by Simon Lord
last updated 23/09/2019
kiwi franchises GOING PUBLIC
by Simon Lord
last updated 23/09/2019
Recently, a couple of well-known franchise brands have also been going public through listing either on the NZX or the New Zealand Alternative Market (NZAX), which is aimed at smaller and growing companies. The Mad Butcher listed earlier this year, while the international arm of Esquires Coffee Houses is also planning what is called a ‘back-door’ listing (a back-door listing is what happens when a private company acquires a publicly-traded company and thus ‘goes public’ without an initial public offering).
They join franchisors such as BurgerFuel and national master franchisees like Restaurant Brands on the New Zealand market, while companies such as Retail Food Group, which operate several popular franchises here, are listed in Australia. We decided to take a closer look at the reasons for going public, the pros and cons and the impact upon franchisees.
Why Go Public?
When BurgerFuel launched its prospectus in June 2007, the franchise was a small company with big ideas. The Ponsonby-based burger chain wanted to fund its global expansion and decided to raise funds through a public listing. The listing which, in a typically flamboyant BurgerFuel fashion, offered customers shares with their burgers, raised some eyebrows in the traditionally reserved financial world and was far from fully subscribed with BurgerFuel founder Chris Mason and his business partner, Josef Roberts, retaining the great majority of the shares themselves. The shares were offered at $1 each but briefly dropped as low as 18c as BurgerFuel’s initial forays into Australia floundered. However, efforts to establish the brand in the Middle East bore fruit and the company has since produced a continuous flow of good news about the granting of local master franchises to well-connected local business groups followed by a succession of openings. At the time of writing, the share price stands at $1.70 following steady growth through 2012/2013 and the company’s bold move looks to be paying off.
Raising funds for expansion is probably the most common reason for a privately-owned company to list on the stock exchange. However, there are other reasons too. These include creating wealth for the existing owners, broadening the company’s knowledge base through the appointment of experienced directors from other industries, creating a long-term exit strategy for owner/managers and raising the company’s public profile.
In the case of BurgerFuel, another advantage was that publicly-listed companies are required to have a much higher standard of financial reporting and governance than privately-owned companies. While this can be both expensive and onerous, BurgerFuel found that it reassured potential master franchisees overseas and attracted a higher calibre of partner than might otherwise have been possible for a small company from a far-away land.
For The Mad Butcher, the challenge was local rather than international expansion. With 36 stores around the country, when it came to investment the company was ‘too big for most independents and not big enough for most corporates,’ says Michael Morton, who bought the business from founder Peter Leitch in 2007. ‘We had identified 37 more locations which would allow us to double in size but, even though they would all be franchised, there is a cost involved in growing that fast. We didn’t actually need to go public to access the capital we required, but it offered a lot of additional benefits – not least the amount of publicity we gained for the company as The Mad Butcher seeks to broaden its customer base. It’s certainly attracted new shoppers into the stores.’
Michael doesn’t deny that there were also personal reasons for floating the company. ‘I was the majority owner before and I am the majority shareholder now so I’m not planning on going anywhere, but one day, when I do, we will have created a market for the shares which will allow me to exit as I choose. In the meantime, I think a lot of the best-performing listed retailers still have majority shareholders who are very much involved – look at Briscoes, for example.’
Listings Achieve Higher Valuations
The Mad Butcher listing (another back-door listing, through Veritas Investments) valued the company at $40 million and the offer was heavily over-subscribed with investors, institutions and franchisees seeking three times the number of shares actually offered. Shares were issued at $1.30 in May 2013 and are trading at $1.40 at the time of writing.
