been positive. It has achieved these trends with no
advertising.
It also had other things going for it: a strong reputation among
consumers, as noted by its high ratings on the restaurant review
site Yelp and from the consumer magazine Consumer Reports.
With only 33 units, it had plenty of white space to develop.
And, as the company’s activist investors from Atlanta-based
Privet Fund pointed out to us, earnings that could be easily
improved with some lower G&A spending.
All of this suggests a restaurant chain deserving of a multiple
closer in line with that of a growth chain (8-10) than a weak
one in need of improvement. No, it didn’t deserve a Yard
House multiple, but it deserved better than 6.7.
And that’s exactly what would happen. J. Alexander’s got
higher bids during the 30-day go-shop period. And more
bids came in even after J. Alexander’s accepted Fidelity’s
higher, $13-a-share bid for the company. In the end, Fidelity
ended up paying $14.50 a share—an 8.5x multiple—and all
complaints subsided.
The market pushed the multiple up to where it belonged.
Page 5
— Jonathan Maze
outlook
Continued from Page One
quarterly results by selling company stores for a profit. In fact,
in one notable transaction in the late ‘90s, Burger King sold
a large company store block to a franchisee on the last day of
the quarter, with the franchisee providing little cash down
and only a “soft” financing commitment.
Refranchising became important to managing earnings. After
Pepsico spun off KFC, Taco Bell and Pizza Hut in 1997 to
Tricon Global restaurants, the selling of company stores to
franchisees improved company performance. Tricon reported
in its 2000 annual report, that except for gains from the sale
of restaurants to franchisees, its profits would be flat.
The availability of financing to multi-unit franchisees also
spurred refranchising. When Taco Bell and Pizza Hut
discovered the benefits of securitized financing in the ‘90s, they
found they could sell large store blocks to franchisees for cash
and no longer had to self-finance the sales. When franchisee
financing from banks and specialty lenders took over after
securitized financing imploded in the late ‘90s, big players such
as GE Capital, Wells Fargo and Bank of America preferred
refranchising deals because they could more easily examine
the operating history of the stores. Plus, large refranchising
deals carry larger loan amounts which lenders generally like.
Now that DineEquity has completed its Applebee’s
refranchising, Julia Stewart will officially become the Fred
DeLuca—he’s the founder of the 100 percent-franchised
Subway—of the casual and family dining business.
Fortunately for Mr. DeLuca, Subway is a private company
and doesn’t disclose same store sales. And unfortunately for
Ms. Stewart, Dine Equity is a public company and she will
be judged by investors and franchisees on same store sales. So
far, the results on the IHOP side have been poor.
Consider this stat: Since Applebee’s was acquired by DineEquity
in 2007 and Stewart focused her primary attention on that
brand, IHOP’s annual same store sales have either been been
negative or flat, erasing a string of 10 straight years of same
store sales gains. So far in 2012, the trend continues. IHOP’s
same store sales have decreased 0.5% and 1.4%, for the first
and second quarters of 2012, respectively, and are expected
to decline again in the third quarter just ended.
This past summer, Jean Birch, IHOP’s president since 2009,
took the fall. In the same press release, Stewart announced “she
would assume day-to-day leadership of the brand and provide
strategic direction until a successor is identified.” IHOP needs
a menu overhaul after franchisees complained of too many
items on the menu and a mixed message to consumers.
Applebee’s has upgraded its menu, too, and is in the process of
remodeling most of its stores. IHOP franchisees, on the other
hand, are waiting for Stewart to throw some love their way.
If she can turn Applebee’s around in five years, why can’t she
also do the same thing with IHOP? Once she is done working
her magic with IHOP, it will be Applebee’s turn again. And,
so on, and so on. Only this time, there are no more company
stores to sell. Just debt to pay back.
More On The Next Big Thing: Frozen Yogurt
Last month’s Outlook on the frozen yogurt boom brought
forth some interesting comments from readers. Adam
Birnbaum of Grandwood Capital wrote to say a new frozen
yogurt chain named 16 Handles is opening up in Manhattan.
This frozen yogurt concept, with 28 locations in the New
York area, like others in the genre, plays loud music and has
the requisite cool-colored décor.
Birnbaum believes the yogurt shop is an “alternative social
outlet for the under-21 set who don’t want to get overcharged
on caffeine.” His view is “many of the Starbucks coffee
competitors, of which there are many still opening in New
York, don’t provide as much of a social atmosphere to talk for
young people.”
