THREE KEYS to FRANCHISE RESTAURANT VALUATION

Transcription

1 THREE KEYS to FRANCHISE RESTAURANT VALUATION a practical guide to unlocking the value of restaurant businesses Scott A. Roehr, CPA, CFA, ASA

2 SCOTT A. ROEHR, CPA, CFA, ASA I am a valuation and financial forensic professional. My practice is dedicated to the analysis of restaurant businesses and business interests. Focused on the restaurant industry for the past 20 years, my professional retentions have included work in over 50 restaurant concepts. Valuation is my core financial competency. I have extensive experience in the financial appraisal of restaurant businesses, including the valuation of chain or franchise restaurant units, restaurant concepts, and restaurant operating companies. Professional History Over 30 years of professional experience. Prior to founding my practice in 2004, I was employed with Coopers & Lybrand for ten years and Deloitte for eight years. Professional Accreditations I am a Certified Public Accountant (CPA), Accredited in Business Valuation (ABV) and Certified in Financial Forensics (CFF) by the American Institute of Certified Public Accountants, a Chartered Financial Analyst (CFA), and hold the Accredited Senior Appraiser (ASA) designation in business valuation from the American Society of Appraisers. Education I received my B.S. in Business Administration from the University of Southern California and an M.B.A. from the Anderson Graduate School of Management at UCLA.

3 THREE KEYS to Franchise Restaurant Valuation Unit Economic Analytics The Market Approach The Income Approach 2018 Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

4 A Compilation of Perspectives curated for valuation professionals Introduction Three Keys A Compilation of Perspectives #0.1 Distributed Ownership Model #0.2 You Get What You Measure #0.3 Valuation Demand #0.4 Valuation Challenges Unit Economic Analytics # 1.1 Analytic Objectives # 1.2 Essential Elements # 1.3 The Comparative/Adjusted-Historical P&L # 1.4 Financial Adjustments # 1.5 Sales Analytics # 1.6 Rent # 1.7 G&A # 1.8 Benchmarking # 1.9 Unit Economic Analytic Summary # 1.10 It s Not About the Multiple The Market Approach #2.1 Industry Taxonomy #2.2 Taxonomy & Technique #2.3 Transaction Multiples #2.4 Financial Alchemy with Public Multiples #2.5 Troubles with Multiples #2.6 The Valuation Formula Methodology #2.7 Multiple Myopia & Formula Phobia #2.8 Professional Valuation Standards #2.9 Prescriptions for Afflictions The Income Approach #3.1 Income Approach Methods & Models #3.2 EBITDA is Not Cash Flow #3.3 Capital Expenditure Requirements #3.4 Cost of Capital/Franchise Finance #3.5 Calibrate, Reconcile, and Adjust Conclusion A Six-Step Valuation Summary A Well-Calibrated Valuation Model is a Powerful Tool 2018 Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

5 #0.1 Distributed Ownership Model Franchisor Franchisee Landlord Concept Business Enterprise Real Property royalty rent Concept, business enterprise, and real property; Owned separately by a franchisor, franchisee, and landlord; Connected with franchise and lease agreements Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

6 #0.2 You Get What You Measure The restaurant unit is the basic building block of the restaurant industry. The financial success of any restaurant business is a reflection of its unit economics Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

7 #0.3 Valuation Demand A Vast Industry IHS Economics estimates there were approximately 195,000 restaurants affiliated with franchised chains, with sales totaling $300 billion, located in the U.S. in Most of these restaurants are independently owned and operated. With a Voracious Valuation Appetite 2018 Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

8 #0.4 Valuation Challenges franchise restaurants are simple businesses that can be challenging to value Two of the most significant challenges include the valuation framework and market inputs: Valuation Framework: To produce credible results, you need a good analytical framework. Generic models for financial statement analysis and valuation are not effective in valuing franchise restaurants. Effective frameworks are hybrids, representing a synthesis of industry convention with traditional valuation models. Market Inputs: There is rarely sufficient empirical data for traditional market approach methodologies to yield reliable value indications. Estimating the cost of capital for franchise restaurants, in most valuation contexts, requires an understanding of how they are financed in the private capital markets. Where there are gaps in the empirical data, valuators need to understand industry standards, customs, and conventions Scott A. Roehr, CPA, CFA, ASA INTRODUCTION

9 Unit Economic Analytics 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

10 #1.1 Analytic Objectives The foundational work: 1. Assembling and analyzing data, 2. With the objective of developing an adjustedhistorical operating statement, and 3. Identifying other issues impacting value Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

