Page 13 of 49 – SEC Filing for these programs is the same that it was two and three years ago despite the Company having missed its initial execution objectives. Even now, management is content to highlight the opportunity while very little tangible progress has been achieved. This issue is representative of a much larger issue of management’s persistent failure to execute and the Board’s failure to hold management accountable.
5) An audit of managerial decision tools and a reconciliation of business outcomes as compared to forecasts. Despite frequent assurance from management of the use of DCF- and IRR-based forecasts to approve investments such as remodel campaigns, new unit openings, or acquisitions, our experience with retail and restaurant businesses has taught us that those processes can be highly flawed. We take seriously the tendencies of development staff to reverse-engineer projections to achieve a stated hurdle rate or highlight data with a selection bias to support past decisions. The Board must review past capital investments to ensure that outcomes compare favorably with the underwriting process. We recommend starting with an assessment of the Company’s large franchisee acquisition in 2015, which based on all available data, has been an unmitigated disaster. That such an obviously misguided decision could be made under the guise of rigorous analysis underscores the weaknesses in the Company’s capital allocation processes and need to commit to a disciplined capital allocation program.
The list above speaks to functional changes that will improve business performance. At a higher level, however, there is an intellectual divide that must also be addressed: there is a glaring deficiency of understanding at the Company in how capital deployment relates to shareholder value creation. Yesterday’s announcement of a $300 million share repurchase authorization further highlights this point. Management self-identifies its objectives to be those of a “growth company” but does not appear to have a clear sense of what that exactly means or how (and if) achieving this poorly defined “growth” objective is best for shareholders. Growth in revenue or earnings simply cannot be evaluated without consideration for the capital deployed in the achievement. This basic principle of corporate finance is tragically underappreciated by the current management team. Instead, management celebrates consolidated revenue growth without discriminating between revenue derived from growth in royalties from franchisee unit development, same-store sales growth (itself a product of tension between higher price and declining traffic), new company-operated unit growth, and the purchase of units from franchisees. Each of these revenue streams has a radically different margin profile and comes at a radically different capital cost (franchise royalties in particular come at no cost whatsoever). Most importantly, the income derived from each of these different revenue streams receives a radically different value in the market due to its unique degree of capital intensity and predictability. Management and the Board should be solely focused on growing market value per share, determining which types of revenue growth will best deliver that outcome.
| for these programs is the same that it was two and three years ago despite the Company having missed its initial execution objectives. Even now, management is content to highlight the opportunity while very little tangible progress has been achieved. This issue is representative of a much larger issue of management’s persistent failure to execute and the Board’s failure to hold management accountable. |
| 5) | An audit of managerial decision tools and a reconciliation of business outcomes as compared to forecasts. Despite frequent assurance from management of the use of DCF- and IRR-based forecasts to approve investments such as remodel campaigns, new unit openings, or acquisitions, our experience with retail and restaurant businesses has taught us that those processes can be highly flawed. We take seriously the tendencies of development staff to reverse-engineer projections to achieve a stated hurdle rate or highlight data with a selection bias to support past decisions. The Board must review past capital investments to ensure that outcomes compare favorably with the underwriting process. We recommend starting with an assessment of the Company’s large franchisee acquisition in 2015, which based on all available data, has been an unmitigated disaster. That such an obviously misguided decision could be made under the guise of rigorous analysis underscores the weaknesses in the Company’s capital allocation processes and need to commit to a disciplined capital allocation program. |
The list above speaks to functional changes that will improve business performance. At a higher level, however, there is an intellectual divide that must also be addressed: there is a glaring deficiency of understanding at the Company in how capital deployment relates to shareholder value creation. Yesterday’s announcement of a $300 million share repurchase authorization further highlights this point.
Management self-identifies its objectives to be those of a “growth company” but does not appear to have a clear sense of what that exactly means or how (and if) achieving this poorly defined “growth” objective is best for shareholders. Growth in revenue or earnings simply cannot be evaluated without consideration for the capital deployed in the achievement. This basic principle of corporate finance is tragically underappreciated by the current management team.
Instead, management celebrates consolidated revenue growth without discriminating between revenue derived from growth in royalties from franchisee unit development, same-store sales growth (itself a product of tension between higher price and declining traffic), new company-operated unit growth, and the purchase of units from franchisees. Each of these revenue streams has a radically different margin profile and comes at a radically different capital cost (franchise royalties in particular come at no cost whatsoever). Most importantly, the income derived from each of these different revenue streams receives a radically different value in the market due to its unique degree of capital intensity and predictability. Management and the Board should be solely focused on growing market value per share, determining which types of revenue growth will best deliver that outcome.
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