Larry Weinberg, a Canadian franchise attorney, wrote he had
recently penned an article for the Financial Post in Canada
about franchise booms and busts he’s witnessed over the 20
years of his career.
Weinberg remembered in the early ‘90s a “lengthy list of new
frozen yogurt franchises being offered in Canada, almost none
of which survive to this day.” The list of brand names Weinberg
cites in Canada were TCBY, Yogurty’s and I Can’t Believe
It’s Yogurt. He points out the yogurt boom was followed by
the bagel boom, and most recently, the Krispy Kreme and
the premium hamburger boom. He says Canadians are now
enthralled with poutine shops, a dish where French fries are
covered with brown gravy and topped with fresh cheese curds.
Franchise consultant Bruce Bloom wrote to say there is
no barrier to open a store. “The equipment and product
are essentially ‘stock’ items accessible to any entrepreneur
interested in starting a yogurt shop,” said Bloom.
We made a simple inquiry to the local equipment distributor
to confirm Bloom’s analysis. One distributor told us
the soft serve machines used by most yogurt shops are
standard dispensing machines offered by Taylor and other
manufacturers. The yogurt bar toppings are contained in
a standard, stainless steel salad unit offered by multiple
manufacturers. And, the yogurt mix and candy and fruit
toppings are carried by all most broad-line distributors. A
bit of ingenuity, a good carpenter and a banker: You, too,
can get into the frozen yogurt business! And the banker
might be the most important ingredient. According to the
Menchies franchise disclosure document, franchisees spend
approximately $100,000 to $160,000 on equipment to open
a new store.
Weinberg says in his Financial Post article that with any new
concept “franchisors and franchisees are hoping to be in at the
early stage of the next ‘big thing.’ But going in at the beginning
is by definition a riskier approach to starting any business, and
the same is true of a franchise,” said Weinberg.
What about going in 20 years after the last boom flamed
out?
—John Hamburger
Page 6
CHAIN INSIDER
Money manager and former Ladenburg Thalman
restaurant analyst Roger Lipton has republished three books
written by the late economist and investment advisor Harry
Brown. Brown’s books sold over 2 million copies in the 1970s
and dealt mainly with his distrust of government monetary
policies and their penchant for creating inflation. Lipton’s
goal is to reintroduce Brown’s investment theories to a broader
audience and expose the recent currency expansion undertaken
by the Federal Reserve. Brown’s first book, written in 1970, was
titled How You Can Profit from the Coming Devaluation. His
second, written in 1974, was You Can Profit from a Monetary
Crisis. And Brown’s third book, New Profits from the Monetary
Crisis, was written in 1978. Lipton has created three short
videos that are available on Youtube (search Roger Lipton)
that introduce Brown’s currency devaluation theories.
CFOs on the move: Michael Cullom is now CFO at Texas
Land & Cattle and Lone Star Steakhouse. Cullom was a
former CFO at Qdoba. And, Fred Dreibholz has been named
CFO at Quaker Steak & Lube. He was previously CFO at
Champps Entertainment from 1999 to 2005.
Qdoba CEO Gary Beisler is retiring. Jefferies anlayst,
Alexander Slagle, salutes Beisler in his most recent research
report on Jack in the Box, the concept’s owner. He points out
that under Beisler’s leadership over 13 years, the company
has grown from 13 restaurants to over 600, and is currently
the No. 2 concept in the fastest-growing segment, fast casual
Mexican, of the restaurant industry. Jack in the Box acquired
Qdoba in January 2003 for $45 million in cash.
Former PF Chang’s CEO Lane Cardwell and Einstein
Bagel CEO Jeffrey O’Neil were recently named to Ruby
Tuesday’s board. The Maryville, Tennessee-based casual
dining chain chose the pair in an effort to boost the capabilities
of the board as it seeks a new CEO. Longtime CEO Sandy
Beall is retiring this year, and the company is a month or two
from naming his successor.
MSD Capital, L.P., an investment arm formed exclusively
to manage the fortune of Dell Computer founder Michael
Dell and his family, owns 2.5 million shares of Dine Equity
(DIN), or 13.71% of the company’s shares. In addition, Dell
owns $5 million principal amount of DineEquity’s 9.5% senior
unsecured notes due 2018. He sold $15 million of those notes
prior to March this year.
