Thoughts on Who’s Next


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Roger Lipton

Roger is an investment professional with decades of experience specializing in chain restaurants and retailers, as well as macro-economic monetary developments. He turns his background, as restaurant operator and board member of growing brands, into strategic counsel for operators and perspective for investors.

An archive of his past articles can be found at RogerLipton.com.

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Inspire Brands, affiliated with private equity firm Roark Capital, announced the intended purchase of Sonic Corp. (SONC), at a premium of about 18% to the market price prior to the offer. That values SONC at about 15x trailing EBITDA and 30x the current years estimated earnings. Without question, the valuation is high by historical standards, consistent with the valuations a year ago when Buffalo Wild Wings (also acquired by Inspire Brands) and Popeye’s (Restaurant Brands International-QSR) were taken private. 

The valuations are a function of investor desire for franchising companies “asset light,” free cash flow model, as well as the relatively low interest rates that have prevailed for almost a decade now. It should also be noted that 50-year-old Sonic’s carhop service has emerged as a uniquely efficient way to serve the convenience driven Millennials, no doubt contributing to the willingness of Inspire to pay what appears to be a full price.

The natural question is “who’s next” in the restaurant business.

The following list of public franchising companies provides pertinent valuation parameters as well as my comments about their current fundamental appeal, starting with the lowest trailing multiple of enterprise value to trailing twelve months (TTM) EBITDA according to Bloomberg.

Jack in the Box (JACK)—sells at 10.4x TTM EBITDA. Having recently sold Qdoba, management is concentrating on reinvigorating the chain, but there is little current sales momentum and real estate economics preclude new unit growth. The refranchising has been done to the tune of 88% franchised, and a buyer would have to be confident in sales improvement. This happened at Arby’s, but that chain was severely mismanaged, not the case at JIB.

Papa Murphy's (FRSH)—sells at 11.0x TTM EBITDA. This chain has consistently disappointed since coming public in 2014. Domino’s has run rings around them, attracting the Take ‘n Bake potential customer. Though several years ago disillusioned franchisees were a feature here, new management has been installed and that problem seems to have receded. PE firm Thomas Lee owns 25% and billionaire Michael Price about 15%. The pair would have to be tired of the situation at the same time that a new player became enthused.

Bojangles (BOJA) – sells at 11.1x TTM EBITDA. This chain is only about 57% franchised so more of that could be done. Operating in a very competitive segment, against KFC and Popeye’s and others, sales and traffic trends have been challenged, so a buyer would hope to restore top line momentum.

Papa John’s (PZZA) – selling at 12.1x TTM EBITDA has been a well-described problem situation since John Schnatter became “the story.” The food and service were not the problem, and PZZA competed with DPZ fairly well until recently.

Denny’s (DENN) – selling at 12.2x TTM EBITDA has been improving operations in recent years, under the excellent leadership of John Miller. However, the family dining segment is very competitive, current real estate economics make it difficult to generate strong ROIs, and there is nothing unique about the venue. Much of the (modest) new unit growth has come at “non-traditional” venues such as truck stops. There is not a lot of low hanging fruit here because operations have already been improved in recent years.

Yum Brands (YUM) – selling at 12.5x TTM EBITDA, having spun off the Chinese franchisee to the public, YUM is not expensively priced, but now there is concern about the government debt driven Chinese economy. Also, with a $37 billion current Enterprise Value, the deal would have to approach $50 billion, which is getting to be real money. If an investor was comfortable with Chinese fast food, which is where the growth at YUM will come, they could look at Yum China (YUMC), which sells at only 8.0x TTM EBITDA, and that has been talked about since YUMC stock came down recently with disappointing results.

McDonald’s (MCD) – selling at 14.4x TTM EBITDA is once again playing a leadership role in the QSR space, especially among the big three hamburger chains. Especially since there is major real estate ownership here, MCD would be an obvious candidate, except that the current Enterprise Value is $159 billion, and a premium to that would be pretty large even in a world where a billion dollars isn’t what it used to be. MCD is buying back billions of their own stock.

Wendy’s (WEN) – selling at 17.4x TTM EBITDA is adequately valued, considering that their venue is not unique and they continue to be in a battle among the big three hamburger chains. Controlled by Trian, a Peltz affiliate, you can bet that the low hanging financial fruit has already been picked through.

Dunkin’ Donuts (DNKN) – selling at 18.0x TTM EBITDA, now without “Donuts” in their name, DNKN continues to lose market share to Starbucks, who we can bet is doubling down to regain their own traffic momentum. You never know whether JAB, who has been paying up for anything related to coffee and breakfast (Green Mountain, Peets, Panera, Caribou, Bruegger’s, etc.etc.) will decide they need DNKN, but we don’t like to bet on a mediocre business based on a takeover.

Restaurant Brands (QSR) – selling at 18.6x TTM EBITDA, has been the stalker, not the stalkee. They are already leveraged and brilliant financial engineers on their own, Tim Horton’s is troubled and Popeye’s can’t move the overall results by much. They could find a relative bargain company to buy, and their stock does not qualify.

Domino’s (DPZ) – selling at 25.7x TTM EBITDA is already fully valued based on their outstanding performance. A buyer would have to be very enthused about the overseas prospects (which are a fact) to pay this kind of price.

Wingstop (WING) – selling at an astronomical 53x TTM EBITDA. A fine company, but the stock is obviously not a bargain. The fundamentals may well catch up with the stock price, so we (and private equity buyers) will leave this one to the long-term growth stock investors.

Conclusion

Based on the above, we would, and we have, bet on Papa John’s (PZZA) as a takeover possibility. As we finish this article, it has just been announced that John Schnatter has shopped the company to private equity buyers. The stock is up over $3.00 today.

As a second candidate, though we have not purchased the stock, we suggest that Bojangles (BOJA) could be interesting. It’s not an easy turnaround, but private equity players have lots of confidence in themselves, and they don’t always ask for my opinion. The valuation is reasonable enough, some of the company stores could no doubt be franchised, and their balance sheet is only modestly leveraged at the moment.

With all the above in mind, nothing surprises us in the current interest rate environment. Very low cost of capital encourages misallocation of same, and the capital markets have been demonstrating this in lots of ways for a decade.  In general, relative to the valuation of restaurant companies, we are much closer to the top of the cycle than the bottom. We suggest that there will be better purchase opportunities in the not too distant future.

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