Franchise Market – Looking back at 2020 and looking forward to 2021
I think there has been enough of a reminder what a fudge up 2020 was. It was probably not the best year to change jobs, get a new car, get married or knock someone up – but was it a good year to start a franchise business?
This question got Franchimp looking back at 2020 to assess how relevant the franchise model was, in coping with the disruptions of Covid-19, as well as looking forward to predict some of the key themes of franchise market in 2021.
As many of you would expect, pretty much all franchises across different sectors were adversely impacted by Covid-19 in some form or another (if only there were franchises involved in the production Covid-19 vaccination or manufacturing of Personal Protective Equipment (PPE)).
By mid-2020, the situation was pretty bleak as franchises such as Starbucks announced the closure of c. 400 stores in US and up to 200 stores in Canada. Even McDonalds said they would close 200 restaurants in 2020.
Anecdotally, franchisors in the food and beverage, hospitality and personal care sectors were putting growth plans on hold and everyone was pretty much hanging on for dear life, just like Dwayne “The Rock” Johnson in almost every one of his movies – Franchimp particularly likes Hobbs and Shaw.
Franchise transactions were also put on hold and in 2020, there were more franchisors willing to sell than franchisees willing to invest.
So the simple answer to our original question is that 2020 was not a good year to open a franchise business.
However, there is a bit more to the story. Franchimp observed that in general, the franchise model had a number of advantages in coping with Covid-19 compared to independent and non-franchise businesses.
Franchisors (especially the larger and more established ones) were offering assistance to franchisees in the following areas:
- Financial support such as suspension of royalties and fees, and even credit lines in some instances
- Managerial and operations support
- Advice on eliminating nonessential expenses and optimising human resources
- Negotiation with landlords and suppliers
- Facilitated in the exchange of ideas and measures between members – certain franchises set up advisory committees
- Helping franchisees access government aids, like the Paycheck Protection Program
Franchimp initially expected that being part of a franchise network would mean inflexibility and challenges to come up with a coordinated plan against Covid-19 but 2020 showed that franchises can work together and adapt quickly to survive.
Negotiating with landlords and suppliers is certainty easy when you have the scale and a well-known brand behind you or when negotiating as part of a network.
Many franchises also took the opportunity to invest in digitalization, IT infrastructure and improve their supply chains during Covid-19. Yum!, one of the largest casual dining franchise operator in the world, managed a 1% increase in total revenue in 2020 with a 45% increase in digital sales and 16% increase in delivery sales.
However, Yum! also reported a 22% decline in operating income, which is a consistent with other reputable franchises such as Starbucks and Restaurant Brands (owner of Burger King), due to the increased costs associated with closures and the implementation of more stringent health and hygiene procedures.
There were certainly investors who believe in the resilience of the franchise model, especially in the quick service restaurant sector.
In October 2020, Inspire Brands offered to buy New York-listed Dunkin’ Brands for USD 11.3bn, which was a 20% premium to an already all-time high share price at the time.
A good way to illustrate the valuation of Dunkin relative to other comparable past deals is to benchmark the implied value of the transaction relative to the earnings of the business. See it as comparing the value of a house relative to its potential rent as a valuation metric.
The chart below shows that Inspire paid a price for Dunkin that was over 22 times its earnings (on a EBITDA basis), which was more cream and sugar than when JAB group bought Krispy Kreme for c. 18 times earnings back in 2016. So what made Inspire Brands pay such a creamy price during Covid-19? Probably because of Duckin’s steady cash flow, expectations that the fast food operator would rebound strongly post Covid, and growth potential as the brand has yet to fully expand in other US regions.
Enterprise Value / Last Twelve Months EBITDA
Source: Company announcement, Mergermarket, Capital IQ
So does Franchimp share the same optimism for the franchise market in 2021? Well it is hard to generalise as not all franchises are the same – they operate in different industries, some larger than others, some with more potential than others and they have different operating models and geographical focus.
After all, selling a burger is a hell of a lot easier than selling a dental machine and operating a restaurant ought to be easier than operating a farm.
But since many of you have asked nicely, here are Franchimp’s prediction of the key themes for the franchise market in 2021:
- Due diligence on franchise transactions is going to taking longer
- All stakeholders will be more cautious in today’s environment than pre-Covid, especially the lending banks, they would want a solid business model with sufficient cash buffer (one area that Franchimp can help)
- Valuations for franchises in the quick service restaurant (QSR) space is going to remain strong due to their proven resilience during Covid-19
- Fitness is going to be an industry to look out for
- Franchises with good digital / IT infrastructure will sell better
- We have started to see more inbounds from younger prospective franchisees as they want to take more control over their economic future
- Brick and mortar franchises may bounce back due to the relatively low lease and interest rates
Now Franchimp does not usually write such a long piece as he likes to write articles like how he writes love letter to Mrs Chimp, short, sweet and no promises.
So thank you for reading to the end and if you have any questions or think Franchimp can help then please get in touch with us at [email protected]