Valuing a franchise is always an interesting challenge as, although group turnover might be $150 million, only a percentage of that actually comes to the franchisor through fees and product supply or other arrangements. However, in the right circumstances, listing a company will often achieve a higher valuation than would be paid by a private purchaser. Dr Callum Floyd, of Franchize Consultants, explains: ‘When a franchisor business is sold outright, a private purchaser or group is often willing to pay a certain figure that falls within a common multiple range based on the level of historical and/or future expected earnings. For many franchise and non-franchise companies that choose to list, the multiple achieved is often greater. That higher multiple can be put down to many factors, not least that a share market listing provides market liquidity (enabling investors to easily buy and sell shares) and the ability for investors to diversify their investments and risk. It should also be noted that self-selection may play a part here: ie, that only those franchises capable of achieving the higher multiples will list in the first place.
‘But listing alone doesn’t provide for a greater valuation. Indeed, two seemingly identical listed companies can trade on quite different earnings multiples. Examples of key factors impacting listed price to earnings-based valuations include the history of revenue and earnings, perceived market opportunity, profit margins, expected revenue and earnings growth and insider ownership. Hence it is not uncommon for some high-growth oriented companies, like BurgerFuel, to trade on an earnings multiple exceeding 30-50 times.’
‘The important thing for investors is not the size of the company so much as its potential for growth. Many years ago, New Zealand franchise Stirling Sports suggested that it might list on the NZX. The idea was hammered in the financial press, because at that time Stirling Sports had perhaps 50 outlets and was already apparently at full market penetration. But The Mad Butcher’s plans to double in size struck the right chord,’ Callum says.
Everyone Sees Your Figures
Callum then highlights one of the drawbacks of listing a company – the need to publish information a business that franchisors normally prefer to keep confidential. ‘If you look at a company’s prospectus when it is seeking investors, it has to detail all sorts of information that its competitors might otherwise not know: royalties, fees, supplier rebates and, in the case of McDonald’s, rent and return on land.’
Callum’s point is underlined when I look at a copy of the original BurgerFuel prospectus in the Franchise New Zealand files. This detailed that in 2007, royalty fees were 6 percent of turnover, the marketing levy was 4 percent and average store turnover was $1,077,804 per year, with an average EBITDA of $102,544 per year after a franchisee’s salary of $35,000 per year. It also quoted a weekly record sales figure. These are all statistics that, six years ago, BurgerFuel’s competitors would have seized upon with great interest as offering points for comparison.
Its not just competitors, either. Callum recently wrote an article for Franchise Times in the US that took the information publicly reported by McDonald’s USA to create some benchmarks against which other franchises could measure themselves. ‘For me, one of the attractive things about McDonald’s Corporation in the US, for example, is their earnings strength (or quality),’ says Callum. ‘On one dimension, McDonald’s net income (or profit) margin was a strong 20 percent creating $5.5 billion profit from circa $27 billion in annual revenue. Looking at profit per store, $5.5 billion over 33,510 units equates to a level of franchisor profit exceeding US$160,000 per store.
‘Considering the size of McDonald’s, I found it very impressive that it was able to increase net income by 9 percent between 2010 and 2011. Those are the sort of statistics which the share market loves, but of course it can go the other way, too – and once a company is listed, those figures have to be published.’ It’s perhaps worth noting that Subway, which has even more outlets than McDonald’s these days (at over 40,000) is privately owned and therefore is not required to publish similar reports.
‘Similarly, looking at Veritas and the Mad Butcher’s figures published in their prospectus, as well as their release of 28 August 2013, the franchisor is projected to generate (after initial listing costs) the equivalent of around NZ$160,000 profit per store. That’s high compared to many New Zealand franchisors and is the result of a combination of income streams (from royalties, supplier rebates and product margin) as well as an efficient cost structure. The prospectus forecast they would open an achievable four new stores a year and investors thought that was reasonable, which made the share offer attractive. Vitally, they’ve already opened two new stores this financial year so they are keeping their word to the market.’
In the 28 August release Veritas noted: ‘Trading in the first few weeks of the new financial year has been solid and the Board reiterates its prospectus forecast guidance for an EBITDA of $6.2 million for FY2014.’ I’m sure most in franchising would regard that figure as solid for a franchisor with stores numbering 35-40 stores.
