Why Is Private Equity Paying Up For Franchisees?



Owners of large franchisees in certain high-performing restaurant brands, like Taco Bell and Wendy's, are getting unusually high prices for their companies right now—prices that have "no ho historical precedent," Chris Kelleher, managing director at Auspex Capital, recently told me.

There are lots of reasons for this. There are relatively few deals in the strong brands that buyers want. There are lots of buyers. And lots of lenders, and cheap debt, meaning that each deal is being chased by several, well-capitalized buyers. The resulting increase in price is pretty predictable.

And private equity groups are among the buyers driving up the multiples being paid for these companies. The investors have been aggressively bidding on big franchisees in strong brands, driving up their multiples to the point that some question whether they'll be able to generate their desired returns.

Yet that's the thing. Private equity groups are typically good at generating returns on their investment, regardless of how much they pay for an acquisition.

Rick Thompson, a longtime lender in the restaurant finance space, and currently the managing director at BMO Harris Bank, has a couple of theories as to why private equity groups might be bidding up the prices of big franchisees.

One theory: franchisee multiples historically have been too low. Private equity is bringing them up to where they should be. EBITDA Multiples are a really fuzzy measurement of a purchase price, and rules of thumb are nearly impossible. But, in general, franchisees have historically sold for much lower multiples than restaurant brands. In general, franchisees get multiples in the low single digits, perhaps topping out at 5x EBITDA, while brands will get in the 7x-10x range.

Yet some of the franchisees being sold now, we're hearing, are going for 7x EBITDA—approximately the same multiple for which Apollo wants to buy CEC Entertainment.

Thompson, however, said that private equity groups are generally really good at deploying capital efficiently, and wonders whether they've found a way to pay these multiples and still generate high returns. "This is not dumb capital," he said. "They're pretty smart folks, and savvy investors."

Aha, but there's another theory: Perhaps private equity groups are just biding their time.

Private equity groups have to put dollars to work. And franchisees of well-run, legacy brands with good, long track records are relatively safe investments, ones that generate lots of cash. So perhaps the equity returns don't matter as much. "They may not be able to enjoy the returns they desire," Thompson said. "But they also know they're not going to lose their money, either. Maybe they just need a place to park their money."

Which theory is right? "Time will tell," Thompson said.