11 #1.2 Essential Elements In addition to basic descriptive information, essential inputs include: 1. Sales data, 2. Historical operating statements, 3. Franchise terms, and 4. Lease terms Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

12 #1.3 The Comparative/Adjusted-Historical P&L the primary foundational analytic framework Adjustments Adj 2017 Sales 100.0% 100.0% 100.0% 100.0% Food 30.0% 30.3% 30.0% 30.0% Labor 31.4% 30.7% 30.7% 30.7% Other Operating Expenses 6.4% 6.3% 6.3% 6.3% Repairs & Maintenance 2.1% 1.9% 3.0% 3.0% Advertising 4.0% 4.0% 4.0% 4.0% Royalty 4.0% 4.0% 4.0% 4.0% EBITDAR 22.1% 22.8% 22.0% 22.0% Rent 4.1% 4.1% 4.0% 4.0% Store Operating Profit 18.0% 18.7% 18.0% 18.0% G&A 0.0% 0.0% 0.0% 0.0% EBITDA 18.0% 18.7% 18.0% 18.0% 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

13 #1.4 Financial Adjustments Adjustments are made to: 1) Address anomalies in historical operating performance 2) Better reflect the prospective earnings capacity of the unit, or 3) To facilitate valuation computations Common adjustments include: Historical anomalies Partial-year operations Business interruptions/extraordinary events Repairs & maintenance Prospective anomalies Royalties (favorable franchise agreements) Rent (beneficial leasehold interests) Reclassifications Vendor rebates as an adjustment to cost of goods sold Expenses in the nature of management overhead Valuation adjustments Royalties (corporate units) Rent for owned and leased real property G&A expense Synergies of a particular investor Anticipated operating efficiencies 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

14 Annual Comps Annual Sales #1.5 Sales Analytics $175,000 $165,000 $155,000 $145,000 $135,000 $125,000 $115,000 $105, $95,000 $85,000 $75,000 January February March April May June July August September October November December January February March April May June July August September October November December Annual Total 2017 $131,128 $137,193 $148,353 $132,741 $156,694 $154,242 $154,831 $151,638 $150,825 $164,649 $150,387 $135,674 $1,768,355 Monthly Sales , , , , , , , , , , , ,752 1,634, , , , , , , , , , , , ,695 1,470, ,722 88, , , , , , , , ,358 96, ,308 1,300, ,819 93, , , , , , , , , , ,662 1,334,623 Monthly Comps (prior year) Trailing Twelve Months % 10.4% 4.3% 8.7% 13.8% 5.1% 8.2% 6.1% 10.3% 12.7% 11.1% -6.9% 8.2% % 16.8% 28.2% 14.2% 6.9% 5.6% 2.1% 8.0% 6.0% 10.1% 9.7% 12.4% 11.1% % 20.8% -1.0% 4.3% 10.9% 16.5% 15.8% 2.6% 8.4% 16.1% 28.1% 26.8% 13.0% % -5.9% 5.3% -7.3% -3.9% -6.0% -4.8% -0.9% 5.2% 2.3% -5.2% -2.2% -2.5% 2017 $1,654,013 $1,666,946 $1,673,032 $1,683,699 $1,702,749 $1,710,288 $1,722,029 $1,730,780 $1,744,808 $1,763,348 $1,778,433 $1,768, ,490,150 1,508,056 1,539,388 1,554,607 1,563,481 1,571,283 1,574,281 1,584,920 1,592,668 1,606,040 1,617,975 1,634, ,311,145 1,329,446 1,328,271 1,332,638 1,345,314 1,364,989 1,384,065 1,387,420 1,397,455 1,415,834 1,442,865 1,470, ,327,526 1,321,997 1,327,623 1,319,517 1,314,745 1,307,094 1,300,949 1,299,719 1,305,652 1,308,231 1,302,972 1,300, Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

15 #1.6 Rent Business Enterprise Real Property rent adjustments to rent are common for both owned and leased real property 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

16 #1.7 G&A G&A a.k.a. Definition Factors impacting the expense Perspective and alignment Allocation methodologies/best practices 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

17 #1.8 Benchmarking concept averages, quartiles, deciles, pass-through analytics 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

18 #1.9 Unit Economic Analytic Summary blizzards of data -- unique as snowflakes Connecting the Dots: Historical EBITDA Adjustments Adjusted-Historical EBITDA Plus: Other Issues Impacting Value valuation as a craft 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

19 #1.10 It s Not About the Multiple 2018 Scott A. Roehr, CPA, CFA, ASA UNIT ECONOMIC ANALYTICS

