Papa John’s announced yesterday a number of proposed domestic franchise system support initiatives in response to the current economic challenges. These initiatives include:
1) Providing continued cheese cost relief to the system in 2009 by modifying its cheese pricing formula
2) Providing additional national marketing support in 4Q08 and FY09
3) Offering expanded royalty relief and local marketing support for struggling franchisees or markets
4) Convening a lender’s summit, principally of regional banks and other lenders, to educate them on the Papa John’s model with the goal of expanding credit availability to franchisees
5) Providing company loans to operationally strong franchisees to help them to acquire troubled franchise groups
6) Suspending the 0.25% royalty rate increase, which was scheduled for January 2009, in the first six months of 2009
PZZA estimates that the incremental costs of these support initiatives will be about $3 million in 4Q08 and $8-$10 million in FY09. The ultimate impact for 2009, however, will depend upon the actual number of franchisees who choose to accept the proposed support program. Although this type of support will broaden PZZA’s short-term exposure to the current environment, the company “believes the support program will produce long-term shareholder benefits by mitigating potential unit closures and strengthening [its] brand during these challenging times.” The need for these support initiatives highlights the fact that it is primarily the franchisees (across the restaurant industry) that are enduring the total profit impact from lower consumer spending, rising commodity costs and the tightened credit markets.
Franchisor financing of its franchisees is becoming the trend recently with more restaurant operators communicating the need to provide assistance in today’s environment. And, a prolonged downturn will likely force more companies to make announcements similar to that of PZZA. Domino’s said on its most recent earnings call that the company is “wading through uncharted waters and we are not going to let our A and B franchisees fail if there are ways we can be helpful with some short-term financial support and solutions.” Management went on to say that although it does not want to be a bank, it would provide some level of bridge financing to help facilitate the acquisitions of its weaker franchisees by stronger franchisees as the company would rather see a deal get done than a store closure. Domino’s would also offer some deferral of costs, royalties or other payments to a franchisee that is in turnaround mode if it would prevent that franchisee from failing. At the time Domino’s made these comments, it was only highlighting its options, but the fact that the company communicated them to the investment community signals that some of its franchisees were in desperate need of financing. That being said, I would not be surprised to hear how the company proceeded with these short-term financing initiatives on its fourth quarter earnings call.
Just yesterday, JBX announced that it provided bridge financing to a small number of franchisees in 4Q08 in order to get more of its company stores sold as the company is the midst of a massive refranchising program, which is being slowed somewhat by current credit conditions. JBX plans to accelerate the pace of its refranchising efforts over the next five years to reach its goal of franchised ownership in the range of 70% to 80% by the end of fiscal year 2013 (from 38% franchise ownership at the end FY08). In order to remain on target, JBX said it is comfortable providing bridge or mezzanine financing to its franchisees to facilitate the completion of transactions on a go forward basis.
As I said before, based on the likelihood of a prolonged economic downturn, I would expect more restaurant operators to announce financial support initiatives for their franchisees, including deferred royalty payments. Two obvious candidates are DIN’s Applebee’s franchisees and YUM’s KFC franchisees. A select number of Applebee’s franchisees are struggling to make ends meet and are aggressively cutting costs. Everyone knows the problems with KFC. Like many other restaurant companies today, KFC’s same-store sales continue to decline (down 4% in the most recent quarter) as costs climb higher. More unique to KFC, however, is the fact that the concept has been struggling from a profitability standpoint for the better part of the last two years so the current environment is only worsening an already difficult situation. At some point, franchisees are going to demand relief.