Giant fast-food chains with global name recognition and billions of dollars in annual system sales do not grow on trees and they most certainly do not put themselves up for sale.
That makes the apparent Subway sale process so fascinating. The sandwich giant is reportedly exploring a potential sale. The Wall Street Journal first reported the news. Reuters later confirmed it. We have no doubt about this, simply because that seemed inevitable from the moment John Chidsey stepped foot in Milford, Conn.
Because of the rarity of such a sale, Subway will likely attract a lot of interest. But this is not an easy time to sell a business. And questions about the brand’s growth potential still linger, making this a particularly difficult situation. Few people we’ve spoken with believe the company could fetch the $10 billion valuation mentioned in the WSJ piece.
Still, this will be one of the most closely watched sales process in industry history. Let’s take a look at it.
The brand has its strengths. In many years, Subway would be a premier target for a deep-pocketed buyer. It has a valuable brand name. It has restaurants all over the world. And it operates in the quick-service sector. Such chains have been fetching valuations of as much as 20 times EBITDA, or earnings before interest, taxes, depreciation and amortization.
It also has no debt and is all franchised, making Subway a particularly profitable business. And it dominates its sector. It generated more than four times the sales of the next largest sub sandwich chain, Jimmy John’s. That kind of market dominance does not become available all that often. There is a foundation to build from here.
It has also done a lot of the dirty work. Chidsey arrived in 2019, one of the most surprising hires in industry history given that it’d been nine years since he helmed a restaurant chain, Burger King. Since then, the company has cut corporate staff multiple times. The company took steps to fix its menu and improve marketing, with multiple broadscale fixes to its sandwiches and ingredients. Subway’s unit volumes have increased each of the past two years after falling almost every year since 2012.
The worst of its locations have already closed. And the company has bought out a number of development agents, which do a lot of the work of the franchisor but also take a lot of the royalties. Without such agents, Subway can keep all its royalties and more efficiently manage the operation.
But there are not as many buyers as you think. We think there would be plenty of interest. But just because you look under the hood doesn’t mean you have to take a test drive. “No one,” one private equity investor told us when we asked them who would buy Subway.
The obvious buyers of such a property will probably sit this one out. Inspire Brands already has a sandwich chain (Jimmy John’s). So does Restaurant Brands International (Firehouse Subs). Yum Brands does not, and in most years it would likely be at the top of the list of potential buyers. Until, that is, you consider various comments from CEO David Gibbs that the owner of KFC, Taco Bell, Pizza Hut and now Habit Burger would rather buy up small-scale brands it can grow. Subway is anything but a small-scale brand. And a publicly traded company probably doesn’t take this on, anyway.
The most likely scenario, in our book, is this: A private equity firm, or perhaps more than one, puts up the cash to buy Subway. It then spends a few years taking some of the obvious steps to fix the brand and increase profitability—such as building unit volumes and shoring up the franchisee base. And then that firm could take the company public.
But $10 billion is unlikely. The number in the WSJ story raised some eyebrows. But the sources for such valuations are often investment bankers working to drum up interest in an acquisition, and such numbers are often pie-in-the-sky figures with relatively little connection to reality (see Freshii $1 billion). That said, this one is sensible given the $11.3 billion Inspire Brands paid for Dunkin’ in 2020. Subway is a relatively similar sized brand.
Financial data is not available for Subway, outside of financial documents in the company’s franchise disclosure document that don’t often paint a good picture of corporate finances. John Gordon, a restaurant consultant out of San Diego, estimates the company generates about $300 million in annual EBITDA (earnings before interest, taxes, depreciation and amortization). $10 billion would be a multiple north of 30x that nobody would be willing to pay.
Even if we were to double that EBITDA number to $600 million, $10 billion would be a multiple of 15. That’s far closer to realistic. But as we’re about to explain, even that number is unlikely unless earnings are a lot higher than people believe.
This is not a great time to sell. The U.S. Federal Reserve is raising interest rates to slow inflation. That, plus overall uncertainty, has increased the cost of debt.
Almost anyone who buys Subway would fund it with debt. But because of the higher cost of that debt, they will have less room to pay the sorts of multiples that buyers paid as recently as 2021. That means it is unlikely that Subway would fetch the 20x multiple paid for the likes of Popeyes Louisiana Kitchen. Strategic buyers are the most likely to pay such multiples, but as noted before there are relatively few of that type in the market for a sandwich chain.
That said, all it takes to complete a sale is a buyer willing to pay a seller’s asking price. And there are plenty of family offices or investment firms out there with long time horizons (anyone remember JAB Holdings?) that may be willing to pay higher-than-expected prices for a fast-food chain. Or maybe the seller in this case simply wants to take what it can get.
Subway also has its issues. As we noted before, the company has done a lot of the dirty work to fix its brand. But it hasn’t done everything. There are still many locations that are struggling. Its restaurants have low average unit volumes, making them vulnerable to a poor economy while franchisees themselves struggle to fund things like remodels that could build sales. Operators have closed more than 6,000 U.S. locations since 2015. International locations have also closed. The brand that once had 45,000 global locations and eyes on 100,000 now operates 37,000.
While Subway’s volumes are increasing, many stores remain on the market, a red flag for some buyers. Franchise relations remain difficult. Subway has required operators to remain open longer, which has hurt profits even as stores make more money. Subway has had trouble luring the types of large-scale operators it wants in the brand.
As an all-franchised brand, Subway’s primary asset is its royalty stream. But if franchisees are angry and closing stores, that stream diminishes.
That alone makes it difficult to envision a sale at the type of multiple the company may want or expect. A buyer will want assurance that the company has slowed the decline of that royalty base. Or they may determine the price they pay based on a smaller number of total locations
As we said, Subway has its strengths. And the deal will likely lure its share of potential buyers. But while this is potentially one of the biggest deals in industry history, it may also serve as one of its most complicated.