Earlier this week, my colleague Peter Romeo wrote about the bankruptcy filing of RMH Franchise, the 163-unit Applebee’s operator, the chain’s second-largest.
Such a filing was not quite unexpected. Applebee’s same-store sales plunged in the past two years before its recent, modest recovery, following a significant operator investment in kitchen processes in 2016.
Indeed, RMH pretty clearly blames those moves for many of its problems.
“The franchisor has had four presidents since the beginning of 2014,” RMH CFO Mitchell Blocher said in one bankruptcy court filing this week. “Throughout this period, different franchisor-mandated initiatives led franchisees … to incur significant capital expenditures, further straining liquidity. These initiatives included converting existing grills to new wood-fired grill platforms in all restaurants and a new ad campaign, neither of which were received favorably by customers …”
Still, the bankruptcy filing illustrates a big problem when it comes to the financial reporting of restaurant franchises: the vast majority of them do not include any information about the financial health of their franchises in securities filings.
For the most part, franchises will report royalty or ad fund income, but little that provides an indication of overall operator health.
Given that many publicly traded restaurant companies are relying more and more on franchisees to operate their restaurants, it would be good to know how healthy that franchisee base is, would it not?
And more than just provide information to analysts, more franchisors should provide some general data in their securities filings that give a good indication of their operators’ overall financial health.
“So many franchisors are so intensely franchised and so intensely asset light, sometimes 95%, sometimes 100%, that the investor is just not informed quickly enough, or at all able to discern what the underlying business fundamentals are,” said John Gordon, a restaurant consultant who has long advocated for more reporting of franchise financial data.
A few brands have reported information on franchise finances over the years. Domino’s, for instance, has long provide operator cash flow, even when that cash flow wasn’t so good. Popeyes, before it was sold to Restaurant Brands International last year, would report franchisee EBITDAR, or earnings before interest, taxes, depreciation, amortization and rent.
McDonald’s and some others will also provide regular updates on the earnings of operators, though not formally.
To be sure, many systems work hard to ensure the financial health of their operators. And even the healthiest system is going to have some franchisees that struggle and close restaurants. Individual market challenges, operator decisions and other factors all play a role in a franchisee’s fiscal health.
But as the Applebee’s situation illustrates, a brand’s overall actions can have a big impact on the health of the entire system. When that system’s same-store sales plunge the rate that its sales did in 2016 and into 2017, that can have a broad impact on operator health.
Dine Brands executives have been talking about their operators’ finances in recent earnings calls, as analysts have pressured them about those issues. As Peter noted in his story, the company said last week that three franchisees are behind on royalty and ad fund contributions—a potential indication of financial problems.
To be sure, all franchises have to publish and make available their franchise disclosure document, or FDD. But the federal government does not require the FDD include relevant information on operator finances—though a large number of systems do report average unit volumes and more progressive systems will provide franchisee earnings data.
But for the most part, FDDs can be big and complex and intimidating, even for sophisticated researchers.
The issue of franchisee health could become a bigger issue in the coming years. Industry same-store sales have been generally weak, especially for casual dining chains. And many systems have refranchised many of their locations, at the request of Wall Street.
To buy these locations, these operators, like RMH, undertook massive amounts of debt. RMH filed for bankruptcy protection with $68.5 million in secured loans, plus another $30 million in unsecured loans. The company used the funds to acquire a number of franchisees and grow larger.
That’s been a common practice since the end of the recession. But, as some of these systems have problems, many of these operators could find themselves behind the financial 8-ball. They could ultimately file for bankruptcy protection or close units or both.
That makes it more important than ever for franchisors to publicly disclose more about the health of their franchisees.