Could Popeye’s give Restaurant Brands a case of indigestion?

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Sunday April 9, 2017

About a year ago, Benj attended the annual general meeting of the Female Health Company, the global leader in female condoms.

Part of the potential of this investment, which we wrote about last year, was the possibility that FHCO might be acquired, which Benj talked about with chief executive officer O.B. Parrish, who was open to the idea.

A bid did emerge, but from a wannabe outfit with zero revenues called Aspen Park Pharmaceuticals. Unhappy with the deal, Benj sold for US$1.04, taking a 32 cent haircut.

One particularly interesting aspect of the trip was the Popeye’s Louisiana Kitchen gathering taking place at the hotel where Benj was staying. There were about 1,200 people, and they seemed like happy franchisees and employees. This was definitely a group that was pulling together to propel its company ahead.

Might unity be derailed? In February, Restaurant Brands International (ticker symbol: QSR) swooped in to buy Popeye’s in a $1.8 billion deal. Restaurant Brands owns Burger King and purchased Tim Hortons in 2014, a change of ownership that is proving tempestuous.

Franchisees rebelling against QSR’s practices have formed the Great White North Franchisee Association to air their lengthy list of grievances. That litany is too long to recite here, but suffice it to say that they are very dissatisfied and feel that the Tim’s brand is being destroyed. Ron Joyce, co-founder of Canada’s iconic doughnut chain, stated, “The head office has been decimated.”

Is QSR a buy? Critical to QSR’s operations is the leadership of the gents from 3G Capital, a Brazilian group that prides itself on efficiency. At both Tim’s and Burger King, there is no question that costs have been slashed and the bottom line improved. But one has to wonder if short-term gain is being traded for long-term pain.

Some pretty smart investors like the stock. Joel Greenblatt of hedge fund Gotham Capital owns a piece, as well as Bill Ackman of Pershing Square Capital Management. A fellow named Warren Buffett also possesses a chunk, and he is considered to be a wizened hand in the stock world.

These guys have watched QSR jump about 75 percent since the beginning of 2016. Sales were $1.2 billion in 2014, and should reach $4.5 billion this year. Net income of about $152 million in 2014 paled compared to the robust $636 million tally of 2016. There is almost $1.5 billion in the kitty. What’s not to like?

Our wariness about this stock stems from a number of factors. The debt load is about $9 billion, which is very fat. Goodwill is almost $4.7 billion, and in all likelihood, some of this will be written off. The book value is less than $10, so at around $56 per share, the stock trades at a very hefty premium.

The dissatisfaction of franchisees is a major source of concern. One has to wonder if their unhappiness and questions about operations and quality will cause some devoted customers to go elsewhere. There is certainly a myriad of competitors. QSR’s devotion to cost-cutting could work immediately, but what will it do to the brands that people love?

Will QSR follow its normal efficiency blueprint with Popeye’s, or will it perhaps decide the time has come to change its line of attack? This chain has over 2,600 restaurants, and former CEO Cheryl Bachelder has said that the “high trust partnership that we enjoy with our franchise owners” was a motivating factor for QSR to do the deal.

Given the operational DNA of Restaurant Brands, one wonders if that relationship might be quickly eroded. And if the Sailor Man’s franchisees are eating their spinach, they might be tough to deal with.

Scarfing down Popeye’s so soon after Tim’s could prove to be too big a mouthful, especially since much of the top brass at Popeye’s has either chosen to leave or is being shown the door. Changes in the way consumers eat at restaurants could also diminish profitability, since none of the QSR brands is known for healthy food.

At the end of the day, our feeling is that owners of this stock could be in line for some major indigestion. Evidently, Messrs. Greenblatt, Ackman and Buffett disagree with us. Which puts us up against some pretty formidable foes in taking this view.