Earlier this week, the activist investor Bruce Galloway revealed an investment in Noodles & Company and then urged the fast-casual chain to sell off most of its company stores and pay off debt.
Noodles has $108 million in long-term debt, which carries an interest rate of 9% to 10%. And it loses money. It recorded a $6.3 million operating loss last quarter, even before adding in the interest payments on its debt. Oh, and Noodles has $131 million in long-term lease liabilities.
Galloway estimates that Noodles would generate about $60 million by selling about 200 of the chain’s 349 corporate locations. That would be about $300,000 per location.
“With the right steps, Noodles can remove bankruptcy risk, clean up its capital structure and allow the equity to move significantly higher, as we have seen in similar situations,” Galloway wrote.
There’s little question that Noodles needs to pay off debt, and it has an asset in the form of those corporate stores that could be used to do so. The strategy also keeps a relatively healthy dose of corporate stores, which is more than we can say for most activist-pushed refranchising ideas.
And ultimately, operating fewer corporate stores in the name of staving off serious financial problems is the better choice. Indeed, Galloway’s letter triggered a 14% increase in Noodles & Company’s stock price on Tuesday.
Noodles stock is up 42% this year, thanks to activist pressure and the company’s ongoing sale process. Yet even after that increase the company’s shares are still down 89% over the past five years, and 97% all-time. That shows just how little Wall Street thinks of the noodle chain.
But we also confess at least some exhaustion from the concept of another activist pushing yet another refranchising push on a publicly traded restaurant company. Activists pushing refranchising tends to be generic financial engineering stuff, even when they have an argument as legitimate as removing bankruptcy risk.
Noodles has been refranchising, at least on and off, for years. It has reduced its corporate unit count by 13% since 2019, for instance. Franchisee unit count has increased to 86 from 68 over that period, an increase of 26%.
But it’s also worth noting that franchisees have closed six locations already this year. They did not open any new locations and they did not buy any from the company. It’s no slam dunk that the company even can sell those stores.
Noodles plans to close a total of 49 locations by the end of next year.
Selling weak stores to franchisees simply transfers that weakness from one owner to the other. It does not fix what really ails the company.
Noodles’ biggest problem, by far, is its unit volumes. The company finished 2024 with $1.3 million in average unit sales. That was up 12% compared with a decade ago—but it is down 20% compared with where those volumes should be, if Noodles’ sales had simply kept pace with the consumer price index.
It is also far below the volumes generated by other prominent fast-casual chains. Chipotle, Sweetgreen, Cava and Shake Shack each enjoy average unit volumes of at least $2.8 million. The average unit volume for those four chains is 146% more than the volume of a typical Noodles.
Noodles’ restaurant contribution margin year to date is 12.1%, which is a function of those low unit volumes. It’s about half that of those other chains. If the company had simply generated more consistent sales growth it would be profitable and franchisees would be lining up for locations.
Franchisees might be able to run stores more profitably, but they will also be required to pay a 5% royalty, plus marketing funds.
Many operators might take on those low-priced restaurants, invest in operations and improve sales.
But they may also cut costs to improve profits and pay off whatever debt they used to buy the locations, assuming they can get debt in the first place. That could hurt the brand in the long run by hurting the quality of service.
Franchising also makes turnarounds more difficult. Brands must convince franchisees to make investments in technology or remodels or equipment to get things done. It’s easier to do those things when you’re just dealing with corporate locations.
There is also an opportunity cost in refranchising. Noodles will not succeed over the long term without improving those unit volumes. If it does improve the unit volumes the amount needed, the company will not receive the full benefit of that profitability.
All of this might be a moot point anyway, given that Noodles is on the market. Then maybe the buyer will be the one to sell those stores.