Conglomerate Investing: Cash Cow or Franchise Fizzle?

NEW YORK (Blue MauMau) - Is buying a franchise unit from a holding company that contains various brands a good or bad idea? Some franchise experts are saying that buyers should be wary.

Franchise conglomerates, those holding companies that own multiple franchise systems and brands, can buy various brands within their own niche, such as Raving Brands buying restaurant brands. Or conglomerates can be as diversified as athletic shoes and ice cream, as troubled NexCen Brands is. And such firms have been making the news with increasing frequency of late, like the announcement of insolvency issues at NexCen, the acquisition of Wendy’s by Triarc or an aggressive selling presence at this year’s International Franchise Expo.

Boom of Buying Brands Now a Bust

Darren Tristano, Executive Vice President for Technomic, Inc., a restaurant and vendor consultancy that tracks the 500 largest restaurant chains, thinks there has been a surge of franchise conglomerates over the past few years. Tristano states, “If you go back about 10 years, there was a trend by the major chains to really go after different non-competitive brands within their portfolio. This occurred within full service and limited service [restaurants].”

Tristano says that franchisors saw having multi-brands as a benefit to franchisees. “If you look at McDonald’s, they acquired Boston Market, Donato’s Pizza and Chipotle.” He continues, “What they were trying to do was give their franchisees an opportunity to own other restaurants within their area without being competitive with the McDonald’s brand.”  

But where conglomerates were once buying companies, they now are trimming down.

Bruce Schaeffer, president of Franchise Valuations Ltd, whose practice of providing valuations, expert testimony and opinions about the “fair price” of franchise companies has put him in a position to follow the finance, accounting and tax aspects of franchising and the economy for 30 years. He observes, “the small boom in franchise conglomerate mergers and acquisition of franchise brands has become a bust in 2008.”

“All of the low-hanging fruit of good deals in available franchise opportunities was picked two to four years ago because the cheap money financing of 2006 and 2007 is but a memory, gone with the wind,” Schaeffer declares.

Technomic’s Tristano also thinks the future of these franchise conglomerates is shifting away from multi-brands. He states, “Over the course of time, we’ve seen Wendy’s move in that direction with Tim Horton’s, Baha Fresh, Café Express, Pasta Bravo. But nothing has really come about and they have divested from that.”

"Take a look at a Kahala, Raving Brands or even Yum,” Tristano says. “Yum has indicated that they are going to move away from their co-branding. They want to strengthen their brand without being the dual or tri-branded units.”

Scott Haner, Vice President of Franchise Development for Yum Brands interjects, “It is true that we do not have as many [brand] combinations as in the past. We have found the ones that work best with our customers and we are aggressively expanding them.”

Other conglomerates are also trimming off brands while trying to focus on what works.

“When you look at Raving Brands, they had a great concept to stay within fast casual and offer lots of different things,” says Tristano. “They’ve since sold off Mama Fu’s. They’ve sold Moe’s. They are now working on smaller concepts. So they’ve gone from a company that wanted to achieve a billion dollars in sales to a company that creates brands and sells them. Franchisors can make money doing that. But they’ve shifted.”

Problems

Franchise buyers understandably are cynical about buyouts of other brands.

For one, franchise operators can be greatly impacted when their franchise system changes management, organizational structure and sometimes even brand name, which means replacing signage. Acquisitions are often touted as creating “synergy”, which seems to be corporate code word for managers who have seen too many fairy tale movies and think that they only have to kiss the ugly frog of a franchise brand to distill their management magic that will unleash the prince inside.

Rebel Cole, associate professor of Finance at DePaul University and a consultant of central banking systems around the world, views the value proposition as particularly poor for franchise holding companies with brands in unrelated industries. Cole states, “The finance literature on conglomerates is pretty clear; they destroy rather than create value. I would look for someone to take apart these new conglomerates during the next few years, especially now that the credit markets have tightened so much during the past year. My guess is that they are highly leveraged and will have trouble renewing their financing when it comes time to do so.”

Franchise attorney Keith Kanouse of Kanouse & Walker, P.A., warns, “There are a lot of small- and medium-sized franchisors that are floundering because they do not adequately service and support their franchisees. A lot of these companies are buying into conglomerates because of back office support, or other ways in which they have economies and buy a royalty stream. What if your system is second cousin in that the other brands get priority? You don’t have your franchisor opening the same brand, but rather it is a different brand but the same franchisor. That can create some cannibalization, where the other brands on the same street can hurt the individual franchisee, but overall doesn’t hurt the franchisor because its revenue base grows through its acquisitions and expanded brand concepts.”