DineEquity CEO Julia Stewart sold 50,000 shares of
common stock on September 12th for $2,760,365, or $55.00
per share. Stewart exercised non-qualified options she acquired
from the company in 2009 for $5.55 per share.
Cowen restaurant analyst Paul Westra has adopted a
more cautious forward outlook on QSR shares such as
Sonic, Einstein Noah Bagel and Wendy’s. Westra recently
downgraded the three companies from Outperform to
Neutral. According to Westra, his latest “channel-checks”
suggest an unexpected slowdown in fast-food comp trends in
September 2012.
Television personality Guy Fieri has opened Guy’s American
Kitchen & Bar in Manhattan. Fieri partnered with restaurateur
and CEO of Heartland Brewery, Jon Bloostein. Bloostein is the
managing partner of the restaurant. Jeffrey Kolton, principal
of Tailored Food Solutions, brokered the deal.
Could Darden’s worker protests spread? Don’t think that
the restaurant industry isn’t paying close attention to the
activities in Orlando, where Darden Restaurants is getting
hammered by workers over sick pay and other issues. The
workers, organized by a controversial advocacy group,
Restaurant Opportunities Center United, nearly took over a
Darden shareholder meeting last month to complain about
conditions at Capital Grill, and clearly got under Chairman
Clarence Otis’s skin. Many in the industry, however, believe
ROC’s ultimate goal is to unionize restaurants. Some believe
that this could spread to other concepts if ROC’s Darden
effort proves successful.
Arby’s refranchising is coming. Both DineEquity and Yum
Brands said recently they’ve largely finished refranchising
efforts. But don’t think that’s the end of the trend. Arby’s, the
Atlanta-based sandwich chain, is gearing up to sell restaurants
in numerous markets. Rumors had suggested as many as
1,000 company-owned stores could be sold off, but several
people with whom we spoke said the refranchising effort will
be limited to certain markets and won’t be that extensive.
Many of these restaurants will come with expensive leases,
which will put pressure on the chain to move the sales needle
in coming quarters.
Wither commodities? There was a lot of talk at the recent
MUFSO conference in Dallas about commodity prices, and
specifically the oncoming freight train called rising feed prices,
and their impact on beef and pork costs. But maybe they
won’t be as bad as many expect. Bernstein Research expects
2% commodity input cost inflation over the next 12 months.
Coffee will decline the most, and beef will increase the most.
Restaurants thus will experience “moderate” inflationary
pressures over the next year, which should be manageable in
comparison to commodity inflation they’ve felt in recent years.
Casual dining is still struggling. Same-store sales at casual
dining restaurants fell 1.9% in September, according to the
Knapp Track index of casual dining same-store sales. Traffic
was even worse: It fell 0.8 percent in September. This, despite
improving consumer confidence and rising employment. In
restaurant consultant Malcolm Knapp’s view, the problem
in September was two-fold: car sales and the iPhone. Knapp
suggests consumers have a fixed amount of income, and when
they spend it in one place, they cut back in another. Thus, huge
sales of iPhones hurt chains like Olive Garden and Outback
Steakhouse.
J.H. Cohn LLP and Reznick Group, P.C., two of the top-20
accounting and consulting firms in the U.S., recently merged
to form CohnReznick LLP. CohnReznick is now the 11th
largest firm in the country with 25 offices, 2,000 employees
and combined revenues of more than $450 million. Gary Levy
leads the restaurant practice there.
Page 7
HEALTH CARE
As Obamacare Approaches, Operators Turn to Part-Time Workers
The Affordable Care Act will extend health insurance and
access to doctors to millions of working Americans who
currently lack coverage. But that doesn’t mean their employers
will be footing the bill come January 2014—at least, not if
they can help it.
I recently interviewed three restaurant operators who have
plans to reduce the costs associated with the new law’s
employer mandate. All currently offer health care insurance
to their full-time management staffs. ACA stipulates, among
other things, that employers with 50 or more full-time
“equivalent” employees (averaging 30 or more hours per week)
must offer an affordable plan or face penalties of up to $3,000
per worker. The first 30 employees are exempt from the rule.
These operators say they have considered the scenarios under
which the penalties will be assessed and are now focused on
creating a restaurant-level workforce with fewer than 29 hours
a week per employee. As a result, suggested one, “The industry
as a whole may become less attractive to people.”
