Multi-Unit Franchisee Magazine Issue II, 2016 | Page 106
ExitStrategies
BY DEAN ZUCCARELLO
Too Big To Sell?
Reassessing unlimited multi-unit growth
C
onsolidation is perhaps the
single most significant trend
we have seen in the restaurant
industry over the past decade.
It is easy to understand why franchisees
and investors have chosen this direction.
Under the right leadership, consolidation leads to greater predictability of
operational results and returns through
economies of scale, implementation of
modern technology, market control, and
fixed-cost leverage. We have entered into
the era of the “mega-franchisee,” but as
these entities become ever more massive,
is there a case to be made for these organizations to strategically divest assets,
becoming smaller over time?
There are two catalysts for where a
mega-franchisee could find deconsolidation the best course of action: 1) when
it reaches an inefficient tipping point in
the context of day-to-day operations,
or 2) when it becomes more beneficial
to break apart the whole to maximize
shareholder value as it relates to an exit
strategy.
Clearly, big can become too big. As
we see with large company-operated
brands, inefficiency can erode the entrepreneurial enthusiasm and control that
originally fueled these businesses. It is
true that on the way to scale, there are
great efficiencies and performance boosters attributed to streamlined leadership,
professionalized systems and procedures,
and direct accountability. At some point
however, size can have the opposite effect. Inefficiency through decentralized
control and oversight may lead to inferior
performance and loss of accountability,
as well as unnecessary growth of supervisory and G&A costs.
The franchise model has always thrived
on a close hand of control and oversight,
ensuring above-average performance.
Technology deployed across operations,
human resources, finance, and marketing has largely been the most influential
force in this equation. It has helped operators move up the point of diminishing returns, but to date has not removed
the tipping point from the equation.
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At this juncture, returns are hampered,
growth slows, and operators could find
themselves forced to simplify in order to
reignite the core business and/or correct
balance sheet issues.
Maximizing shareholder value is another catalyst for dividing restaurant assets. Whether an organization has reached
its point of diminishing returns or not,
there is real value in breaking a megafranchisee into multiple parts upon a
sale or other exit strategy. In some cases,
the massive scale of a mega-franchisee’s
holdings could give this company control over multiple, distinct market geographies. This presents the seller with
a couple of challenges—and therefore
opportunities for buyers.
First, there is the chance that no qualified buyer can be found for a business of
such a large size. Second, even if a buyer
is found, there is no guarantee that the
franchisor will share the seller’s sense
of optimism about the buyer’s qualifications and the sale’s perceived risk to the
system. Additionally, in today’s market,
small and medium-sized franchisees are
bidding most aggressively on individual,
adjacent markets with minimal G&A assumptions attached to their valuation.
So, while the entire transaction would
likely require a large institutional private
equity buyer who would look to the historical oversight expenses, smaller individual market buyers might help drive
more margin to the pro forma EBITDA
they are buying. It’s also worth noting that
individual buyers might see other storelevel P&L opportunities in purchasing
assets out of the mega-franchisee that
are particularly attractive to them given
their geographic interest and structure.
This essential argument bears some
similarity to what has gone on with
corporate refranchising over the last 5
years, with new buyers finding unique
individual market opportunities and
subsequently paying a premium price for
them. Franchisors are selling those assets
at a discount to where the brand itself
trades. In return for that step down in
valuation, they get a predictable royalty
stream and diminish future capex requirements. In contrast, the mega-franchisee
seeking the same kind of divestiture by
separating markets may actually see a
step up in overall value by selling their
markets individually.
There are a number of takeaways
from the ideas expressed here. First, we
expect to see continued consolidation.
The best operators will certainly continue to leverage their infrastructure
and technology to push the bounds of
what it means to be in the top 200. However, this consolidation is not without a
limit, creating additional consolidation
opportunities for smaller, nimbler buying groups.
We frequently hear that these groups
are frustrated by losing deals to the megafranchisee, but we advise that time and
patience will afford opportunity just as
it has with refranchising.
Additionally, there is the “risk and reward” factor concerning the franchisor.
As franchisees pursue further growth,
we do see some franchisors taking steps
to limit the risk associated with concentration. Some franchisors have imposed
caps on the number of units one franchisee can acquire. Others have taken a
more aggressive role in the transaction
approval process by limiting private
equity participation or by exercising
their right of first refusal to control the
deconsolidation process, subsequently
reselling the individual markets of the
mega-franchisee.
The most important conclusion you
can make is to control your own destiny
as it relates to your M&A activity. As a
mega-franchisee, ensure that you understand the value of the whole versus the
parts; and as a smaller buyer, make sure
you are prepared to be nimble when megafranchisee transactions take place.
Dean Zuccarello is CEO
and founder of The Cypress
Group, a privately owned
investment bank and advisory services firm focused exclusively on the multi-unit
and franchise business for 25
years. He has more than 35 years of financial and transactional experience in mergers,
acquisitions, divestitures, strategic planning,
and financing in the restaurant industry.
Contact him at 303-680-4141 or [email protected].
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