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What to do when big franchisees fail

Pizza Hut, Wendy’s and Perkins all face challenges with struggling operators, says RB’s The Bottom Line.
Photograph: Shutterstock

the bottom line

Franchise systems love big operators. Or at least the legacy systems do. Bigger operators, in theory, have more access to financing to do things like remodel restaurants and build new units and overhaul their point-of-sale systems.

But those bigger operators also present outsized challenges when they run into financial problems, as we’ve seen numerous times of late.

To wit: NPC International, which has had financial problems all year long amid weak sales and higher costs, is creating headaches in two different corporate headquarters: Pizza Hut and Wendy’s. The Kansas City-based operator is the largest franchisee in both systems.

Pizza Hut is working to convert more of its primarily dine-in locations to delivery-and-takeout units, and NPC operates a lot of those more traditional locations. The operator’s financial challenges make that much more difficult.

Greg Creed, CEO of Pizza Hut parent company Yum Brands, was clearly referring to NPC as he talked about addressing the brand’s struggling franchisees.

“We’ll need to directly address franchisees who are burdened with too much debt, don’t have access to capital, or aren’t committed to the long term,” he said, according to a transcript on financial services site Sentieo. “In a few cases, some of these businesses will need to be restructured in the near-term to address capital structure and leverage issues.”

But don’t discount Wendy’s, either, which also needs NPC to remodel units and build new ones.

NPC became Wendy’s largest franchisee two years ago when it acquired 140 restaurants from DavCo, another struggling operator that had been warring with the franchisor in recent years. As part of that deal, NPC agreed to remodel 90 restaurants by the end of 2021 and build 15 new units by the end of 2022. NPC’s financial problems could well put those goals into question.

To be sure, NPC’s challenges could have ripple effects that go far beyond the company or the brand. Some lenders we’ve spoken with believe that it could force some banks to limit financing to the sector if NPC were to fall into bankruptcy.

The operator, according to Bloomberg, is close to a technical default on its loans even though the company’s private-equity owners have spent the year injecting the company with cash to avoid that prospect.

Earlier this year, a large Perkins franchisee filed for Chapter 11 bankruptcy protection—actually Chapter 22, because the operator had bought the restaurants out of bankruptcy two years earlier. Perkins had sued the operator, alleging $2 million in unpaid royalties.

The franchisee, 5171 Campbells Land Co., operated 7% of Perkins’ locations. And those unpaid royalties, and the operator’s overall struggles, clearly didn’t help Perkins and parent company Perkins & Marie Callender’s as it was trying to find a buyer. The company ultimately ended up in bankruptcy protection itself.

To be sure, franchise systems can thrive even when their largest operators do not.

Two years ago, there were major concerns about the state of Applebee’s franchisees as the brand was in deep struggles. And then, more than a year ago, its second-largest franchisee filed for credit protection. But the brand’s recovery last year eased worries about Applebee’s overall health. Strong sales, after all, can fix a lot of problems.

Still, big franchisees are not immune to the operational challenges the industry has faced in recent years. And many of them have aggressively used lending to grow larger and pay for remodels and build new units.

As these challenges hit the operators’ bottom lines, it can make it far more difficult for franchisors to accomplish their goals.

The brands can take steps to help the franchisees out, as Perkins did for more than a year with its franchisee. But it can also be difficult, as its subsequent lawsuit proved.

These franchisees are their own companies, after all, and brands’ ultimate choices are limited. When times grow tough, this can be a problem for franchising. Brands should hope the environment doesn’t get any worse.

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