20 The Market Approach 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

21 #2.1a Industry Taxonomy Taxonomy \tak-ˈsä-nə-mē\ The science or technique of classification. The first key to valuing any restaurant business is identifying what type of business it is, such that appropriate models and market inputs can be applied Scott A. Roehr, CPA, CFA, MARKET APPROACH

22 #2.1b Industry Taxonomy Independent Restaurants: Independent restaurants are uniquely branded establishments. Chain Restaurants: When a single restaurant concept (i.e. brand) is employed across multiple restaurant locations it is considered a chain. Franchise Restaurants: Some chains are franchised. In franchise systems the franchisor owns the concept and executes franchise agreements with franchisees that own some or all of the restaurant units Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

23 #2.1c More Industry Taxonomy Example Segments and Sub-Segments: Fine Dining Family Dining Sandwich Beverage/Snack Quick Service Hamburger Chicken Pizza Fast Casual Better Burger Mexican Pizza Casual Dining Traditional Casual Polished/Upscale Casual 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

24 #2.2 Taxonomy & Technique In a chain restaurant business (that is not franchised) all of the restaurant units are operated under common ownership and control. The individual restaurant units are not readily marketable; the system is the marketable unit. As such, chain restaurant businesses are typically valued in the aggregate -- using market inputs derived from other chain restaurant businesses. But in franchised chains, unit-level ownership and operation is diversified. Each franchise restaurant is a readily marketable business. So if you are valuing these restaurants (or a franchisee restaurant business) it is common to perform the valuation analysis at the unit level -- using market inputs appropriate for the type of restaurant being valued Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

25 #2.3 Transaction Multiples Common screening criteria: 1. Franchise restaurants 2. Limited or full-service 3. Segment or sub-segment 4. Transaction date 5. Sales volume (per unit) 6. Reporting EBITDA Then clean out the clutter Common analytics: Sales multiples sorted by EBITDA Margin EBITDA multiples sorted by EBITDA Margin Due to limitations in quality comps: Start with a bigger-picture perspective then refine to a concept-specific analysis if sufficient data is available. due to limitations in the availability of transaction data, the results of this analysis are typically less than compelling on a stand-alone basis 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

26 #2.4 Financial Alchemy with Public Multiples alchemy (ˈalkəmē) noun: the medieval forerunner of chemistry, based on the supposed transformation of matter. It was concerned particularly with attempts to convert base metals into gold or to find a universal elixir. Faced with the lack of market data for franchise restaurant businesses, some valuators manufacture market inputs by adjusting multiples observed for other types of publiclytraded restaurant companies. looking at the industry through the lens of the wrong business model 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

27 #2.5 Troubles with Multiples the devil s in the lack of detail This lack of empirical market data is why use of the valuation formula methodology is so widespread in the franchise restaurant industry. Necessity is the mother of invention, and in this case, an industry convention Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

28 #2.6 The Valuation Formula Methodology Adjusted EBITDA The output of unit economic analytics. Estimates of valuation multiples typically starts with a five, adjustments considered may include: x Valuation multiple = Value indication +/- Valuation adjustments = Concluded value Issues identified in unit economic analytics, and quantified using income approach methodologies. 1. Concept strength, 2. Location, 3. Market conditions, 4. Transaction size, 5. Subject-unit economics (the fixed-multiple fallacy). it s a methodology, not a multiple rigorous application is required to produce credible results 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

29 #2.7 Multiple Myopia & Formula Phobia common afflictions regarding use of industry valuation formula/rules of thumb Multiple Myopia: Over-reliance on rules of thumb typically using as the sole valuation methodology. Most commonly observed among industry professionals. myopia (\mī-ˈō-pē-ə\) noun: lacking imagination, foresight, or intellectual insight. lacking imagination, foresight, discernment, or intellectual insight : a narrow view of something Formula Phobia: Avoiding reliance on rules of thumb if considered at all, the method is relegated to use as reasonableness check. Most commonly observed among valuation professionals. phobia (\ˈfōbēə\) noun: 1) a type of anxiety disorder, usually defined as a persistent fear of an object or situation the affected person will go to great lengths to avoid, typically disproportional to the actual danger posed. 2) an extreme or irrational fear of or aversion to something Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

30 #2.8a Professional Valuation Standards Rules of thumb are acceptable as reasonableness checks, but should not be used as standalone method Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

31 #2.8b Professional Valuation Standards Although technically not a valuation method, some valuation analysts use rules of thumb or industry benchmark indicators (hereinafter, collectively referred to as rules of thumb) in a valuation engagement. A rule of thumb is typically a reasonableness check against other methods used and should generally not be used as the only method to estimate the value of the subject interest Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

