Multi-Unit Franchisee Magazine Issue II, 2011 | Page 98
FranchiseMarketupdate
By Darrell Johnson
Beyond the FDD
Multi-unit operators need more to
make investment decisions
W
ith the stock market on a run at the
start of 2011, I began thinking about the
similarities of how stock investors and franchisees choose an investment.
Prospective franchisees with no previous franchise experience seem to act a lot like retail stock investors, relying
on news articles and other information gleaned from magazines, newspapers, and the Internet. Stock investors see ads
(and variously disguised versions of ads, like infomercials and
many press releases). They get calls from brokers who have
plenty of suggestions. Some even get regulatory documents
on targeted companies. They often buy on rumor or suggestions from a trusted advisor. That sounds a lot like the process
prospective franchisees go through.
Sophisticated stock investors may do some of the same
things retail stock investors do, but they perform much more
extensive research on a prospective investment. They review
analyst reports on a company, as well as regulatory documents,
and they may speak with customers and competitors. They
do this in large part because they know the questions to ask.
And not only do they understand the information they are
reviewing, they also know the limitations of that information
as the basis of an investment decision.
What about multi-unit franchisees? When it comes to
deciding whether to add another unit of a brand, they clearly
emulate the sophisticated stock investor (the parallel being a
further investment in the same company they’ve previously
invested in). On the surface, the comparison also applies equally
well when a multi-unit operator is considering investing in
another brand. When some performance attribute catches a
multi-unit operator’s eye, they usually do a bit of preliminary
homework. But it’s at this point the comparison begins to diverge—and for the wrong reasons.
Better information needed
The sophisticated stock picker has access to more information, such as analyst reports on companies and their competitors, than their multi-unit counterpart. To get a handle on
future performance, the sophisticated stock picker looks at a
company’s historical performance (the assumption being that
history is a good predictor of future performance), at industry
statistics, and at a company’s current strategy and how that
relates to its competitiveness. The management team’s track
record also is a common area of focus. Terms that often are
used include return on investment/capital equity/earnings,
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Multi-unit Franchisee Is s ue II, 2011
same-store sales, unit expansion and unit closures, capital expenditures, unit and chain cash flow, and earnings per share.
They can track specific metrics about a public company, and
can do so on a quarterly basis.
The multi-unit investor has access to regulatory documents as well, but how useful is the regulatory information
for making investment decisions? Are the other sources and
types of information comparable to what the sophisticated
stock investor has available?
A 10(k) and an FDD have some content similarities (e.g.,
both have audited statements and descriptions of management). However, a 10(k) relates directly to the company the
sophisticated investor is considering investing in—whereas
an FDD intertwines information about the franchise system
with information about the company that controls the system
that the multi-unit operator is considering investing in. Thus,
an FDD’s value as a guide to evaluating a franchise unit investment is far less than its value as a guide to evaluating the
company that controls the system.
Over the years, the FDD has been seriously misused and
misinterpreted regarding system performance. In my opinion, prospective franchisees, the media, lenders, and all sorts
of experts have tried to infer some system performance attributes and investment potential from many sections, most
notably Item 19 and Item 20. From a potential investment
standpoint, the information contained in an FDD simply tells
a small portion of the story, particularly as it relates to system
performance. Combined with the absence of the quarterly
reports publicly traded companies are required to issue, an
FDD’s usefulness to the multi-unit operator’s investment decision process is rather limited.
Unfortunately, other sources of information for the multiunit investor aren’t there either. There are no independent
analysts reporting on a franchise brand’s performance (unless,
of course, the brand is a public company). Even more challenging is that there are no common metrics for comparing
franchise brands (although the hospitality industry does come
closest). Therein lies the point of my comments: Multi-unit
operators have the power to define the performance metrics
systems should strive to achieve. And if you ask for it with a
loud enough voice, franchisors will produce it because they
want you in their systems.
What is it that would allow you to evaluate the appeal of
a franchise brand in the same way the sophisticated stock investor evaluates companies? Perhaps that is a good topic for
the upcoming Multi-Unit Franchising Conference, if not as
a session topic then certainly as a hall topic.
Darrell Johnson is CEO of FRANdata, an independent research company supplying information
and analysis for the franchising sector since 1989.
He can be reached at 703-740-4700 or djohnson@
frandata.com.