Under Constant Scrutiny
Of course, taking a company public is a huge undertaking. The NZX sets very strict compliance, reporting and governance standards, and that means taking the best possible advice. ‘All in all, it could cost up to $1 million in professional fees and that doesn’t include the time you put into it yourself,’ Michael Morton says frankly. ‘Then you have all the procedures, policies and disciplines that you have to comply with when you are a public company. In some ways, it can take away some of the freedom and nimbleness with which you operate, but on the other hand it removes the danger of knee-jerk reactions.
‘I also have the benefit of working with a highly-professional board rather than making decisions in a vacuum. The six directors of Veritas have experience at board level in everything from high-level retail and alcoholic beverages to supermarkets, food and fashion, as well as considerable experience in the financial markets. That’s a great advantage for the company and for our franchisees, too.’
Ah yes, the franchisees. How do they feel about the franchisor now being a listed company? ‘In some ways, not a lot has changed. I am still running the company on a day-to-day basis and all the publicity around the listing has helped them realise that they’re involved in a well-respected business and they’re responsible for a lot of that. Maybe three-quarters of our franchisees took up the opportunity to buy shares themselves. A lot had never been in the share market before, so I think that’s a very positive sign about our people and where we’re going.’
And Michael is sanguine about the constant scrutiny that the company will now come under every time it makes an announcement. ‘I was general manager of Pizza Hut, which is operated by Restaurant Brands, and I know how it works. If you get something right, you get praise from the market and the share price goes up; if you get it wrong, you get caned. It takes quite a few years for the market to get confidence in you and allow for the odd hiccup.’
Callum Floyd agrees. ‘One of the downsides of listing is that there is a fair amount of hassle involved: making announcements in a careful and timely fashion to avoid charges of insider trading, courting investment houses and managing public meetings. That can all be a distraction if you aren’t big enough to manage it all, which is why going public has been the exception rather than the rule for franchisors to date.’
Franchisees Versus Shareholders – A Win-Win?
One franchise group which is about to take the plunge, though, is Esquires Coffee Houses, which will become part of Cooks Food Group through a back-door listing if all approvals are granted. While ownership of the Esquires brand, which originated in Canada, is complex, since the announcement was made Cooks has gradually been acquiring franchise and master franchise rights around the world to add to the empire already established by brothers Stuart and Lewis Deeks.
‘We’re going public because we want to grow aggressively – we want to be the next Starbucks, only better,’ says Stuart. ‘The higher valuation generated by listing raises funds for us to do some really exciting things and control the way we grow. It’s about building a strong, sustainable set of numbers and sharing the vision with investors. In turn, they can share the risk and reward but they don’t have to buy the whole company. It should mean we’re a better-funded organisation able to provide better services and assistance to our franchisees and make their businesses worth even more.’
But isn’t that approach at odds with the pressure on a publicly-listed company to return the highest possible dividends to the shareholders? ‘I think that depends on the company philosophy,’ Stuart suggests. ‘There’s no point in producing record profits if the franchisees are hurting, because the company just can’t survive long-term on that basis, so you have to have an inclusive culture that invests in people and the system. That’s something any wise prospective franchisee or shareholder or will look at when considering their own investment. At the end of the day, a company built on a strong foundation with a long-term outlook will benefit both.’
And Stuart concludes by summing up the reasons for going public very succinctly: ‘Yes, ultimately we would like to make money, but you don’t make money simply by floating a company – you get rich by bringing on board the skills you need and investing in long-term growth. And that means helping others – franchisees, master franchisees and shareholders – to prosper alongside each other. Just like franchising itself, the idea is a win-win for all concerned.’
This article was first published in Franchise New Zealand magazine Volume 22 Issue 03.
Disclosure: Callum Floyd has shareholdings in both McDonald’s and Veritas.
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