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Blog - Earnings

How to know when to 'pull the plug'

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One of my business mentors – a corporate director who knew I was ‘into’ music theatre - asked my opinion about which of the three productions their company should bring to Sydney. The company chose my third choice because it was new to Australia. Soon after opening night, the director rang and offered to show me some interesting numbers.

There was only one metric – occupancy percentage (colloquially called “bums on seats” – “tickets sold" (1) for each week. The six weekly results tracked from 99.2% to 93%. “We needed to make 95% for 18 months for investors to get their money back. Reviews didn’t generate a kick in sales. We’re now just covering variable costs so as soon as we drop to 88% we’ll announce the end of run.” That happened two weeks later!

WOW. That seemed pretty cutthroat – no time to get word of mouth, bus tours or schools through.

I think about having just one metric - and the drivers of that one metric – often. And I wonder why boards of listed companies don’t have a metric that is a “flashing red light” to prompt action.

Look at Woolworths’ DIY business unit, Masters. After losing over $600m in the first four years and not expected to make a profit until 2020, the investment community is almost begging the company to “Pull the plug”. Meanwhile joint venture partners pour in more millions of dollars. Headlines such as “Wind down Masters” suggests that there’s hope that …something different will happen. Living in hope doesn’t seem to be a decisive strategic response.

What factors are involved in the decision to 'pull the plug'?

Let’s use a case study of Sizzler. Remember that 1970’s dining fad? At the recent AGM, Sizzler was described as ‘non-core’ to strategic growth in Australia”. What does that mean?

As always, let’s see what the numbers tell us so that we can look in the right direction. 

                                                                                    

I HAD wanted to determine where Sizzler was on the lifecycle curve - because then you can apply that valuable theory to guide decision making. 

I HAD expected the graph would show the point of the RED DOT but it seems Sizzler never got on the lifecycle curve! So there’s lesson no 1 – look at key numbers in different ways (raw, percentages, tables and graphs).

Lifecycle theory proposes that when you launch a product or invest in something that you will spend more than you receive for a while (the early drop in the curve) but then you start to generate revenue/profit as the product or investment captures the market.

Then comes the point of the RED DOT where you need to invest before the product or asset loses its market position. Companies that don’t invest soon enough will find the market share will drop and they’ll then have to spend much more to regain market position, if ever they do. You see this with ads on TV for products we’ve known about for years –  they have a different design spruiking the health attributes of the product and so on.

If you invest, the product should extend its lifecycle and returns will continue (shown by the yellow line continuing). If you don’t – or, in Sizzler’s case, choose not to – you lose market share and returns. Then you need to make the decision to ‘pull the plug’ - and sell the product or investment to another company that wants to develop it, or just close it down.

A company’s portfolio of products will consist of individual lifecycles that have to be given unique thought. A high-margin product will be managed differently from a core product, for example. Property developers and infrastructure companies will have a low, long and deep curve because of all the ‘below the ground’ costs before revenue kicks in and you actually see the building or road. The Star Wars Episode VII: The Force Awakens merchandise lifecycles will have a steep curve over a narrow period of time.

That’s the theory, so now let’s review Sizzler’s history, to consider the key issues to consider when making a decision whether to “pull the plug”.

Factor 1. Understand your business

The Sizzler chain was founded in 1958 as Del's Sizzler Family Steak House in California, USA, with the hook 'Enjoy a great steak dinner at an affordable price'. Its first Australian store opened in 1969 and there are now 26 franchises in Australia (Brisbane 11, Sydney 3 and Perth 5, then regional, seaside Queensland) and 61 in Asia.

Sizzler presented a new casual family dining concept that gained popularity in the emerging consumer-focused domestic markets of the 1970s.