John Brodersen, president of Brodersen Management, which
operates 37 Popeyes in the upper Midwest said his area
directors are already replacing, through attrition, full-time
hourlies with part-timers. He intends to avoid the non-taxdeductible penalties, which can run as high as $3,000 per
employee depending on household income and whether the
worker is eligible for the federal subsidy. Most of his unit-level
workers will be, he added.
Last month’s surprising decline in unemployment, Brodersen
believes, was due mainly to an unwelcome rise in part-time
jobs. “It makes it a lot harder to motivate employees when
only the cream of the crop is full-time and everyone else is
part-time,” he says.
Brodersen once contemplated selling his company to
employees and collecting rent and servicing their debt to avoid
the new law. His lawyer, however, disabused him of the notion,
explaining that doing so would be costlier than the penalties
and reminding him there was an outside chance Obamacare
could be repealed.
Many small companies, nonetheless, want to keep lower-wage
earners off employer-sponsored coverage while keeping higherpaid employees, who won’t be eligible for subsidies, insured.
Consider IHOP franchisee Scott Womack, who operates 14
units in Ohio and Indiana that employ some 900 people.
He recently trimmed the hours to fewer than 30 a week for
servers, bussers and hostesses and admits those positions have
now become less desirable.
His cooks’ hours remain untouched. “It’s a position you have
to keep happy,” said Womack, chairman of IHOP’s franchise
association.
Womack has studied Obamacare and its impact for several
years and blames industry trade groups and politicians for
not recognizing how much the employer mandate would cost
workers and owners alike.
“Originally, there was the hope that bringing [health]
insurance into our industry would make us more attractive as
a place to work. The problem is that there’s now a $5,000 or
$6,000 price tag,” he said, referring to employer-provided plans
that may cost $1,500 annually and have a $4,000 deductible.
Few full-time hourly workers, he suspects, could afford it.
In 2012, worker contributions for employer-sponsored
coverage averaged $360 per month for family coverage and
$79 for individual coverage, according to the Kaiser Family
Foundation. Yet even Womack is in the dark as to the number
of hourly employees who will sign up for such plans, which
have to meet minimum federal guidelines. “That is the
big question,” he says. IHOP franchisees have pegged perrestaurant costs at $30,000 post-ACA.
Annual employer-sponsored premiums this year averaged
$5,615 for individual coverage and $15,745 for family coverage,
says Kaiser.
Womack is relying on insurance brokers to shed light. “Like
it or not, they will be the experts because they are bringing
the product to you,” he says.
An expensive product, at that. This year, a Kaiser survey of 500
health insurance agents and brokers working in small group
markets reported steep increases in premiums and deductibles
for small businesses purchasing health insurance. Four in 10
agents expected premiums to climb between 11-20 percent
with deductibles rising above $2,000 for single-coverage plans.
“Operators need someone to come along and say, ‘This is the
way you do it,’” Womack says.
Enter David Barr, who walked us through a slide presentation
detailing how his franchise expected to navigate ACA. Barr,
who operates 23 KFCs and Taco Bells, frequently speaks on
the subject and once charged on Fox News that health-care
legislation “incentivizes companies not to grow.” Indeed, his
PowerPoint shows post-ACA cost increases that might give
expansion-minded operators pause. Today, for instance, of
Barr’s 109 full-time equivalent employees, 36 are deemed
eligible for health insurance though just 30 take it at an annual
cost to Barr of $129,000 for single and family coverage.
ACA, however, will require Barr to offer a plan to all 109
with an actuarial value of 60 percent and that is otherwise
affordable, i.e., costing no more than 9.5 percent of an
employee’s W-2 wages. Barr’s current insurance exceeds
these numbers. Should everyone take the plan he now offers
under ACA rules, Barr estimates his plan costs will climb by
$300,000 a year, or 1.5 percent of sales.
Although it’s highly unlikely all 109 would, Barr believes he
can save $100,000 merely by trimming the hours of 35 people
in that group who now average 30-33 hours a week to below
29. He doesn’t think losing a few hours will cause them to
quit, though some may look at an additional part-time job.
“I’m not sure we’ve solved healthcare for them. Well, I know
we haven’t,” he laments.
Page 8
—David Farkas
Biglari and Cracker Barrel are in an Election Year Dogfight
Shareholders of Cracker Barrel might be feeling overwhelmed
right now. Not only are they bombarded with the avalanche
of political ads like the rest of us, they’re also being hit with
a campaign for the Cracker Barrel board that’s become every
bit as contentious.