Franchise owner-operators and potential buyers may want to watch the financial health of their franchisor when an acquisition occurs. Says Mr. Schaeffer, “The real question is what makes you think any merger or acquisition of a franchise brand in any franchise sector is worth contemplating in light of the just issued KPMG study that shows that only about 17% of all M&A transactions increase profits for the acquirer.”

Benefits

Acquisitions of franchise companies and brands make sense in certain situations. Kanouse, who acts as counsel for Diversified Health and Fitness, a holding company of five brands, states, “Mergers can combine back office operations and reduce cost.”

A franchisor with fewer costs can translate into lower fees for franchise owner-operators to support the system. A study has shown that combining back-office operations, eliminating redundancies, rather than promises of vast growth, are more likely to be successful. Kanouse elaborates that in various franchise sectors this can be marketing and other services when brand concepts are similar. Conglomerates can help consolidate and lower the “costs of field support, back-office support, making reservations, and passing on sales leads.”

Kanouse adds, “If you are buying different concepts in different industries, you should have separate field support. I would imagine that franchisors would want more economies of scale in their field support by having more outlets that they have to service and support in a given location to cut down the drive time. If the concepts are nearly identical, I don’t see why a field rep couldn’t handle different ones.”

What should an investor of a franchise unit look for in large multi-branded conglomerates?

Investors of businesses and consultants look for firms that “stick to the knitting,” focusing on what they know best. This mantra is best known among managerial leaders from the 1982 book In Search of Excellence, by Tom Peters and Robert Waterman. Peters and Waterman warned how easy it was for companies that had a diversified portfolio to be the jack of all trades and master of none.

Franchise experts warn of portfolio companies who think that they are masters at selling franchises and back office functions, no matter what business the franchise operations carry out.

Tristano advises to look at three things when considering a franchise that is under a conglomerate. He thinks it is important to first look at the segment. In restaurants, that means whether it is quick service or full service. Tristano observes, “Quick service offers much greater value, and it will continue to grow, not at the pace we’ve seen for the last ten years, but at a rate that will outpace full service.”

The second thing to look at is how the brands fit together. Are they really competitive? Are they well suited? Was there a good strategy on how they were acquired? Did they pick the right brands, turn around some of the brands that they have and to build success on that?

Tristano observes, “Kahala can now co-brand with Cold Stone Creamery and Cereality to be able to hit different day parts. I think what is part of their strategy is that if you have something that does well during breakfast, but does nothing at dinner, you co-brand to be something to everyone throughout the day instead of just Cereality that is open in the morning or Cold Stone that is midafternoon to night. So if you are able to combine some of these and hit multiple day parts with one fixed unit, you’ll have more success.”

And lastly it is track record—the management of the business and the financial performance of any investor in terms of going forward and looking at the upside. Here's a recap:

1. Look first at whether the franchise system is in a growth segment

2. Look into how the brands fit for you—the owner operator. Do they compete with you or will they make a good co-brand expansion? Are the brands in the conglomerate a good fit for you as the franchise operator to build your business?

3. Look at the financial track record and management leadership of the franchisor and its holding company

Buyers should watch out for problem brands in the portfolio because the holding company may have to devote considerable resources to their problem child.

Tristano observes, "When franchisors have eight, nine, or ten brands, unfortunately, the loser brands require the most attention. The troublesome kids are always 80–90% of the work, while franchisors tend to leave alone stars. If franchisors have a star brand, they should be focusing attention on that. It’s kind of like restaurants. When you have weak performers, you close them down. When conglomerates have strong performers, they should try to understand what the brand is doing right and try to replicate their success."

Yum Brands’ Haner adds that a buyer should look at brand winners that customers want. “Yum is different than many others in that when we talk about multi-branding we talk about two distinct brands to the customer but only one restaurant operational system for the operator. When we started, multi-branding was unique to certain companies that had a portfolio of brands. We believe our portfolio is the best portfolio for multi-branding because it allows the franchise investor to have leading brands in very popular categories in America. For example, when you put KFC and Taco Bell together, you get the leader in the chicken category and in the Mexican QSR category, and you get complimentary brands that give you lunch, dinner and late night appeal.”