Restaurant 200: Big operators show the power of scale
In the world of restaurant franchising, bigger is almost always better, as shown in our annual ranking of the 200 largest U.S. restaurant franchisees. Reasons vary, but “scale” usually tops the list.
Large multi-unit and, often, multi-brand franchisees get more attention from their franchisors, bankers, vendors and real estate developers. In some cases franchisees are real estate developers, sometimes developing strip centers and becoming landlords to other franchisees.
“It’s not a priority, but sometimes we have to buy a larger site and develop a strip center,” says Sun Holdings (No. 8) CEO Guillermo Perales, adding in the process he has had to turn down offers for non-restaurant franchises. “I don’t know anything about those businesses,” he says with a laugh.
This has been a trend for years for a lot of reasons. Restaurant franchising is complicated enough considering the operators on this list often navigate among brand cultures, landlords, local governments and labor markets. Yet once at scale, they can wield their biggest advantage over smaller rivals: leverage. The sharpest continue to use it to swell their pipelines, access technology and satisfy store re-imaging requirements.
The fastest grower on the Restaurant 200, GPS Hospitality (No. 13), is happy to take tired locations and revive them. According to CEO Tom Garrett, the company spent much of 2017 painting and taking care of deferred maintenance on the 193 restaurants it acquired in the final days of 2016. It slowed things down some, but still meant GPS grew sales by more than 70 percent.
“I would say 2017 was a retrenching year for us,” says Garrett. “But as we moved through 2017, we began to really accelerate, and that has pushed all the way to date in 2018.”
Like many big operators that become bigger, that growth means more cash flow and more opportunity for further growth.
Three of the Restaurant 200 companies grew sales by more than 50 percent, and the largest continue to grow and evolve. At the top, Flynn Restaurant Group out of San Francisco stays comfortably in the No. 1 position but saw some changes as well. The company grew annual sales by $34 million but continued refocusing its efforts, selling off 11 Applebee’s restaurants and adding 33 Panera Bread locations and 16 Taco Bells.
That shift demonstrates another power of scale: Brands want sophisticated operators to drive the business forward. So having that massive scale means they can tap into the trendy, money-making brands and they have the access to capital necessary to outbid smaller competitors for ever-larger collections of restaurants that hit the market.
Overall, the Restaurant 200 grew by $1.6 billion in 2017 to $39.1 billion, up from $37.5 billion the year before. That growth marks a deceleration of more than $1 billion for the group overall compared to the average $2.7 billion added in the past five years of the Restaurant 200. That isn’t altogether surprising, since 2017 was a tricky year for restaurants.
Last year “got a little challenging from a competitive standpoint. You saw commodities bump a little bit, you saw discounting bump up a little bit, too,” says Garrett.
The overall growth trends also show an ongoing industry preference to award acquisitions and development deals to the very largest companies. The Restaurant 200 grew by 1,112 restaurants, bringing the average number of locations in the group to 141 restaurants, up six from last year. The top 25 companies added 839 restaurants, and the top 10 companies added 753 out of those locations, a 12 percent growth in units, outpacing the overall group.
With those additional restaurants, the top 25 companies added more than $1.25 billion while the top 10 added $773 million. The other 175 companies added less than half of that, growing by $345 million in 2017, sharply down from the four-year average of $1.4 billion. That may look like a worrying trend for smaller operators, or a year of frenzied M&A and smart strategy at the top to others.
All the M&A across the group means someone is getting smaller, and there were a lot of companies selling off a few restaurants here and there. But a whopping 10 Restaurant 200 companies left the list completely, selling off a total of 857 restaurants accounting for $1.3 billion in annual restaurant sales.
Wendy’s was especially busy. Across the system represented in our rankings, 700 restaurants changed hands. Three Wendy’s operators got out completely: No. 23 in last year’s rankings, Cedar Enterprises unloaded 215 restaurants, No. 45 DavCo sold off 145, Valenti Management (No. 53) sold 119 and Pennant Foods sold 87.
Yum operators were active, too as OCAT, No. 120 in last year’s rankings, sold 56 Taco Bell restaurants—the entirety of its operations—in a complex deal that ensured all back-office employees kept their jobs. And No. 126 sold its two Taco Bells and 84 KFC restaurants.
The strategies for those large companies differ from year to year and company to company. We asked two CEOs of two growth-oriented franchisee companies to explain how they avoid over-leveraging their empires given easy accessibility to the various treasure chests filled with growth capital.
“I always look at the historical cash flow and never at future cash flow,” explains Anil Yadav of Fremont, California-based Yadav Enterprises (No. 12). “If you have to invest a lot of money back into the brand, you have to back that into the model and cash flow before you purchase locations.” The company has been adding to its stable of Denny’s, Jack in the Box and TGI Fridays over the past year; it also has been acquiring resort properties in California.
Yadav says it’s crucial today to use leverage carefully, citing rising gas prices, minimum wage increases and government regulations that crimp EBITDA (gross earnings) margins and potentially limit returns. “That is something we don’t want to see. So the right leverage is always key and cash flow is the biggest determinant,” he adds.
Dallas-based Sun Holdings, which operates about 600 restaurants—most are Burger King—throughout Texas and Florida, likes to own land. “Today, I feel we are very under-leveraged,” Perales says. “We pay down debt and grow every year. What has helped over the years is that we own real estate.”
Of 30 restaurants now under construction, for instance, the company owns the land underneath 28. The company will add 17 Arby’s (its latest portfolio brand) this year in Houston and Florida. “Then we will reload with Arby’s,” he adds.
Sale/leasebacks are out of the question for Perales, despite the fact they could help him maintain less debt.
“But it leaves a huge 15- to 20-year debt and uses your cash flow,” he says. Private equity? Nope. “I’ve been in this space for 20 years. If I’d brought in private equity, I’d probably be on my fourth or fifth partner,” he says. Sun Holdings would probably be a smaller entity, too.
“Every time you’re changing partners,” he says, referring to private equity firms, “you have to slow down and think about how you’re investing your cash and agree with them on how to invest. So you lose time.”
He added investors who base every move on returns may at times decline to invest in remodeling or building new restaurants. “That is all we do. We invest our cash in remodels and new builds,” he says.
About this project
Our annual Restaurant 200 franchisee research, prepared by sister publication Restaurant Finance Monitor, includes questionnaires, phone surveys, and in some cases, a review of public documents such as annual reports, 10Ks and FDDs. We sincerely thank the companies that responded to our surveys, as most of the top 200 companies in this year’s ranking provided us with their complete data.
Our report consists of ranking companies according to revenue generated by the company’s franchised restaurants. If the company happens to operate a restaurant concept that is not franchised, or is the franchisor of another concept, we will not include that number in the overall revenue or unit count. In some cases where an acquisition took place during the year, we derive pro-forma revenue in calculating the company’s ranking.
For companies that did not respond to our survey, we confirmed the number of units operated by their company, and then estimated the revenue. In the case of a tie in the amount of total revenue, we settled the tie in favor of the company with the most units.
If you believe your company might make the Restaurant 200 list or we’ve missed you (or you know of another company that should be listed), please contact Liz Olson at (612) 767-3200 or firstname.lastname@example.org.
Wells Fargo Restaurant Finance provides financing to corporate restaurant brands, restaurant franchisees, experienced commercial real estate investors who own restaurant properties, private equity firms, and other investors in restaurant concepts. Our loan products include: syndicated corporate senior financing, fixed and floating rate term loans, acquisition facilities, sale-leaseback financing, bridge/development financing, working capital revolvers, and interest rate risk management. For more information, visit www.wellsfargo.com/restaurants.