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Sunday, 26 October 2014 22:00

Unchained Growth: Meritage seeks acquisitions as Wendy’s franchise owners approach retirement

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Gary Rose, left, and Robert Schermer, Jr., right, believe Meritage Hospitality can leverage its back office infrastructure and track record for successful M&A to continue consolidating Wendy’s franchises across the country. Gary Rose, left, and Robert Schermer, Jr., right, believe Meritage Hospitality can leverage its back office infrastructure and track record for successful M&A to continue consolidating Wendy’s franchises across the country. PHOTO: KATY BATDORFF

It’s a good time to be an consolidator of quick-serve restaurant chains.

Just ask the executives at Grand Rapids-based Meritage Hospitality Inc. (OTCQX: MHGU), the sixth largest Wendy’s franchisor in the country.

In the last six years, the restaurant operator has acquired 12 Wendy’s franchises with more than 80 individual restaurants and expanded its geographic presence into a territory spanning its home state of Michigan, as well as Georgia, Florida, Virginia, North Carolina and South Carolina.

That expansion corresponds with a distinct period of change in the Wendy’s operation, said Meritage President and CEO Robert Schermer, Jr.

The average owner of the roughly 600 Wendy’s franchises is 64 years old, and franchisors typically own six stores apiece. On top of that, Wendy’s corporate is launching a national rebranding strategy that’s pushing owners to renovate their stores at a cost of more than $500,000 per restaurant.

“This is (Wendy’s) first major brand transformation in 40 years,” Schermer said. “(Owners) have to decide over the next 36 months whether they are going to reinvest in their business or retire.”

That’s where Meritage Hospitality has been able to step in. In the case of some franchisors, selling off part of their portfolio at this stage in their careers is a more attractive option than making a significant investment in rebranding and new equipment, Schermer said.

“This is a unique period in time that creates opportunity for us as (other owners) want to start exiting the system,” said Gary Rose, vice president, COO and CFO at Meritage.

The industry shift is creating opportunities for companies like Meritage Hospitality. In growing from 50 eateries to more than 140 restaurants overall in six years, Meritage has developed the infrastructure to support a network of restaurants across the country, Schermer said.

That kind of back office and operational horsepower allows Meritage to come to the table with an attractive menu of options for existing owners who may be looking to scale-back their business ventures.

Many of the smaller chains Meritage has acquired simply lack modern franchise necessities such as IT departments, real estate development departments and the capabilities to get real-time data on the business, Rose said.

Those in-house operational capabilities are a major factor driving Meritage Hospitality’s appetite for M&A, he added.

“We can do it better,” he said, noting that Meritage operates “at better margins than our sellers, thereby getting a huge benefit going forward.”
Meritage typically funds its acquisitions with cash on hand and via a strategic lending partnership with First Franchise Capital Corp., a New Jersey-based lender specializing in restaurant franchises, Rose said.'

PERFECT TIMING

Meritage Hospitality also has the benefit of timing on its side in pursuing deals. As many owners reach retirement age, they’re not prepared to invest in construction projects to rebrand the restaurants or buy new equipment, Schermer said.

For example, the Wendy’s “Image Activation” program costs up to $700,000 per store, Schermer said. Similar to the process in which automakers incentivize their dealer groups to upgrade their facilities to new brand standards, the Wendy’s program typically involves store improvements and updated equipment.

“It’s going to the next generation … for the brand,” Schermer said.

Typically, when Meritage buys a franchise, it also immediately invests in bringing the facilities up to the brand standards, positioning the stores for the long term, he added.

According to a spokesperson at Wendy’s corporate office, the typical Image Activation program investment falls in the range of $450,000 to $650,000 but can go higher if a franchisee selects optional enhancements.

Not every owner can — or wants — to make that kind of investment, Schermer said.

That was true for Wendy’s franchisor Don Allen, who sold 19 Wendy’s restaurants in Richmond, Va. and Atlanta, Ga. to Meritage in December 2012, one of the larger acquisitions the Grand Rapids-based company has made to date.

“The timing was right for me,” said Allen, 62, who noted that the Wendy’s corporate office initially brought him together with executives at Meritage.

Allen said that at the time, he wanted to scale back some of his restaurant holdings, which were profitable. The deal with Meritage provided him an exit and gave the buyer access to two strong new markets, he said.

Since doing the deal, Allen wound up selling the real estate that was part of the portfolio of restaurants Meritage purchased and went on to build two new Wendy’s stores, he said.

Pairing up franchise sellers with potential buyers is a common for practice for the restaurant chain.

“If franchisees are operationally and financially sound and have a growth orientation, we help bring interested parties together,” said Bob Bertini, a spokesperson for Wendy’s corporate office. “In essence, we provide a networking system to help assist and match up interested franchisees across the U.S. and Canada.”

Wendy’s is also not alone in rebranding itself or asking franchisors to invest in their operations in recent years.

For example, Carl Wiseman of Wiseman LLC owns seven McDonald’s stores around metropolitan Grand Rapids and recently added a second drive-thru to his 28th Street location.
In a statement emailed to MiBiz, Wiseman said he tries to constantly upgrade his stores to conform with McDonald’s standards. Reinvesting in his existing restaurants is the best way to grow his business, he said.

