Back in July I wrote the following column about the impending float of Collins Foods/KFC at between $2.50 and $2.92 per share and suggested I would not be participating in the float on behalf of investors in the Montgomery [Private] Fund. For Value.able investors, the column along with the fact the shares now trade at a substantial reduction offers some insights into the thinking around a new float…
“As a parent I’ve never been much of a fan of fast food but I do know that many of the strong brands in this sector command enormous market share.
But I’m not here today to give you a lesson in nutrition; what I want to talk about is the opportunity to invest in the future success of KFC in Australia through the $238 million initial public offering of Collins Food Group.
The KFC brand is owned by US-based and listed Yum! Brands. Owning a strong brand is one of the best competitive advantages money cannot buy.
The value of this competitive advantage is reflected in the returns on equity, gross margins and pre-tax profit margins Yum! Brands generates of 66.2%, 33.6% and 14.3% respectively for the most recent 12-month period.
Amongst 47 listed restaurants in the United States, Yum is number two by return on equity and 17th among 790 listed services companies by the same measure. There are indeed very high returns to be made from leveraging a great brand like KFC and selling franchises.
Being the franchisee, on the other hand, is rarely as lucrative and the forthcoming listing of Australia’s largest KFC franchisee – Collins Foods Limited (CKF) – will demonstrate this to investors.
Collins has 119 KFC stores (117 of them in Queensland), along with 26 Sizzler restaurants in Western Australia, NSW and Queensland, and it’s the franchisor of maybe 60 Sizzlers in Asia.
The price point of these restaurants will inevitably have fund managers – who are participating in this week’s bookbuild – referring to Collins as a “defensive” investment. But as I have previously indicated, the only defensive investment is a brilliant one; mediocre companies need not apply.
To begin with it is important to note that Pacific Equity Partners (PEP) – the private equity firm behind REDgroup, the parent company of Angus & Robertson and Borders now under administration – will be exiting its stake completely.
Perhaps more interestingly, the existing management team is cashing in, too. Managing director Kevin Perkins will reduce his holding from over 20 per cent to about 8% and the rest of management will reduce their holding, too.
When Pacific Equity Partners paid $US210 million in September 2005 (the $US6.92 a share was a 42% premium to the then traded price of $US4.92) for Worldwide Retail Concepts, the US publicly listed company that is now Collins Foods, management then co-invested with a 48% stake. According to all reports, management will now retain just 10%. In other words, management is selling 80% of its holdings into this float.
If PEP bought the company in 2005 alongside management who owned 48%, and you buy in 2011 with management owning just 10%, do you think the deal has a whiff of fried chicken to it?
During the privatisation, PEP and the management were arguably similarly incentivised but when you buy Collins Food Group’s from PEP in the IPO, you will not have the same committed management.
And when PEP bought Worldwide Retail Concepts in 2005, the company operated, joint ventured or franchised 302 Sizzler restaurants (with 28 in Australia), 112 KFC sites (111 in Queensland) and it also owned 22 sites of the US “quick casual” or family value restaurant chain Pat & Oscars.
Worldwide Restaurant Concepts reported revenues of $US347.2 million in the year to April 30, 2004 ($A444 million at the then exchange rate of US78¢) and 70% was generated in Australia. All this for $US210 million ($A269 million).
According to reports, you are being asked to pay $A230–278 million ($US244–295 million) for 119 KFC outlets, 26 Sizzlers and around 55 franchised Sizzlers in Asia. I am not sure if the IPO company will offer a stake in the other 220 Sizzlers but I can tell you the Pat & Oscars chain was sold to management in 2009 after another buyer in 2007 failed to secure funding.
Oh, what doesn’t Google know!
Same-store sales growth has been positive while in the care of PEP and Collins Foods, and is forecast to hit $430 million in 2012, according to one report, but it is the growth in earnings since the purchase in 2005 that has been spectacular.
For the year to April 30, 2004, Worldwide Restaurant Concepts earned just $4 million. In 2011 that number might be closer to $25 million for Collins Foods and it is probably for all this hard work that management want to cash in their 38%.
Despite this wonderful growth in profits, the best (read most optimistic) estimate of intrinsic value I can give you is $2.55. This represents the low end of the expected range of possible prices at which you might be entitled to any shares.
But before you jump in like a headless chicken, remember two things: management are taking their cream; and the franchisor always makes more money than the franchisee. Just look at Yum! Brands’ return on equity and compare it to Collins Food Group’s when we see it.
Finally, it’s always interesting to follow the cash account, which can give an alternative picture of the company’s position before and after its float. For those who have access to the prospectus have a look at the pro forma cash balance prior to the float.
Let’s presume it is close to $50 million. That cash balance will first increase by the proceeds of the float – say $250 million – but any debt repayment will see the acco