Restaurant Insight | Consumables Digest Call, Big Sandwich (FTC), SHAK Update

Subway's 10 Billion Deal Under FTC Scrutiny: A Sandwich Empire or a Monopoly in the Making?

@SenWarren worries about the Subway deal, saying, "We don't need another private equity deal that could lead to higher food prices for consumers."

The Federal Trade Commission (FTC) is investigating the potential monopoly implications of Roark Capital's 10 billion acquisition of Subway, adding to its portfolio, which already includes Jimmy John's, Arby's, McAlister's Deli, and Schlotzky's. This scrutiny is part of the FTC's broader focus under Chair Lina Khan on private equity deal-making and consumer prices. The FTC is also probing other significant mergers, including Kroger and Albertsons, Amazon's acquisition of iRobot, and Pfizer's purchase of Seagen. Despite its resource constraints, the FTC is actively involved in several high-profile cases, yet to secure a significant litigation victory under Khan's leadership.

This increased vigilance has led to actions against various mergers and acquisitions, such as a lawsuit against a group of Texas anesthesia practices and their private equity owner and an ongoing investigation into the Kroger-Albertsons merger. The investigation into the Subway purchase is still in its early stages, and a resolution could take several months, as antitrust reviews often extend over a year or more. The FTC has several options, including suing to block the merger, negotiating terms to address its concerns, or choosing not to act. A vital aspect of the investigation is defining the relevant market that might be affected by the merger. The companies involved argue that the FTC should consider a broader range of fast food options beyond just sandwiches, noting that Roark's holdings represent only a tiny fraction of the overall U.S. fast food market. According to QSR Magazine's August 2023 rankings, Subway is the leading U.S. sandwich chain based on 2022 sales, with Arby's, Jimmy John's, and McAlister's Deli also ranking in the top seven. The FTC, facing resource constraints, is simultaneously investigating several high-profile mergers, including Amazon's acquisition of iRobot and Pfizer's purchase of Seagen. The commission has had mixed success in blocking deals and is under pressure to secure a win in court under Khan's leadership. This investigation into the Subway acquisition by Roark Capital highlights the FTC's commitment to scrutinizing mergers that could potentially impact market competition, even in sectors as every day as sandwich shops.

Update on Shake Shack's Strategic Sizzle

The conference presentation was upbeat but structural issues persist.

Yesterday, SHAK's management CEO, Randall J. Garutti, and CFO, Katherine Fogertey, addressed various topics at a conference, including consumer behavior, marketing strategies, and financial performance. They noted a recent slowdown in consumer spending and a rebound, attributing this to seasonal trends. Mr. Garutti emphasizes Shake Shack's focus on value and premium branding despite a market trend towards heavy promotions and discounts. He also highlights the importance of consistent, high-quality customer experiences and the company's increasing marketing efforts. Ms. Fogertey adds insights into the company's financial strategies, including managing inflationary pressures and labor costs. Both executives express cautious optimism for the future, acknowledging challenges and pointing to strategic plans for growth and efficiency. Yet they did not talk about the 3Q23 decline in traffic. On traffic trends, specifically, they mentioned how the COVID-19 pandemic had affected their traffic patterns, particularly in major metropolitan areas compared to other markets. They noted that the situation became more normalized while there was still some ongoing adjustment (so traffic is still soft?). They observed changes in travel patterns and how different locations (like those in major urban centers versus neighborhood-like areas) were experiencing varying traffic levels compared to pre-pandemic levels (structural?). Thus they talked about their growth strategy, which includes expanding more into suburban areas, and their plans for new restaurant models like drive-thrus, which are expected to influence future traffic trends.

• Consumer Trends: Noted a slowdown in consumer spending, followed by a rebound, possibly due to seasonal patterns.
• Shake Shack's Positioning: Emphasis on value and maintaining a premium brand despite a market trend towards heavy promotions.
• Marketing Strategies: Increasing marketing spending, focusing on brand campaigns, and leveraging digital channels.
• Financial Performance: Strong performance in high-income consumer segments, with effective cost management strategies.
• Inflation and Labor Costs: Acknowledgement of inflationary pressures, particularly in food and labor, with strategies to manage these challenges.
• Future Outlook: Cautious optimism for 2024, with plans to improve profitability, manage build-out costs, and expand market presence.

Given the pressure the CEO is under, we care more about the comments about how the company would improve overall profitability. Shake Shack's strategies to improve profitability can be broken down into several key areas:

1. Wage Management and Pricing Strategy: Shake Shack is aware of the rising wages across various regions. To manage this, they are prepared to adjust their pricing regionally to offset increased labor costs. This approach ensures that they remain competitive in wages to attract and retain quality staff while maintaining profitability through strategic pricing adjustments. Shake Shack has historically been cautious with price increases, often aligning with or below the CPI. They plan to continue this approach but are ready to adjust prices as needed, focusing on regional and digital channels. This strategy helps in balancing customer affordability and revenue growth.
2. Staffing and Workforce Stability: Post-COVID, the company has seen improvements in staffing, with longer employee retention and lower turnover rates. This stability in the workforce is crucial for operational efficiency and reducing costs associated with hiring and training new employees. A stable, experienced workforce can also enhance customer service and operational efficiency, contributing to better financial performance.
3. Growth and Expansion with a Focus on Unit Economics: The company aims for mid-teens unit growth, emphasizing improving the economic model of both current and future restaurants. This includes optimizing costs and ensuring that each new unit opened is financially viable, contributing to overall profitability.
4. Cost Reduction in New Restaurant Builds: Shake Shack is actively working to reduce construction and pre-opening costs for new restaurants. This involves optimizing restaurant design, reducing the size of some locations, refining kitchen models to reduce equipment needs, and overall cost management in the construction process. They plan to open around 80 new restaurants domestically and internationally next year. The company plans to focus more on suburban growth.
5. International Expansion and Diversification: The company is expanding into international markets, recognizing the potential for brand growth and increased revenue streams. This includes entering new markets like Canada and Malaysia and focusing on high-potential areas like airports and roadside locations. Mr. Garutti mentions challenges such as the war in the Middle East and the economic situation in China but remains optimistic about international growth.
6. Operational Efficiency in G&A: Shake Shack focuses on finding efficiencies in its G&A budget. This involves leveraging existing investments more effectively and driving efficiencies across various administrative functions. By managing these overhead costs, the company can improve its bottom line. As the company grows, it expects to see leverage in its G&A expenses.

Shake Shack (SHAK) has implemented several sales-driving initiatives to boost their performance and address the challenges of the current market environment. These initiatives include:

• Digital and Mobile Ordering Enhancements:  Shake Shack focuses on improving its digital channels, recognizing the higher willingness to pay in these segments. Digital and mobile ordering enhancements can attract more customers and increase order sizes.
• Menu Innovation and Engineering:  The company is likely focusing on introducing new menu items or promoting higher-margin items. This could involve seasonal offerings or limited-time products to create excitement and attract customers.
• Enhancing Customer Experience:  Improving the overall customer experience in-store, such as through better service or restaurant ambiance, can drive repeat business and positive word-of-mouth.
• Marketing and Branding Efforts:  Continued focus on marketing initiatives to promote the brand and its offerings. This could include traditional advertising, social media campaigns, and partnerships.