The proxy for the Tennessee-based highwayside chain has
all the hallmarks of an election: an aggressive challenger in
Sardar Biglari, the activist investor who wants two seats on the
company’s board; an incumbent, the Cracker Barrel board,
that is trying to sow doubts about that challenger and push
its own successes. There are websites. There will probably be
billboards, and daily communication until November 15,
when the vote is held.
“It is an election,” said Chris Davis, who heads the shareholder
activist group at the New York law firm Kleinberg Kaplan.
“It does have similarities. You have to count your votes. You
have to give somebody something to vote for, and you have
to suppress the other side’s votes, too.”
The election has also come with its own October surprise.
Earlier this month, Biglari sent a letter to the Cracker Barrel
board, questioning the stated experience of the chain’s
incoming chairman, James Bradford. The chain’s past two
proxy statements said Bradford led a company, AFG Industries
that was publicly traded on the New York Stock Exchange, yet
Bradford became CEO of the glass manufacturing company
in 1992, four years after it was taken private.
For Biglari, chairman of Biglari Holdings, it was a good find,
and also fortuitous. The proxy statement “misunderstanding,”
as Cracker Barrel would later call it, diverted attention away
from Biglari’s failure to submit a filing with the FTC as his
company was buying up Cracker Barrel shares. That failure
led to an $850,000 fine.
Biglari’s letter came only days after that fine was announced,
and Cracker Barrel management was already making it an
issue in the board proxy. “An activist never wants to make a
mistake that makes the issue not about the board, but about
the activist,” Davis said. “An $850,000 settlement with the
FTC never helps.”
The proxy mistake is a legitimate issue. Biglari initially
suggested that Bradford had falsified his application for board
membership, though Cracker Barrel later said he did not, and
that it was a misunderstanding. Biglari shot back that, as the
misunderstanding was in two straight proxy statements, the
only conclusion to draw is that Bradford either didn’t read
his biography, or that he did and didn’t do anything about it.
Biglari has now requested records related to Bradford’s
ascendance to the board, and his selection as the next chairman
when Michael Woodhouse retires in November, to conduct
his own investigation. The likely outcome is that the issue of
Bradford’s experience will be a main focus of the proxy for
weeks.
Still, in the end it may not matter. Cast aside the opposing
mistakes, and the proxy is a simple issue of whether Biglari and
his vice chairman, Phil Cooley, deserve board membership.
Biglari tried, and failed, to gain a single seat on the board last
year. Rather than sell his stock and try something else, he
instead bought up huge numbers of shares in the company,
ultimately amassing 17.3 percent of Cracker Barrel stock,
making him, by far, its largest shareholder. Biglari Holdings
has invested nearly $205 million into Cracker Barrel. He could
have bought J. Alexander’s with less than half that.
Cracker Barrel’s board has made numerous changes to fend
off Biglari. It almost completely overhauled its board. All
but three of the company’s directors have joined the board
since last year. The company’s performance has improved
considerably—traffic grew 1.4 percent last quarter and samestore sales grew 3.8 percent. The company’s stock is up by
nearly a third this year, and the company argues that it doesn’t
need the activists on its board.
The increase in share price clearly benefits management and
blunts many of Biglari’s arguments. He is now trying to
convince shareholders he is a big reason for the stock price
increase, and that the company is taking much of his advice,
even if the company denies doing so.
Cracker Barrel also argues Biglari runs a competitor in Steak
N Shake, another family dining chain. In his filings, Biglari
says Steak N Shake is more like a QSR, and notes the NPD
Group considers the chain a QSR in its research. (Note to
NPD Group: Companies with wait staff, like Steak N Shake
uses, cannot be considered quick service; Steak N Shake is a
family dining chain, period.)
Still, as we’ve covered numerous times here, the question of
Biglari’s membership on the board is as much about Biglari
himself as it is about Cracker Barrel. While Biglari insists two
seats do not give him control of the company, he has used proxy
fights to get positions on the boards at Western Sizzlin and
then Steak N Shake. He then maneuvered to gain control of
both chains amid a wave of retirements on the boards, took
over the companies and merged them into one.
A strong board could keep Biglari at bay. Then again, few of
these board members own much Cracker Barrel stock—many
in our view are way too quick to unload stock options—and
they could simply go away if Biglari proves to be too much.