Factor 2. Know how it makes money

Sizzler is a franchise and so there are ‘levels’ of people trying to make money:

  1. Listed company Collins Foods intends to make money on behalf of shareholders. It owns the Sizzler franchise in Australia and Asia and is paid licence fees and for other shared services, often marketing and product supply. Sometimes a franchisor owns or leases the property; sometimes an independent business will ‘brand’ itself using a licence. The Sizzler licence generated 5.1c before tax and amortisation and depreciation per dollar. You thus need a large number of products – licences – to be able to retire wealthy by 40 (2)… actually, you’d need many, many more than just 26. 
  2. Individual franchisors – who may run one or more restaurants.
  3. Franchisees – who run the business. Do the numbers on $3.4m revenue per restaurant. How many customers per week on the lower salad price point of $18pp (as opposed to a steak price point of $30)? Alas, you’re not retiring for many years – you’ll be working long hours for your money.

Business advisors will tell you that the rule of thumb (cost: revenue expense) for restaurants is 92% and so you only make 8% profit if you have a good business, know what you are doing and don’t have wastage. Eating out has become a competitive business.

Factor 3.  Manage the business well

The business was launched by keen people at the start of a casual dining trend. It was a knew concept.  By the 1990s Sizzler differentiated itself by offering its ‘endless salad bar’ as a ‘side’ but customers started to order an’ entrée plus side’ rather than purchase a full meal. Margins suffered and by 1996 Sizzler filed for Chapter 11 bankruptcy. This US-only legal arrangement allows companies to restructure their balance sheets and start trading again. Sizzler used it to end leases(3), closing 140 of 215 stores and changing its logo.It left Chapter 11 in 1997. 

So the 'business model' was not working in the 1990's. The original owners sold it operated a range to Worldwide Retail Concepts (WRC) - a US company that managed a number of food businesses - and it appointed its MD Kevin Perkins to manage Sizzler.

In 2005 WRC accepted a buy-out offer from private equity group Pacific Equity Partners (PEP) at $US210 million (a 42% premium to the then share price). PEP now operated, joint-ventured or franchised Collins foods with 302 Sizzler restaurants (28 in Australia, the rest in the US) and 112 KFC sites (111 in Queensland). 

WRC made money and got out of a challenging business and its MD stayed on the run it.

How does a private equity firm make money?

Private equity firms look for businesses that they consider poorly managed and not performing well but with ‘sellable’ or ‘improvable’ assets. Their intention is to make a quick profit from implementing a strict financial performance regime and then selling the business or by listing it on the stock exchange (an Initial Public Offering; IPO). Private equity firms don’t usually invest their own capital - the original purchase price is often borrowed and the firm is given shares that are sold as part of the IPO (listing rules require some to be held in escrow usually for 12 months to give the public some confidence that the private owners are still involved and committed). A management fee often paid during the private ownership.

In the 2011 IPO of the Australian business (4) Collins Foods, owner of retail food businesses raised $202m, the owners and corporate managers who had 80 per cent of the equity sold down to about 10% - so they made money - and MD Kevin Perks, sold down from his 23% and stayed on to manage the new listed company. PEP was said to net $60m.

Did its second life as a listed company work?

Within three months, revenue was down. Lower-margin salads now represented 57% of meals for the 80% of customers (who were ‘repeat’ customers - ???? Do the numbers - there are a small number of loyal customers it seems) and shares were trading at 50 per cent of the listing price of $2.50. Sizzler’s performance has continued to decline to the point where now, in 2015, it is 15.5% of group earnings.

In September 2015 the board announced that it would keep Sizzler trading while EBITDA was positive, but not to invest any capital to develop the business but direct capital to the business units with higher growth potential . Is that 'pulling the plug'?


FOR YOUR BUSINESS UNIT OR PROJECT

Knowing that there is a ‘challenge to make money’, there are two factors in the decision.

Two issues to consider

1.  The intent of the owners

In a listed company, the board must act in the best interests of the company - usually the same as in the best interests of the shareholders as a whole.

