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Franchisee Due Diligence of Franchisors: Lessons from Applebee's

In the November 2016 Restaurant Finance Monitor, published by John Hamburger and Franchise Times, there is an excellent article about current issues underway in the Applebee’s system. Applebee's problem is also broadly present in parts of the restaurant franchise space.

The article, in part, begins:

Applebee’s franchisees were seeing red when parent DineEquity raised the dividend payout by 5.4% in the third quarter. A nickel a share on top of a buck each quarter is a pittance, yet it was more smoke and mirrors on the heels of 5.2% decline in same store sales for the Applebee’s brand. IHOP also reported negative same store sales after a run of successful quarters.

DineEquity reported flat earnings in the third quarter and would have been down if it weren’t for G&A cuts. By its own measure, the chain reported 12.5% lower free cash flow year to date than a year ago, yet the dividend was raised annually by $3.6 million, perhaps in order to keep the stock price from tanking.

That DineEquity CEO Julia Stewart could muster an increase in the dividend payout when the sales and marketing at Applebee’s had collapsed is a testament to the audacity in which the “asset-light” model has been hijacked by the“shareholder value” crowd.

Franchisors are money making corporations who focus on their own numbers and results, first and foremost. They have either equity investors (stock shareholders), private equity majority and minority owners or founding families, all of which have either debt to banks or other investors, and dividends to pay.  They service their debt, pay salaries, and pay either periodic dividends or buy back shares of stock

These corporations are all at different parts of their business cycle, and have different strengths and stresses. Franchisees, before they sign up, should take noted of not just the brand but the circumstances facing the brand. Here is brief checklist I’ve assembled, for franchisees to study beyond what is most apparent. Little of this is in the franchise disclosure document (FDD).

This seems to be the case with Applebee’s. Casual Dining Bar/Grill is very difficult right now, but has been for almost a decade. Things are getting tight there and franchisees are saying that corporate support is eroding.

  • How much can I make? Remember that store profit (usually a EBITDA number) is reduced by taxes, franchisee overhead, future capital outlays for remodeling, maintenance capital spending (CAPEX) and future brand equipment and building mandates, not to even mention debt service (interest expense and loan amortization). There are many subtractions from store EBITDA.  Ask the McDonald’s (MCD), Wendy’s (WEN) or Burger King (QSR) franchisees about that.

  • Franchise Disclosure Document clues: Look at the trend in stores opened and closed. Look also for the amount of litigation.Check the franchisor's balance sheet that is attached to the Franchise Disclosure Document. Is the franchisor cash amount low? Does it have a used up line of credit?

  • Examine the franchisor performance itself: How many units does it have? Is there a sizeable company-owned store base? Has it been in Chapter 11 or near insolvency? Has it been through multiple Chapter 11s? Is its franchise system expanding or not? Is it growing too quickly such that good franchise support systems might be stretched past its limits?  Does it have a ton of debt? (Hint: there are ratios of EBITDA to debt that are industry standards). One idea is to check its ratings with Standard and Poor’s, Moody’s and Fitch. Just google it. Has it changed CEOs and other corporate officers? Do those corporate officers have any restaurant experience?

  • Is the franchisor publicly traded or not? If it is public, has the company frequently missed Wall Street earnings estimates? Big misses? Did it miss both revenues and earnings per share? Again, just google it. Is the company in a cost cutting mode? Are same store sales down materially for quarter after quarter? This seems to be the case with Applebee’s. Casual Dining Bar/Grill is very difficult right now, but has been for almost a decade. Things are getting tight there and franchisees are saying that corporate support is eroding.

All of these are stress indicators.  Since everything relates to everything else, insure you are approaching a strong brand platform before you sign on the dotted line.

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About john a. gordon

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John A. Gordon, founding principal of Pacific Management Consulting Group provides analysis and advisory services relative to complex restauant topics. This includes buy or sell due diligence, operational analysis and improvemenrs, expert litigation support and business investigation and analysis.

Gordon focuses on restaurant strategy, operations and financial management topics, and has a 45-year background in restaurant operations and financial management staff roles for both franchisors and franchisees. He is a certified Master Analyst of Financial Forensics (MAFF). He supports both franchisees and franchisors, and has a franchise standards and practices sub speciality.

Pacific Management Consulting Group provides creative, detailed and effective insight, independent research and analysis that is free of conflicts of interest. The company provides chain restaurant earnings and economics analysis, research, expert witness engagements, suppors both consulting and sell side equity research firms, due diligence and other analytical investigations. He routinely partners with other restauant subject matter experts in a variety of specialities.

Visit him at Pacific Management Consulting Group. Contact him by email or call (619) 379-5561. Gordon blogs on on his website and publishes discussion papers; his press clips and a real time restaurant analysis blog, is included.

Area of Interest
Franchise Operations