Ultimately, the key element in the vote may be the
recommendations of proxy research firms Institutional
Shareholder Services and Glass Lewis. Many funds simply vote
based on their recommendations. “That would be influential,”
Davis said. “The dirty little secret (in proxies) is that sometimes
institutional investors don’t pay attention to these things.”
Page 9
— Jonathan Maze
FINANCE
Mezzanine Debt Has a Role in Acquisition Financing
By Phil Mangieri & Wally Butkus
Restaurant Research
Over the years, franchise finance has defined senior debt
in different terms, depending on the economic mood and
competitive appetite of the lenders. Rewind 15 years ago and
we can remember a period when borrowers could expect to pay
zero down when acquiring restaurants that would be 100%
financed with senior debt. In that case, senior debt would be
defined as 5x to 6x EBITDA or whatever the full amount that
a buyer would pay for a branded store.
Things are more conservative today, and lenders may define
senior debt as a maximum of 3x EBITDA for operators that
are not the absolute top-tier credits. This is the level which
would provide the lender with an approximate 11% sales
decline cushion as outlined in our model below. We believe
this senior debt leverage level is better for the industry as it
provides sufficient cushion for the sales and profit volatility of
the chain restaurant business. In any case, store level valuations
still remain in the 4x to 5x EBITDA range today which means
buyers now have a lot of equity to come up with in order to get
deals done, even with a lender stretching to 3x for a senior loan.
Senior Debt Sales Breakeven Analysis
One way buyers can bridge the funding gap to get deals done
(after lenders stretch to 3x for a senior loan) is to incorporate
mezzanine debt for 1x EBITDA of capitalization. It seems
like a win/win situation to us as evident by the table below.
Even at a 20% interest rate for the mezz piece, we calculate the
hypothetical equity investor/operator could generate a 38.5%
cash-on-cash return assuming no change to the P&L during
this period—based upon a 10-year cash flow IRR (with mezz
paid back in year five and an exit unit sale at 5x EBITDA in
year 10). Given healthy returns for senior, mezz and equity,
this structure seems reasonable to all parties.
Seems like a pretty good deal for a mezz lender willing to make
smaller loans. In a well-structured mezz portfolio, the risk that
a cumulative sales decline of 11% moves them into equity
positioning, should be offset by a 20% coupon. Compares
nicely with a 1.5% 10-year treasury rate, we think.
Our conclusion? We think it is time for the branded chain
restaurant industry to finally get the balance sheet structure
right. Senior debt needs to be truly senior (in which case
lenders could possibly offer better risk adjusted rates). For this
to happen, there needs to be a mezz tranche under the senior
piece. Structured appropriately, risk is properly assigned and
rewarded.
Financing Assumptions:
Interest Rate
Loan Term Months (Full Amort.) 6.00%
120
Annual Sales Food & Paper
Labor & Benefits Royalty
Advertising Other Operating Exp.
EBITDAR Margin
$1,150,000
28.5%
27.0%
5.5%
4.5%
14.5%
20.0%
EBITDAR Less Rent Less G&A Less Capex EBITDA $230,000
$85,000
$35,000
$30,000
$80,000
Hypothetical QSR P&L
Store P&L
Annual Sales
Food & Paper Labor & Benefits Royalty Advertising Other Operating Exp. EBITDAR Margin $1,150,000 28.5% 27.0% 5.5% 4.5% 14.5%
20.0%
EBITDAR Less Rent Less G&A Less Capex EBITDA $230,000
$85,000
$35,000
$30,000
$80,000
Senior Debt Multiple Senior Debt Principle Annual P&I 3.0 $240,000 ($31,974)
Interest Rate Term
6% 120 months
Mezzanine Debt Multiple Mezzanine Debt Principle Annual Interest 1.0 $80,000 ($16,000)
Interest Rate Term
20% 5 yr. balloon
EBITDA less P&I $32,026 Cash flow to owner
Equity Multiple Equity Principle Cash on cash return 1.0 $80,000 38.5% B
Assumes 5x
acquisition price
Based on 10 yr. cash flows
Senior Debt Sensitivity:
Senior Debt Multiple Senior Debt Principle Annual P&I 2.0 3.0 $160,000 $240,000 ($21,316) ($31,974)
4.0
$320,000
($42,632)
EBITDA less P&I $58,684 $48,026 $37,368
-13.0% -10.7% -8.3%
Cash return assumes 10-year exit with unit sale at 5X EBITDA
Mezzanine Debt has a Role in Acquisition Financing
Sales Decline to Breakeven Source: RR
The market continues to struggle with this reality and we
imagine something will have to eventually give, either: (1)
the lenders move senior debt to 4x; (2) sellers accept lower
valuations to allow senior lenders and investors to get paid
appropriately for their risk; or (3) buyers start to incorporate
mezzanine debt to fill the gap.
