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Financial Sniff Test

A Simple Financial Test Using Due diligence, UFOCs, and Industry standards

Although a version of this blog entry was previously posted in another forum, it is reposted here in order to illustrate a simple method that can be utilized to determine overt franchise concept viability. By overt, I mean this is but a preliminary screening test. There is no reason to go the expense of hiring a lawyer, a forensic accountant, or pay for in depth analysis if a concept cannot pass a simple “sniff” test.

The methodology is simple. Many concepts are in industry verticals, and in general if there are players in the vertical there also are trade groups that attempt to disseminate information “for a fee”. The disadvantage is often you need to be a member of the trade group which can runs hundreds of dollars. One way around this is to simply ask someone involved in the vertical for a back issue or other relevant data on a one time basis. People tend to be very accommodating.

What you are trying to do, is use industry averages to determine overall viability. National data is available for QSRs, certainly for sub and other sandwich shops. In this example I was examining the “Quick Lube Market”. There is an trade journal for the quick lube industry, NOLN (National Oil Lube News) that formed the basis for simple comparison test. Armed with the data from NOLN and the companies UFOC a simple screening sniff test could be employed. In this case we are comparing a 2004 UFOC and 2003 NOLN data, the information is dated but the purpose of this post is to demonstrate a simple screening technique.

The prerequisites:

Get the UFOC, what you are after is the Income Projects – Exhibit J, click here

An Excerpt from 2003 National Oil & Lube News (NOLN) Survey
 Year 1999 2000 2001 2002 2003 2003
Independent/company-owned facilities 81% 85% 84% 87% 85% 40%
Franchised Facitilies 19% 15% 16% 13% 15% 60%
Years in Fast Lube Business 7.1 7.6 8.1 8.9 8.2 17
Ticket Total 32.55 35.25 36.66 38.51 39.18 48.27
Number of Cars Serviced Per Day 41.6 40.6 41.4 40.3 37.6 40.7
Break Even Car Count 28.9 26.6 26.7 25.8 24.8 28.1
Operators Planning to Sell Next Year n/a 7% 8% 8% 6% 0%
Operators Planning to Sell Five Years n/a 24% 21% 25% 21% 0%
Number of Bays Per Facility 3 3 2.8 2.7 3 3.4
Price of Standard LOF $24.18 $24.71 $25.35 $26.86 $26.71 $29.13
Cost of Goofs for Standard, Full Service LOF $7.98 $8.29 $8.54 $8.40 $8.73 $6.62
Time Required to Perform a LOF n/a 11 Min. 11 Min. 11 Min. 11 Min. 11 Min.
Operators Who Offer Up-Scare/Premium LOF n/a 68% 70% 63% 63% 70%
Price, if Offered n/a $36.37 $38.03 $43.82 $44.33 $49.32
Operators increasing LOF 29% 72% 66% 34% 51% 60%
How Much? $1.39 $1.43 $1.46 $1.49 $1.47 $1.35

Note: LOF = Lube, Oil & Filter Job. The 2003 column on the left represents "Less than 30 stores", the 2003 column on the right represents "more than 30 stores". NOLN started breaking this down in this fashion in 2003 for select categories. Operators increasing LOF" means operators increasing LOF price in the past 12 months. "How much" in the next line is how much the LOF price has been increased.

In view of some industry standards (NOLN survey) I find the Franchisor’s earnings claims enlightening. According to NOLN (National Oil Lube News) the "average" car count was between 37-40 in 2003 (the latest year I have numbers for), but historically the car counts have been closer to 40 [a sign either the market has matured (not likely) or a sign of competition as historically this is a price inelastic service]. And in the same report NOLN's number for breakeven in terms of cars served s between 24-28 cars a day depending on lease/buy arrangements. Looking at the Franchisor’s exhibit J we can see that about 40% of their franchises hovering around or more significantly below the break even threshold at 30 cars a day. What is more telling is that 85% of the NOLN respondents are independent. That makes me question the overall "value" of the franchisor’s franchise process. Why is it that operationally independent lube shops are outperforming a franchise operation? It makes you strongly question the "operation" side of the equation and makes you wonder if their selection process is more geared to selecting candidates who will stay with the "system" and put money in the franchisor’s pocket rather than looking for candidates with the ability to expand market share as the independents must be doing. Another way to say this is, your franchise fee may buy you somethings procedurally but they certainly are not buying you a process that even slightly approaches what I would term success.

There is another thing, here is information from one of the Franchisor’s web pages:

Site Selection Assistance: We provide the tools and real estate information necessary for the franchisee to make an informed decision on the correct location for a new center. Our real estate department will help select a X location by evaluating market conditions and trends, population density, traffic patterns, demographics and proximity to traffic-driving influences, such as primary retail centers.

Hmmm, what do you know? Part of your franchise fee goes for site location. Given that 40% of their franchises are either below the breakeven point, at the break even point, or barely turning a profit, you have to wonder the value of the site location.

The esteemed barrister Webster made the following observations:

  1. Exhibit J, an earnings claim, shows that 11 out of 32 participants in a disclosure program, from a maximum of 177 franchisees, earned less than 10k before paying rent, or any debt repayment. Basically, you could not survive on these stores average ticket count of 19.
  2. Even the 4 stores with an average ticket count of 27, are only showing 61k before paying rent. Rent, from their estimates, could be anywhere from 36 - 72k.

Basically, half the reporting stores are either insolvent or barely making the rent. Unless you average 40+ cars per day, you are going to have a tough time, especially if you financed the construction of the site.

I put this out here for discussion and analysis. I deliberately did not mention a lot of things you can pull out of this to stimulate some discussion. But here are a few additional points. Look at the NOLN data,one thing to notice is the % of owners who are planning on selling. It is relatively low…that implies a few things and casts more doubt on the franchise proposition proffered by the franchisor.

And the point is diligence, which is what Michael, Paul, Mr. BlueMauMau, Richard Solomon and so many others have tried to get across to many of the posters. Folks it is your money on the line. If you are not willing to ferret out industry norms and compare the franchisor to those norms and normalize the figures for the circumstances you are simply gambling.

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