In 2014, McDonald’s (MCD) announced it was to refranchise up to 1500 units out of the United States. In 2013, Wendy’s (WEN) announced refranchising of 450 units in its non core markets. In 2012, Burger Bing (BKW) and Jack in the Box (JACK) kicked into serious refranchising, so much so that Burger King now only owns and operates the 50 plus units in Miami out of a 130000 unit total. Even Starbucks (SBUX) is finally in franchising for its flagship Starbucks brand, refranchising stores in the UK and Ireland. It franchised its non premium Seattles Best Brand for some time. YUM has been furiously refranchising since 2009 but intends to keep China company operated.
To be sure, some brands have been defranchising—buying franchised stores back. Red Robin Gourmet Burgers (RRGB), Noodles (NDLS), Qdoba (JACK) and Texas Roadhouse (TXRH), among others. Chipotle (CMG) wont franchise—it would destroy its culture and they make more as company operated stores.
The debate in restaurant circles about the proper mix of company and franchised units has been legendary. In the 1970s and 1980s, the trend was towards company owned locations. In the 1990s, as return on invested capital (ROIC) and awareness of the free cash flow expanded, refranchising picked up.
Refranchising means the company can make more on the royalties, maybe rent spreads (if it owns the real estate) and reduced G&A and capital expenditures (CAPEX) associated with its former units. In almost every case, refranchising involves weaker stores beyond a certain profit or EBITDA point or weaker brands or geographies.
Benefits of refranchising
Refranchsing can be a stock catalyst, some new news, particularly if it funds increased dividends or buybacks, or if it is associated with more debt that can fund dividends or buybacks. That what McDonalds is doing.
Optical improvement: refranchising takes the lower stores out ofn the base, and optically makes restaurant sales and margins improve, as both WEN and JACK have noted.
Refranchising should lower debt, improve credit ratios to allow for special dividends
Boost ROIC: with units sale proceeds and capital investment falling lower or to near zero if no real estate is involved, it provides a bump to ROIC.
It can help out franchisees, as large franchisees have a need to get larger (WEN example)
And, in some cases, if the company can’t operate stores well, refranchising is a type of outsourcing of the problems. See: YUM’s KFC, Burger King (BKW)
Limitations with refranchising
The ultimate problem is the company becomes an outsourced restaurant provider—no expertise in running restaurants. Franchisees site “no skin in the game” as a perennial problem in brand management.
Adaptability/Flexibility: franchised concepts take longer to get new products to market and keep the physical plant remodeled and renewed. In the US, Starbucks will always have an advantage over McDonalds as it can make decisions and implement market change quickly, while in McDonalds case it takes years to attain buy in and effect market change.
Unit level economics: while there is the perception that franchisees run a tighter P&L,than company operations, franchisees do have to pay a royalty and are generally territory constrained. In addition, the availability of funds and cost of debt for franchisees typically are unfavorable versus that of the franchisor . This implies higher cost of debt and missed opportunities. Franchisees have higher debt to EBITDA ratios. For example, the McDonalds US franchisees debt/EBITDA is appx. 5.4 X, versus 2.2X at MCD corporate.
Company structure; good franchisors run their company units as a training and development ground for franchisees. If the company store base is deteriorated or nonexistent, quality development staffing comes at risk.
Once the refranchsing is done, that arrow is no longer in the quiver. What next?
Cultural bifurcation, franchisor v. franchisee conflicts.