Two key words in the franchise finance world for 2006 will be “multiples” and “activity.” It is apparent, through recent and pending transactions, that the valuation Multiples (the cash flow from the target business times a multiple) are at historic high levels. This is true both on the franchisee and franchisor side and for both private and soon to be public companies. It is not just high multiples but a tremendously high level of funding, i.e., Activity. Let’s take a closer look at what this means for three areas in 2006:
• Franchisee transactions. These transactions normally have the lowest multiples, but this view may not be held in the case of both financial and strategic buyers. The targets usually are significant multi-unit operator franchisees with between 30 and 150 units. These targets can range across all types of concepts in the franchise world including convenience stores, quick lube service stations, casual dining restaurants and quick serve restaurant segment. Solid performing franchisees can expect much higher multiples than they could in the past. It is very difficult to assemble complete data, but we have observed multiples as high as eight times free cash flow (EBITDA). These multiples are sometimes overstated if the real estate is purchased and then sold in the sale/leaseback market. Nevertheless, many of these transactions do not involve real estate and are straight enterprise acquisitions and the multiples still may get to historic highs.
• Concept areas (the keeper of the concept – the franchisor). We have seen a number of transactions (including the infamous Dunkin Donuts transaction) at extremely high multiples. Some of these transactions are public companies going private transactions. These companies may be underperforming but have a strong concept and system. In many cases, the buyers are private equity groups that believe the concept value will increase with better management and growth. A great example of this type of transaction is the recent acquisition of the LaQuinta hotel chain by the private equity group Blackstone.
• The IPO market. The most recent example of the robust IPO market is the Burger King announcement of an IPO. The reasons are obvious. There is a window for high multiples for companies going public, and a company like Burger King needs to take advantage of this rising fortune. Even franchise companies that have “significant hair” with problematic franchisor/franchisee relationships still seem to be pursuing public offerings.
What does this mean for the franchise business owner? It means this is an optimum time to sell. Obviously, as the market heats up, companies that are fringe concepts or have a problematic business situation may not be able to take advantage of this feeding frenzy. However, companies that are in a position to sell would be remiss not to consider this option.
Let’s look at other key concepts and ideas for 2006:
• Franchisor control. It seems the franchise world has recognized the excesses of the past, and many franchisors are looking more critically at leveraged transactions, private equity groups entering their systems and the heavy use of sale/leaseback. Further, because of the competitive pressures (particularly in the restaurant arena), franchisors are making forceful demands for capital improvements and upgrades to system stores.
• Reconfiguration. The franchise world has grown for more than 30 years (and the growth has accelerated over the past 10-15 years). This growth has resulted in franchise systems that are at a mature stage with many sites needing to be relocated, reconfigured or remodeled. Franchisors, seeking growth, cannot rely on the sale of new franchises because the cost of real estate is so excessive. In many cases, franchisors are encouraging growth by providing financing to their franchise community for stores that need to be retooled and reconfigured to get the most out of existing development areas.
• Availability of debt funding. While we are no longer in the “go-go” times of the 1990s with securitized lending and the tremendous availability and supply of senior debt financing, we are seeing a continuous growth in bank and finance company funding for this sector. We are also seeing hedge funds combining a senior debt facility with an equity investment to provide funds. Equipment leasing groups still continue to be active in the franchise sector and regional banks, as well as the national banks, continue to look and pursue this sector. In summary, there is no contraction in debt lenders, but a slow and steady growth in the number of players and the availability of funds.
• Sale/leaseback. Sale/leaseback continues to be a significant source of financing for the franchise industry, both for franchisees and corporate store development for the franchisor. If a concept is real estate intensive, sale/leaseback can be a great source of financing. Obviously, the rates are still historically low, which creates a higher sale price for the seller/lessee.
• Consolidation. Like everything in the business world, one of the key opportunities is consolidation. Franchisees and franchisors are getting bigger by acquiring multiple concepts and, just in general, are becoming bigger businesses. Obviously the RTM/Triarc merger of Arby’s shows the value of being a large franchisee and the opportunity to be acquired by a franchisor. Additionally, we are still seeing franchisors that want to acquire other concepts thus, providing growth opportunities.
With the growth of large franchisees, one of the interesting phenomena is that in many cases the franchisees are larger than the franchisor. This franchisee growth has shifted the power base and may be a concern to some franchisors. Recently, we have seen small systems where the franchisees have united and basically dictated what the franchisee expects the franchisor to do.
• Technology. The franchise world and its ability to grow and finance has become more dependent on good financial reporting and real-time monitoring at the unit level. Franchisors have developed financial reporting tools that provide the franchisors with system wide information and a sophisticated business model for the franchisee. This model can show the franchisee an appropriate capital structure, calculate levels of leverage and indicate significant variation in unit performance to the norm of the system. Internet reporting on a unit basis has allowed both the franchisor and franchisee to effectively control units on a real-time basis and make adjustments. These new tools have created a new type of informational processing which helps to grow and finance a system.
These are just a few highlights. Remember, our industry is now in a Cinderella mode; do not get caught holding the pumpkin. Next month—“Raising Money With a One Unit Concept.”
From March 2006 Franchise Times