Phil Mangieri and Wally Butkus­are Partners at Restaurant Research
LLC, which provides clients with valuable restaurant store-level
data obtained through their extensive network of restaurant
industry players. Go to www.ChainRestaurantData.com for more
information.
Page 10
Analyst reports
Yum Brands
YUM-NYSE
(Positive)
Recent Price:$70.82
Bloomin’ Brands
BLMN-Nasdaq
(Buy)
Recent Price: $14.80
Ruby Tuesday
RT-NYSE
(Outperform-2)
Recent Price: $7.35
Yum Brands is the Louisville-based operator of KFC, Pizza Hut and Taco Bell.
The company is the largest restaurant operator in the world. Its brands have more
than 38,000 restaurants in 120 countries.
Yum Brands recently reported that its same-store sales in China improved by
just 6 percent, the first time in seven quarters that the company’s comps in that
country fell into the single digits. It also said that same-store sales will be a smaller
component of the company’s operating income going forward. Still, Rachael
Rothman, analyst at Susquehanna Financial Group, said the company’s China
growth story remains intact. Yum’s profits in China expanded for the first time
in seven quarters as inflation eased. Yum expects stepped-up unit growth to be
the primary driver of profit growth. Meanwhile, Yum’s same-store sales grew
6% in the U.S., beating estimates thanks to the strength at KFC and Pizza Hut.
Commodity inflation has eased in the U.S. and China, but potential inflation
in 2013 could “mute” out-year EPS growth.
Bloomin’ Brands is the Tampa-based owner and operator of casual dining
restaurants, most notably Outback Steakhouse, but also Carrabbas Italian Grill,
Bonefish Grill, Flemings Prime Steakhouse, and upscale chain Roys.
Goldman Sachs analyst Michael Kelter recently initiated coverage of Bloomin’
Brands with a Buy rating and a $17, 12-month price target. Kelter said that
Blooming Brands is at the “fountain of youth” phase of its life cycle, with Outback,
Bonefish and Carrabba’s driving a “renewed leg of growth.” The brands are strong
and have outperformed the industry, he said, with 4% same-store sales growth
over the past 10 quarters, vs. 1% for the industry. Margins have expanded by 400
bp since 2008, and Kelter expects additional gains over the next year or two. The
company generates strong free cash flow, which could lead to dividends or share
repurchases. And the company’s shares are inexpensive compared with those of
its peer companies. “We think BLMN can continue to grow SSS by 3% annually,
ahead of the broader industry, driven by ongoing Outback restaurant remodels,”
lunch expansion, new product introductions and advertising.
Ruby Tuesday is the owner and operator of restaurant chains, mostly the Ruby
Tuesday casual dining brand, but it also operates 13 fast-casual Lime Fresh
Mexican Grill restaurants, 11 Marlin & Rays, plus Truffles and Wok Hay. It has
714 Ruby Tuesday locations.
Ruby Tuesday reported its first improved same-store sales in seven quarters, yet
investors were hardly enthused as the stock initially fell 5%. Raymond James
analyst Bryan Elliott called the quarter “reasonably constructive,” but he noted
that investors “are increasingly confused as to the financial strategy that is
occurring during the current period of management transition.” Ruby Tuesday
is slowly swapping real estate, which Elliott calls “Will Rogers assets,” for cash,
or “Ben Bernanke assets” by doing sale-leasebacks of company owned locations.
“With no clear use for this cash, investors are understandably puzzled that it is
not coming back to shareholders.” Elliott warned that management “appears to
be at risk of dissipating” its asset base.
Page 11
ANSWER MAN
Dave & Buster’s failed in their most recent attempt to go
public. What’s the problem with this company?
There’s nothing wrong with the company. The market just
couldn’t get excited about the deal. Management of the
company, its private equity sponsor Oak Hill Capital Partners
and the investment bankers tried to get $12.00 to $14.00
per share. That would value the dining and entertainment
company with 59 stores at approximately $850 million.
