Fast Food Franchise

There are four different types of valuation methods that can be used to value fast food companies, these methods are:

1. Asset-based valuation
   The basic formula to use for this method is: The fair market value of a company's assets less the fair market value of its liabilities = the fair market value of a company's equity.
2. Income approach to value (capitalization of earnings)
   This method is most the accurate for restaurants, which usually have a constant growth of earnings. The capitalization rates for restaurants range from anywhere from 20% up to 100%.
3. Income approach to value (discounted cash flow)
   The value of equity utilizing this method is equal to the present value of free cash flows available to equity holders over the life of the business.
4. Market approach to value
   This method utilizes market indications of value such as publicly traded comparable restaurant company stock and acquisitions of privately held restaurants.

Description of the Industry

The fast food industry is a highly competitive and labor intensive industry. The fast food industry falls into the SIC code of 5812 and NAICS Code of 722211.1 Fast food or Quickservice restaurants include national chains, regional chains, franchises, and independent operators. Fast food franchises permit independent owners to use a well-known brand name and benefit from the purchasing capabilities and operational proficiency of the franchiser. Franchises must adhere to quality and operational guidelines dictated by franchisers, and may have limited control over menu offerings, hours of operation, pricing, and store design. According to the National Restaurant Association (NRA) a franchised fast food restaurant can generate $1 to $2 million annually. The fast food industry as a whole has annual sales of approximately $120 billion and includes about 200,000 fast food restaurants. 2 According to the National Restaurant Association, sales for US Quickservice restaurants are anticipated to rise 4% to $163.8 billion in 2009. Some of the biggest players in the fast food franchise industry, both private and public, include:

1. McDonald's Corporation (MCD)
2. Burger King Holdings, Inc. (BKC)
3. YUM! Brands, Inc. (YUM)
   
   
   1. Pizza Hut, Inc.
   2. Taco Bell Corp.
   3. KFC
   4. Long John Silver’s
   5. A&W All American Food
4. Chipotle Mexican Grill, Inc. (CMG)
5. Wendy's International, Inc. (WEN)
6. Panera Bread Company (PNRA)
7. The Quiznos Corporation (Privately Owned)
8. Doctor's Associates, Inc. (Subway) (Privately Owned)

Industry Trends

There are several main trends that arose in the fast food industry during 2008 and are continuing through 2009. Three of the biggest trends are:

1. Technology advancements
   In terms of marketing, fast food and Quickservice restaurants are increasingly utilizing the Internet in addition to traditional television, radio, and print advertising. Online media allows restaurants to track and qualify marketing efforts, determine the best websites to advertise on, and modify their ad message quickly depending on the consumer response.
2. International growth
   All the major market players have an abundant number of franchises strategically located throughout the US. Some of the chains are experiencing low growth due to the increased competition and flooded market. The focus of the franchisors in the food industry has shifted to international markets. One of the countries with great potential is Bulgaria. In 2007 Bulgaria officially became a part of the European Union and has the lowest corporate tax rate in the EU. The Bulgarian legal framework is also very accommodating to foreign franchises.
3. Healthier menus
   As health awareness increases among consumers, so do their choices in fast food. In an effort to appeal to these consumers, restaurants are offering healthier selections on their menu. Fast food restaurants are offering salads, bottled water and healthier side options, especially on the children’s menu.

Many Fast food franchises such as have reported strong sales during the current recessionary environment in the U.S. Strong performance during the difficult economic environment of 2008 and 2009 is a result of convenient, inexpensive menu offerings. Fast food establishments that are able to offer inexpensive meals at a profit will be best able to weather the U.S. recession.

Key Fast Food Performance Metrics

There are several different performance metrics in the fast food or Quickservice industry, the major ones are listed below: 3

Financial:

1. Orders and sales (actual, comparable, and budget)
2. Delivery vs. carryout mix
3. Ticket dollar average
4. Food cost
5. Labor hours and cost
6. Menu mix (quantity and percent)
7. “Zeroed-out” orders
8. Overrides
9. Cash over/short

Customer Satisfaction:

1. “Out –the-door” time
2. Deliveries per run
3. Customer complaints

Benchmark Statistics

The following benchmarking data is based on studies from various franchises within the fast food industry:

	2003	2004	2005	2006	2007
Gross Profit (% of Net Sales)	60.3	62.1	61.3	62	59.8
Operating Profit (% of Net Sales)	4.7	4	3.8	4.5	5.1
Sales/Working Capital	-46.5	-35.6	-48.9	-53	-52.7
% Owners Compensation/Sales	4	3.7	4.1	3.9	3.6
Cost of Sales/Inventory	49.6	40.6	43	43	45.8
Debt/Worth Ratio	26.7	8	12.7	20	9
Current Ratio	.6	.6	.7	.7	.7
Quick Ratio	.1	.1	.1	.1	.1

Most Quickserve or fast food restaurants are moderately leveraged. This brings a higher return but imposes a greater risk to investors. There are a few restaurants that are highly leveraged, which makes projecting future cash flows very difficult and can have dire consequences on the business. However, other players in the industry such as McDonalds may have too low an operating leverage which limits the return that they could be earning for shareholders. A sample of fast food restaurants in the industry had a median ROE of 33% and a debt to equity ratio in the third quartile of 1.14 times.

Industry Organizations

Some organizations that publish helpful information include:

1. National Restaurant Association
2. International Franchise Association
3. American Franchisee Association
4. Restaurant News Resource

Availability of Publicly Traded Guideline Firms

There are approximately 42 publicly traded companies in the U.S. fast food industry. The sales of these companies range from $0.01million to $22,787 million dollars and market capital ranges from $0.04 million to $66,505 million dollars. The average P/E ratio is 13 times and the average price to free cash flow is 3.7 times. 4

The top five publicly traded fast food companies ranked by sales are:

1. McDonalds Corp.
2. YUM! Brands Inc.
3. Starbucks Corp.
4. Jack In The Box Inc.
5. Burger Kings Holdings Inc.

Availability of Purchase Transactions

According to one database that tracks fast food company purchase transactions, as of 1/22/09 there have been 492 fast food chain purchases in the U.S. from January 1, 2000 to present. The size of these private companies varied enormously, both in terms of their vehicle sales volume, and the purchase price paid for the companies. From 2000 to 2008, the ratio of:

1. Market value of invested capital (MVIC) to Net Sales ranged from 0.15 to 2.5 times
2. MVIC to earnings before interest, taxes and depreciation (EBITDA) ranged from 2 to 7 times.

This range of market multiples is too variant to be useful without further analysis. A proper value for the company that you are assessing should be based on the performance of the subject enterprise, compared to the performance of others in the same industry. Industry economic conditions also vary at different times, which obviously affect fast food franchises as investment opportunities.

Fulcrum Inquiry performs business appraisals for fast food franchises, and other businesses.

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1 First Research – www.firstresearch.com
2 Hoovers Fast Food and Quickservice Restaurants – www.hoovers.com
3 “Operational Business Intelligence at a Fast Food Chain” By: Dave Stark
4 Thompson ONE Banker