“I can be as creative and innovative as any business owner,” Wiseman said. “Customers and employees want to see reinvestment and growth.”

ATTRACTIVE TERMS

While it didn’t factor into Meritage’s deal with Allen, some owners like the option of having a revenue stream even after they sell their restaurant operations, leading to some buyers working with sellers on sale-leaseback agreements for the real estate, Schermer said.

Although Meritage prefers to own its real estate, it has worked with sellers on sale-leaseback agreements when it makes sense, he said, noting the company has entered into approximately 50 sale-leaseback deals as part of its recent acquisitions.

“If we can own it, that’s our preference,” he said. “When we go into an acquisition, we get a brand-new franchise agreement … for 20 years, so we want to make sure we are matched up on the real estate for at least that amount of time, if not more.”

While Meritage generally seeks out an ownership strategy for its real estate, other Michigan franchisors have taken a different approach.

Southfield-based Diversified Restaurant Holdings Inc., a franchisor of Buffalo Wild Wings and Bagger Dave’s Burger Tavern, has been selling real estate as a means to re-capitalize and build new restaurants, according to an October report in Crain’s Detroit Business.

Last year, the company opened a Bagger Dave’s franchise at 241 Fulton Street NW in downtown Grand Rapids.

GROWING EMPIRE

Meritage Hospitality’s acquisition strategy has propelled the company’s operating results.

The company’s sales grew nearly 78 percent from $77.5 million in 2010 to nearly $137.8 million in 2013, and executives said they’re projecting revenues of more than $153 million for the current year.

In the third quarter that ended Sept. 28, Meritage reported sales of $40.7 million, up 13.5 percent from the same period last year, according to statements released by the company. The company’s net income was $512,000 in the quarter compared to $303,000 a year ago.

Investors appear to be reacting positively to Meritage’s acquisition strategy. The company’s Over the Counter stock has traded above $4 per share for all of 2014, including a period from February to early October when it traded above $5 per share. As this report went to press, Meritage’s stock traded at $5 per share, and the company’s market capitalization stood at $28.5 million.  

Comparatively, the stock traded below $1.70 per share as Meritage started on its acquisition strategy in 2008.

The company has leveraged up over the past few years, reporting $25.8 million in long-term debt as of June 29, 2014. That compares to 2012, when Meritage reported $16.6 million in long-term debt. That debt is directly related to the volume of deals Meritage has completed, Rose said, noting, for example, that the company acquired 19 stores in the last 30 to 60 days. It can take some time after the deal for the franchises to realize a profit, particularly given the company’s strategy to invest in improvements up-front, he said.

Once the stores are fully integrated into Meritage, the company also tends to operate at better margins than its peers in the industry, he said.

Based on its successful track record with acquisitions, the company maintains a healthy appetite for deals, especially given the current market factors, executives said.

That dealmaking could continue as one franchise industry association projects a sustained active period for M&A across the sector.

John Reynolds, president for educational foundation at the Washington, D.C.-based International Franchising Association (IFA) that includes all types of franchises, including restaurants, said that more franchisors are moving toward the multi-unit model deployed by Meritage.

“(Franchisors) see ways to organize and get economies of scale by taking the multi-unit direction,” Reynolds said. “The whole restaurant sector is always changing and a very competitive market to be in. That creates a lot of new businesses and a lot of synergies for constantly changing brands.”

BREAKING THE CHAIN

Aside from Wendy’s restaurants, Meritage also continues to focus on its line of casual sit-down eateries that includes three Twisted Rooster restaurants — one on East Beltline Avenue in Grand Rapids and two in Southeast Michigan — as well as the Crooked Goose restaurant in Standale and Freighters Eatery and Taproom in Port Huron.

By attempting to localize the menus and serve craft beer and cocktails, Schermer said that the sit-down portion of Meritage’s business represents a void left by legacy chain restaurants such as Olive Garden and Red Lobster, which Schermer said have gone “stale.”

“This millennial generation, they break the chain,” Schermer said. “They want high-quality, fresh food, but they are not a fan of chain restaurants.”

The company plans to expand its sit-down eateries with The Wheelhouse, which will be located on the ground floor of Orion Construction’s new Arena Place development in downtown Grand Rapids upon the facility’s completion in 2015. Meritage plans to move its corporate headquarters to the development at the same time.

The company is also launching a similar casual sit-down concept at another Orion Construction project, the Gateway at Belknap development just north of downtown Grand Rapids, as MiBiz has previously reported. The restaurant for that property has not yet been named.

In moving downtown from its current headquarters at a suburban office park on the northeast side of Grand Rapids, Meritage is setting the table for future growth, Schermer said, noting the move also fulfills the company’s desire to continue attracting the kind of employees that it needs to keep growing.

“We’re busting at the seams,” Rose said of Meritage’s existing office space. “As we’ve gained momentum, … we’re really attracting stronger and stronger talent. We think the move downtown is another click in the right direction to continue to add stronger talent. We think it will be really positive.” 

 

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