Burger King has done none of that and is facing a difficult reality in this new world. As consumers demand higher standards, Burger King is going to have to invest billions of dollars in capital over a period of years to get its brand perception to where it needs to be.
We have to give credit where it is due – Bill Ackman is going to make money on this deal. But as independent observers, we have to wonder what happens after his payday. It's worth bearing in mind the factors driving the decision of Justice Holdings to make this transaction. Having been public for over a year, the company – as a SPAC – was compelled to complete a transaction by February 2014. We think Justice Holdings saw in Burger King the same attributes that many PE investors have seen in the past: BK is a tried and tested cash machine and it fits the bill perfectly for Justice Holdings.
Looking at valuation levels of peer companies that could accurately be labeled as "brand royalty", it makes sense for a deal to be done now. We believe that the success of the Dunkin' Donuts (DNKN) IPO last summer – for the insiders and others that got a piece of the deal – is the biggest driver behind the timing of the Burger King deal.
But the current strategy does not seem to be focused on investing in the brand. The program to remodel restaurants is not yet being embraced by the franchisee base. If the current strategy fails, the question is whether that could be a death knell for the Burger King brand? We don't think that's as dramatic as some might believe. Our best guess at this point is that Burger King may be better off shrinking in order to grow. As it currently exists, the turnaround may be too great a task. Closing underperforming stores and bringing the average unit volume higher may be a good first step on the road to recovery.
Below are our top 10 ten reasons why, according to the Ackman's "Justice is Best Served Flame Broiled" slide deck, Burger King is fixed (so to speak):
1. CAPITAL DRAIN: In April 2011, BK issued $685 million of notes, yielding $401.5 million of proceeds, of which $294 million was returned to 3G in the form of a dividend.
2. BRAIN DRAIN: Last year, management gutted the company of $107 million in administrative expenses and cut head count by 40%, taking EBITDA up 50% but various one-time adjustments have to be made to get there.
3. ROYALTY STREAM/REMODEL PROGRAM: The company has reduced store ownership by 3%, reducing the need for capital spending. Unfortunately, 85% of the franchisee-base (measured in stores) has not bought into the remodel program thus far.
4. NEW MENU INITIATIVES: BK is introducing a new menu that is defensive and looks just like products that McDonald's is selling.
5. POSITIVE SAME-STORE SALES: On the back of an extra trading day in February and the warmest winter in generations, the chain is seeing four months of positive SSS after three years of declines.