32 #2.8c Professional Valuation Standards ASA Business Valuation Standards Rules of thumb may provide insight into the value of a business, business ownership interest, security or intangible asset. However, value indications derived from the use of rules of thumb should not be given substantial weight unless they are supported by other valuation methods and it can be established that knowledgeable buyers and sellers place substantial reliance on them Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

33 #2.9a Prescriptions for Afflictions: Formula Phobia a more balanced market approach Traditional Market Approach Methodologies Other Indicia of Value Industry Valuation Formula/Rule of Thumb while relative strengths and weaknesses need to be weighed on each valuation assignment a more balanced approach can produce a more credible result 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

34 #2.9b Prescriptions for Afflictions: Multiple Myopia a more balanced valuation Industry Valuation Formula/Rule of Thumb Add an Income Approach Methodology a more balanced valuation can produce a more credible result 2018 Scott A. Roehr, CPA, CFA, ASA MARKET APPROACH

35 The Income Approach 2018 Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

36 #3.1 Income Approach Methods & Models Utility of the approach: 1. Business enterprise value indications 2. Valuation adjustments: a. favorable franchise agreements b. beneficial leasehold interests c. net present value of remodel requirements d. feasibility issues Diversity in practice: Discounted future earnings, discounted cash flow, and capitalization models are common with hybrid models (five years of projections and an exit multiple) often observed in valuations prepared by investment bankers. The diversity in practice is driven by the nature of the subject interests, the context of the valuation studies, assignment specific facts and circumstances, and/or professional preferences. Many industry professionals do not utilize this approach Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

37 #3.2 EBITDA is Not Cash Flow EBITDA - Depreciation & Amortization Earnings Before Interest & Taxes - Income Taxes Debt-Free Net Income + Depreciation & Amortization - Capital Expenditures +/- Changes in Working Capital Debt-Free Net Cash Flow 2018 Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

38 #3.3 Capital Expenditure Requirements restaurants are capital intensive enterprises Development or Acquisition Remodels Renewals Where is the subject unit on the clock? Maintenance-Level Capital Expenditures Deferred Maintenance 2018 Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

39 #3.4 Cost of Capital/Franchise Finance Equity Capital Debt Capital PUBLIC CAPITAL MARKET INPUTS capital asset pricing model build-up method corporate finance PRIVATE CAPITAL MARKET INPUTS surveys franchise finance 2018 Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

40 #3.5 Calibrate, Reconcile and Adjust concluding the valuation analysis Calibrate: 1. Check implied market multiple of income approach methods. 2. Consider subject-unit economic adjustments to market multiples. Calibrate Reconcile the market and income value indications. Adjust for: 1. Favorable franchise agreements, 2. Beneficial leasehold interests, 3. Deferred maintenance and/or remodel requirements, and 4. Feasibility issues. Reconcile Adjust 2018 Scott A. Roehr, CPA, CFA, ASA INCOME APPROACH

41 Conclusion 2018 Scott A. Roehr, CPA, CFA, ASA SUMMARY

42 A Six-Step Valuation Summary 1. HISTORICAL EBITDA: for the subject units totaled $X, representing a Y% margin on sales of $Z for the twelve months preceding the valuation date 2. FINANCIAL ADJUSTMENTS: issue 1 adjustment (number of stores, total $) issue 2 adjustment (number of stores, total $) issue 3 adjustment (number of stores, total $) other adjustments (number of stores, total $) G&A adjustment (G&A was $x, representing x% of sales, went to $50,000 per unit/representing 4% of concept-average sales) 3. ADJUSTED-HISTORICAL EBITDA: totaled $X, representing a Y% margin on sales totaling Z$, for units viable as going concerns 4. VALUE INDICATIONS: x units (with $sales and $EBITDA) had feasibility issues and were valued separately market approach value indication income approach value indication the concluded value of the subject units (before adjustments) totals $x representing a 4,5,6 times multiple of adjusted-historical EBITDA a premium/discount of $x is a function of the subject units superior/inferior unit economics that was driven by the sales of the units averaging 90%/110% of concept average 5. VALUATION ADJUSTMENTS: favorable franchise agreements beneficial leaseholds remodel requirements deferred maintenance feasibility issues 6. CONCLUDED VALUE: resulting in a conclusion of $x 2018 Scott A. Roehr, CPA, CFA, ASA CONCLUSION

43 A Well-Calibrated Valuation Model is a Powerful Tool 2018 Scott A. Roehr, CPA, CFA, ASA CONCLUSION