John Weiss, a senior advisor with the investment banking firm Harrison Co., told a crowd at the Restaurant Finance and Development Conference this week that publicly traded franchisors were misallocating their capital.
“I would suggest that the shareholders of most franchisors, and most certainly the franchisees, would have been much better off if franchisors, instead of repurchasing their stock and making poor acquisitions, just gave the funds to franchisees to remodel restaurants,” he said.
Much of the audience cheered. “Sounds like there are a few franchisees here,” he said.
Weiss is not wrong. We won’t necessarily address his concerns about poor acquisitions, but we do believe that more franchisors would be better off if they invested those funds into store remodels, marketing or other strategies that boost unit volumes.
In theory, share buybacks can boost stock when management believes shares are undervalued, and can be a sign of faith to Wall Street investors. They also increase earnings per share, by reducing the number of outstanding shares, which can theoretically make those shares more valuable.
It doesn’t always translate into actual success. Weiss noted that eight of the 10 largest publicly traded franchisors have reduced their shares outstanding by 20% to 50% over the past 10 years. Only three of them, McDonald’s, Domino’s and Wingstop, have outperformed the broader stock market.
Buybacks may have their benefits, but they pale in comparison with real-world and market impacts on companies and their stock prices. Domino’s and McDonald’s are market-leading brands that generally outperform their markets. Wingstop has been one of the best restaurant investments on Wall Street. “Wingstop has repurchased very few shares,” Weiss said. “It was way too busy driving sales and franchisee profit to listen to Wall Street.”
Weiss noted that Dine Brands Global, the owner of Applebee’s and IHOP, bought back 19% of its stock over the past decade yet its shares are down 67%. Denny’s bought back 38% of its shares, which have fallen 40%. Jack in the Box bought back 51% of its shares and its stock price fell 50%. The S&P 500 over that time is up 183%. Each of those companies and their brands have generally struggled for much of that period.
Share buybacks can look bad when companies are struggling and in need of store-level assistance.
A lot of franchisors, for instance, have outdated locations and want them remodeled, yet their locations have poor unit volumes, which makes it harder for operators to spend funds sprucing up their stores. In those cases, franchisors are better off devoting some funds to get these remodel programs off the ground, much in the way Burger King has done over the past few years.
One perfect example of capital misallocation is Wendy’s. The fast-food chain has spent $302.9 million to buy back shares this year. Its stock is down 46%.
Wendy’s can certainly argue that its shares are undervalued, and many investors agree. It is a great brand with a quality reputation and all kinds of potential. A smart, new CEO could certainly give that brand a huge lift.
The company in the recent past invested behind new store development, using company funds to build stores that are later sold to franchisees. But Wendy’s unit volumes are about $2 million, which is about half that of McDonald’s. If the company’s restaurants were profitable enough, that store growth would come.
More to the point, Wendy’s might have been better off using that $300 million on extra marketing, remodels or both. Instead, its sales this year tanked. Its CEO left. It is now on its second round of closures in two years that, all told, could top 500, or nearly 10% of the chain’s unit count from just more than a year ago.
The company is now, smartly, focusing on unit volume growth and it just hired former Yum Brands CEO Greg Creed to help improve its marketing, so Wendy’s is certainly taking a big step in the right direction. But it spent much of the past two-plus years sending cash back to shareholders when that cash could have been used on remodeling older locations.
None of this is to say that brands should not send cash to shareholders or buy secondary brands or whatever. But franchisors do not grow unless the condition of their restaurants are strong enough to attract customers and help franchisees profit. When franchisees are profitable, then they will do plenty of investing.