Obviously, they couldn’t round up enough institutional
investors willing to fork it over at that price. Rather than
reduce the size of the offering, or God forbid, lower the
valuation, they decided to pull the deal.
Three years ago, Dave & Buster’s tried to go public when it was
owned by private equity funds Wellspring Capital Partners and
HBK Main Street Investors. When the PE firms couldn’t get
that one done, they sold their interests to Oak Hill for around
$600 million. The company had 56 stores back then and now
has 59. Based on recent history, Dave & Buster’s will try the
public market again in 2015. Until then, they should build
a few more stores and pretend they are a growth company.
Is there a problem with today’s IPO market?
Facebook and Zuckerberg really screwed the pooch with their
greedy little IPO deal a few months ago. That being said,
Facebook was something new even if it was grossly overvalued.
The restaurant IPO market has really been depressing for upand-coming restaurant chains. IPOs used to be reserved for
young, exciting—and here are the key words—fast-growing
companies. In the restaurant business, the IPO has become a
playground for the golden age crowd.
For instance, look at the companies that went public during
the most recent cycle:
• Del Friscos (DFRG): The steakhouse launched in 1992.
• Bloomin Brands (BLMN): The first Outback Steakhouse
opened in 1987.
• Ignite Restaurant Group (IRG): Their signature concept,
Joe’s Crab Shack, was part of Tilman Fertitta’s’s empire back
in the mid-‘90s.
• Burger King (BKW): I ate my first Whopper in the 7th grade.
• Dunkin’ Donuts (DNKN): I love the chocolate donut with
milk, but this concept has been around since Jack Benny
was popular on radio.
The only new concept that went public in this recent round
of IPOs was Chuy’s, a Tex-Mex brand. It came out at $13.00
and is now trading at $27.00. Perhaps investors would like to
see more of the up and comers.
Hedge fund manager and short-seller David Einhorn
told a value investing conference Chipotle was grossly
overvalued. What are your thoughts about Chipotle’s
valuation?
Since Einhorn made his comments on October 2nd, the shares
of Chipotle (CMG) have dropped by 10%. Obviously, he has
a following. If anyone had read the Monitor during the past
year, they would have seen comments about Chipotle’s “grossly
overvalued” valuation. Remember, Chipotle’s shares closed
at $417.50 on June 20th of this year and there were still buy
recommendations out there from some analysts. Einhorn’s
right about this one, though. Competition will moderate their
advantage. I see Chipotle’s stock half of what it is now by 2014.
Are there other restaurant stocks you think are overvalued?
I think Panera (PNRA) is too rich at 15x EBITDA. CEO
Ron Shaich is running around opening “Panera Cares” stores,
which are non-profit versions of Panera where customers pay
what they want. In my view, Panera should start paying a
dividend to their shareholders and let them make their own
charitable contributions.
I think Dunkin’ Brands (DNKN) is a bit rich for my blood
at 15x EBITDA. The question is whether the new franchisees
will be as successful as the ones out east. I think Ruby
Tuesday’s (RT) is a disaster waiting to happen. If you look at
the last quarter ended in September, the company had a paltry
operating profit of $271,000. The interest rate on its senior
notes is 7.6%. It has resorted to sale-leasebacks of its real estate
to generate cash and buy back debt. Its former CEO, “Lord”
Sandy Beall, is still hanging around, too, although when he
walks he gets a lump sum payment of $8.1 million under a
special pension plan. I’ve never seen a situation where a CEO
with such lousy performance got paid so much.
Are there restaurant stocks you would buy?
I still like QSR as a defensive play. Burger King (BKW) is
doing a nice job of upgrading at a time when McDonald’s
momemtum has stalled. Wendy’s (WEN) is in the first stages
of a turnaround. The stock can be had for less than the price of
a combo meal. I also like Jack in the Box (JACK) and Popeyes
(AFCE). Jack in the Box is quietly becoming a national brand
and Qdoba is a nice growth concept. As for Popeyes, CEO
Cheryl Bachelder has done a wonderful job.
The Answer Man is a former restaurant operator who gives his opinion to
anyone who will listen, and to those who don’t. You may see him at the
Restaurant Finance & Development Conference in Las Vegas on November
12-14th, but he’ ll probably be incognito. As is his custom, he will lurk in
the hallways with the other creeps who show up, but don’t register.
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