The two largest shareholders in Collins Foods are private companies (Allan Gray 17.1 per cent followed by The Copulos Group with 13.7%, which owns Australia’s second largest KFC franchise (50 restaurants, from 1990) - it paid over $12m to increase its ownership during the post-listing share price slump) (5). The remaining company (Collins Foods) ownership profile is of individuals with a small holding  - perhaps they are accidental owners who purchased at the IPO.

What do they own (in terms of Sizzler)? Not much. Given there are 26 Sizzler restaurants, only the individual franchisees will have an interest - it is their business and livelihood.

Remember that in some situations, such as when running a Government enterprise, the intent of the owner can drive all other decisions. 

2. Legal constraints

When property leases are concerned, a company can have a debt liability for the life of the lease if it cannot be assigned (6).

Each Sizzler site has a separate licence and no single owner has more than two sites. At 2011, the lease expiry profile was 30% at less than five years and, in addition, another 52% of leases were at less than 5-10 years (7). The company could be playing a waiting game – if most leases will soon expire, the property owner will lease the property to a different lessee.

A question to ask

Is sale an option?

Is sale of the Sizzler licence an option? There are 61 franchises in Asia, with the dominant country being Thailand (39) followed by China. The licence is an asset so it should be hard at work in the gym either increasing in capital value or generating revenue. The Asian licences contributed only 2% to revenue in 2014 so perhaps an Asian-based investor might be interested. When the world – and business potential – has changed, maybe it is best to sell... but do the numbers of the average revenue per restaurant of $3.4m (2015) first!


Is that all there is to it? Well, no. 

Sometimes you have to check that there is no impediment to running the business well. This could be unrealistic attitudes, poor management, a structural change that everyone has missed... Or it could be a lesson from the school of hard knocks.  Let's finish with my theatre lesson:

What caused the company to 'pull the plug' after eight weeks? 

The director reviewed by reasons for not choosing that show: Not well known - it had short seasons in London or New York; No hit songs on the radio; Leads need to be high profile to attract a broader audience and the Previous production by the “book and music” team was a dud.

The reason we had to 'pull the plug' on the show was because the contract negotiations allowed the producer/owner to get a(too) high percentage of Revenue. There's no time for your qualitative drivers to kick in.

"Remember two things:

  1. Never allow anyone, no matter how famous (they think they are), to get a share of Revenue. There’s no incentive and they are not taking any risk. Percentages of Net Profit lead to a more rigorous analysis and upfront negotiation because a percentage of not much is … not much.
  2. Define terms in contracts carefully. The contract said ‘Revenue’ rather than ‘Sales Revenue” but it should have said “Box Office” or it could have said “Box office excluding subscription income”. It’s important to think this through and make sure the correct terms are in the contract.

Alas, the ‘book and music’ duo effectively got a percentage of corporate sponsorship, advertising, merchandising and food and beverage".

What a difference a word can make! 


For education purposes only.


(1) This is an example of knowing what a metric means and making sure you use the right one. Some occupancy figures are given that mean “bums on seats” because the performance has been ‘papered’ (freebies).

(2) Ask your team members this: Will we be able to retire wealthy by 40 with this budget? That helps everyone identify the issues that need changing to make money!

(3) In Australia, courts have required businesses to keep trading in a space if the property owner cannot find another lessee. Fashion Retailer Country Road – that was opening a store in a nearby upmarket retail centre – intended to keep paying the rent on its arcade store but not trade from it. The court decided that, given that other stores in the arcade relied on active trade at the front of the arcade to draw customers, Country Road had to maintain active trade until the end of the lease.

(4) The US Sizzler business was sold separately in 2011.

(5) YUM! Australia is the leading KFC brand and systems brand and systems franchisor in Australia with over 600 franchisees.

(6) The Accounting standards are introducing the requirement to report lease terms as a non-current liability (so that) yet offset it as a non-current asset (as the company has a right over that property and what matters most: position, position, position). This reporting will have an offset effect in terms of values in the Balance Sheet but it does serve to ensure that the reader of the report will understand that risk.

(7) Collins Foods IPO Prospectus 2011, p34ff.

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