The Brexit Burger isn’t delicious
- Global, South Africa
- Brexit, Debt, Famous Brands, GBK, Hard currency, Offshore expansion, Return on assets, Return on equity
- April 5, 2020
Famous Brands is well on its way to being another great case study of a South African business failing miserably to expand globally.
They announced last week that they are not going to give financial assistance to Gourmet Burger Kitchen (GBK) in the UK, the business they wish they had never bought back in 2016 for £120m.
It marks the end of a long and painful journey into foreign lands. Oddly, they announced the deal in September 2016, just a few months after the Brexit referendum. Hindsight is always perfect, but most corporates shy away from doing landmark transactions in hugely uncertain times.
This is why:
Not so mouth-watering after all
The official press release in September 2016 called it a “mouth-watering” agreement to acquire all the shares in GBK. Shareholders can only lament those words.
This wasn’t Famous Brands’ first foray into the UK market. They acquired Wimpy UK in 2007, having owned Wimpy SA since 2003. Wimpy is a very different business though, with GBK having focused on the premium market.
At the time, Famous Brands was trying to add “hard currency” income to the group. This means income earned in currencies like the Euro or the Dollar, vs. emerging market currencies (like our beloved Rand) which are subject to potentially violent swings.
Whether or not the Pound could be called a hard currency in the wake of Brexit is a different story.
Beware of founders willing to sell 100%
Famous Brands bought into a perfect storm. Whilst Brexit put the entire market under pressure, the premium burger segment exploded with competition. That’s always great news for consumers, but not for established businesses in the market.
The New Zealanders who launched GBK in 2001 are credited with pioneering the gourmet burger category in that market. They built the business up to around 75 restaurants and sold it.
We can only speculate that they saw the trouble coming down the road. This is why companies often agree to buy only a controlling stake in a business (i.e. 51%), leaving the founders with a large stake to incentivise them to carry on growing the business.
When the founders are happy to toss you the keys to the entire thing, you need to ask yourself what they know that you don’t. Sure, they might be happy to stay on in a management role, but ideally you need them to stay on as shareholders.
Within two years of the deal, GBK entered into insolvency proceedings, or a concept similar to “business rescue” in South Africa.
Layering operational risk with financial risk is dangerous
The market loved Famous Brands up until 2016 because it was a dependable source of dividends and had no debt on its balance sheet. The management team then decided to completely flip this on its head, going on an acquisition spree and suspending the dividends to give themselves breathing space to pay down the debt.
The GBK deal was risky operationally. It was in a foreign country going through political upheaval, in a segment of the market that Famous Brands knew nothing about. To layer high levels of debt on top of this was looking for trouble.
The cracks showed very quickly, if you knew how to spot them:
- 2017 return on equity 40.3% (vs. 2016 36.4%)
- 2017 return on total assets 22.6% (vs. 2016 36.6%)
Return on equity painted a great story, until you look at return on assets. The critical thing to understand about return on equity is that it is a combination of how well your assets are doing and how you financed them. Using more debt will typically improve return on equity, as you simply have less equity invested. It’s like buying your house with a 100% bond.
The massive drop in return on assets in 2017 would’ve spooked investors and sent the share price on its downward trajectory. The restaurants weren’t performing well and the debt balance desperately needed the business to perform.
Suddenly, the market darling for dividends and earnings reliability had morphed into a high-risk investment holding company and people hated it.
Towards the end of 2019, things were actually looking up at GBK. The “business rescue” process launched in 2018 seemed to be right-sizing the business. Although total sales were down 12.5%, that’s to be expected when the business is becoming smaller. Importantly, like-for-like sales had risen 8.6% against a decline of 9.7% in the previous year. That’s a much better way to measure how restaurants are performing on an individual basis.
Sadly, the GBK acquisition seemed unable to avoid disaster, despite best efforts.
The restaurant industry is being decimated by the global shutdown over COVID-19 and Famous Brands is going to need to focus on its businesses that were doing well until this crisis. That leaves neither management time nor money for further efforts around GBK.
Within two decades, a business that pioneered a market segment has gone from being founded to being on life support. It will in all likelihood disappear from the UK market unless a buyer is found.
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