Alicia Miller
The following is an excerpt from Alicia Miller’s new book, “Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.”
Was there a dramatic moment that pushed private equity into franchising? Success often breeds imitators and quick followers. Private equity firms have a capital and investment mandate that pushes them to launch into entire industries seemingly overnight, especially after early investors demonstrate success. This is exactly what happened in franchising. It wasn’t a single tipping point. Rather, a series of events “suddenly” created an “aha!” » collective. among the PE companies that have put franchising on the collective PE radar.
The first major wave of franchise PE investments was marked by the following activity:
The first participants arrived and placed a few bets. In retrospect, you can imagine a few prescient heads turning almost in unison, as if on a giant pivot, to suddenly “see” franchising. But at the time, the participants probably didn’t consider themselves at the peak of the coming wave. The franchise industry was largely untouched by the trading frenzy of the 1980s. Starting in the mid-1990s, a few private equity firms, particularly those with exposure to retail and shopping centers, started to get into franchising. For example, Catterton Partners and a consortium of others invested in Baja Fresh (1998), Argosy Private Equity invested in American Huts, a 95-unit operator of Pizza Hut (1998), American Securities Capital Partners purchased El Pollo Loco in difficulty at Advantica. Restaurant Group (1999) and Gemini Investors purchased Buffalo Wild Wings (1999).
Three mega-deals created significant visibility. At the end of the heady era of leveraged buyouts, three acquisition deals led by Bain Capital – Domino’s Pizza (1998), Burger King (2002) and Dunkin’ Brands (2006) – increased the attractiveness and visibility of the entire franchise category to other private equity firms. . There was nothing subtle about these three $5 billion deals combined.
Bain’s $1.1 billion purchase of Domino’s Pizza attracted market attention in December 1998. Then Bain Capital, Goldman Sachs Private Capital and Texas Pacific Group teamed up to buy Burger King for $1.5 billion. dollars in 2002, paying just 14 percent of the purchase price, or $210 million.
But the trading community was even more inspired by Bain’s reported 500 percent return on its modest initial investment of $385 million when it took Domino’s public in 2004. Bain withdrew further distributions of the Domino’s business in several tranches, including a 2003 refinancing, proceeds from the 2004 IPO, and what the press called a “monster” dividend of $897 million in 2007. (Note from reader: The use of debt is covered extensively in “Big Money.”)
Bain, Goldman Sachs Private Capital and Texas Pacific Group subsequently managed to reinvigorate Burger King, leading to a public offering in 2006. After initially paying only five times EBITDA in 2002 for the struggling company, the IPO exchange raised $425 million. But that was after private equity investors took out more than $800 million in dividends and fees, including a $367 million dividend paid just before the IPO, funded by $350 million in new debt. Investors retained a stake in the company and sold their shares over time, netting an estimated additional $900 million.
Also in 2006, Dunkin’ Brands was acquired by Bain, the Carlyle Group and Thomas H. Lee Partners for $2.425 billion in another high-profile transaction. The debt from the acquisition was refinanced in 2010 and total debt ballooned to $1.87 billion, while the PE owners quickly pulled out an attractive $500 million dividend.
The tech bubble and junk bond markets burst. Keep in mind that many investors of all types were truly slammed when (1) the tech and telecom bubble burst between 2000 and 2002, and (2) junk bond bankruptcies created a devastating downstream impact in other sectors, such as retail. Thus, high-profile paydays like the three Bain deals mentioned previously have garnered attention in part because of their stark contrast to more negative market stories.
Going private had a new appeal. The EP benefited from reforms implemented after scandals at publicly traded companies such as Worldcom and Enron. The Public Company Accounting Reform and Investor Protection Act of 2002 imposed strict new regulations and reporting requirements on publicly traded companies. This had the effect of pushing some state-owned enterprises to consider privatization with the help of PE.
Many franchise systems had long since become public, creating a vast field of privatization opportunities that PE dealmakers could exploit. And for companies no longer considering going public, the PE was well-positioned to provide exits to early investors. Creative debt instruments encouraged transactions and provided additional support to the PE investment model, at least in larger companies where leverage could be used.
Impressive multi-unit empires continued to be built by franchisees. These were high cash flow companies with strong growth prospects and open space for further development. The operational models were easy to understand.
Two other high-profile PE moves have caught the market’s attention. Levine Leichtman Capital Partners and Roark Capital Group entered the franchise scene around this time. LLCP took Quiznos private in 2000 in a deal that received significant media coverage. Neal Aronson, after recently successfully exiting the American hotel platform Franchise Systems Inc. that he built from 1995 to 2000, founded Roark Capital Group in 2001. Roark was created specifically to invest in franchise and multi-business businesses. units, which provides additional validation. The money was paid into the EP; this capital had to be deployed.
At the same time, franchising continues its constant global expansion. We can imagine that after the tech bubble burst, some previously favored businesses suddenly appeared as highly speculative investments compared to simpler franchise businesses, like selling pizza.
Thus, a confluence of factors conspired to make franchising suddenly both attractive and visible to PE dealmakers looking for new ideas. Together, these factors formed the tipping point that changed the franchising industry when private equity entered in droves.
Alicia Miller is the founder and CEO of Emergent Growth Advisors. His Development Savvy column covers smart ways to market and grow a franchise. She is the author of “Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.” Contact her at amiller@emergentgrowthadvisors.com.
