franchise report - capstone partners

August 2017

M&A INSIGHTS

FRANCHISE REPORT

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The franchise industry is a $2.3 trillion market, and accounts for nearly one out of every six jobs in the U.S. The franchising industry includes businesses across many different types of industries, geographies, and business sizes ranging from small players like H&R Block and Grease Monkey to giants like Subway and 7-Eleven.

Franchises are proven systems that operate under a common system and are only responsible for their day-to-day operations. The model comes with operational and marketing expertise specific to each business; additionally, franchises are founded and operated with pre-existing and established brands and product/service offerings1.

Historically, the most promising franchises carried a high buy-in fee and required substantial overhead costs, and the cheaper and more affordable franchises typically required years of difficult and strenuous work without much opportunity for growth. However, statistics show that franchise-owned businesses have a better chance of survival over an extended period than an independent small business. According to the U.S. Small Business Administration, seven out of ten new employer companies survive only two years; five out of ten survive five years; and three out of ten survive ten years; and a two out of ten survive 15 years or more.2

In 2016, the franchise sector grew faster than overall GDP and will continue a similar trend through 2017. The International Franchise Association estimates that the number of franchise establishments grew 1.7% in 2016, and will increase by 1.6% in 2017. Furthermore, franchise employment grew 3.5% in 2016 and is forecast to grow 3.3% in 2017. Franchise output grew 5.8% in 2016 and will grow 5.3% in 2017.3

States in the south and the west have continued to lead the nation in franchise employment and output growth in 2017. Factors such as domestic migration, growth of population, personal income and tourism, (especially for the lodging and restaurant industries) have fueled growth across many of the franchise sectors.

FRANCHISE REPORTMARKET OVERVIEW

Market OverviewWhat is Franchising? Key PlayersM&A Activity

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TABLE OF CONTENTS

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Franchising is a method for expanding a business and distributing goods/services through a licensing relationship to third-party retailers or individuals (franchisees), who can use the franchise’s logo, name, and business model. There are two key parties in a franchise relationship, the franchisor and the franchisee. The franchisor is a person, company, or trademark that grants the use of the business license to a third-party under their mark(s). The franchise business model is typically broken into three key categories:

i. Business format franchising: This model is the most recognized and identifiable franchise business model. It offer’s franchisees the right and opportunity to use the trade name, products, and services, as well as the entire system for operating the business. The franchisee generally receives site selection and development support, operating manuals, training, brand standards, quality control, marketing strategy and business advisory support from the franchisor. This renowned franchise model is used by companies such as McDonalds, Subway, and Pizza Hut and spans more than 120 industries from automotive and business services to senior care and medical services, and restaurants.

ii. Traditional or product distribution: This model licenses the right for a third party to sell the parent company product (e.g. Toyota, Ford, Nissan, etc.).

iii. Trademark Licensing: Allows companies to buy the right to use the parent company’s trademark along with their own brand (e.g. Coca-Cola licensing to other companies).

WHAT IS FRANCHISING?

Source: Entrepreneur Magazine: What's Hot in Franchising? January 2016

FRANCHISE UNIVERSE

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According to Entrepreneur, the hottest segments in the franchise industry include: Food/Quick Service, Maintenance & Services, Personal

Care, and Children’s Businesses.

i. Food & Quick-Service continues to be the dominant category with 177,922 units that make up 19.2% of the Franchise 500; however, represents a significant drop from 20.8% from 2015’s profile. While fast-food companies still dominate the rankings, the majority of new entrants fall into the fast-casual category. New entrants are unable to compete based on price and speed, so they have been focusing on higher food quality and atmosphere. Additionally, fast-casual concepts and the use of fresher ingredients have been the result of shifting tastes and eating habits among consumers.

ii. Maintenance & Services continues to be a top performer year-over-year in the Franchise 500 due to the low cost of entry - especially for commercial cleaning services. Cleaning franchises are considered the epitome of low-cost franchise models. The buy-in for typical cleaning franchises ranges from $50k - $950k and is responsible for creating the famous two-tier franchise system that provides various financial opportunities for franchisees. Under the two-tier system: the master franchisee provides the largest capital outlay by purchasing a territory, then is responsible for signing up franchisees within that territory; pushing the lower capital requirements down the funnel. This provides franchisees a budget to get into the game.6

Jan-Pro is one of the oldest and largest cleaning franchises in the world with 8,000+ unit franchises in 14 countries. Jan-pro states that many of their unit franchises are first-generation Americans or lower-income citizens looking to build a better life.

The commercial cleaning sector has seen a sharp increase in specialization and differentiation due to the low cost which has flooded the market with new entrants. To remain competitive, companies have shifted their focus on residential cleaning and restoration services.7

iii. Children’s franchises are also a fast-growing market of the franchise industry. Franchises are bolstering learning from pre-school to high-school, including services like daycare and tutoring, children’s gymnasiums etc. A central topic in the children’s franchise world is focused around STEM (science, technology, engineering, & mathematics). As U.S. students continue to fall behind in math and science among industrialized nations, parents will continue to be the driving force to change that. That trend will continue to push growth in this sector. Impressive franchises like Mathnasium and Bricks 4 Kids will benefit with this consumer spending. This sector will likely receive spotlight in both M&A and private equity activities.7

Franchise 500 Companies with the Greatest Growth (U.S.)

Franchise 500 Companies with the Greatest Growth (Worldwide)

Source: Entrepreneur Magazine

KEY FRANCHISE SEGMENTS & GREATEST GROWTH COMPANIES

0 200 400 600 800 0 100 200 300

700%

270%

250%

2015: 1 Franchise2016: 8 Franchises



250% 2015: 4 Franchise2016: 14 Franchises



0 200 400 600 800 0 100 200 300

700%

270%

250%







5

#1 7-Eleven Inc.Initial Investment: $37K-$1.6M

#2 McDonald'sInitial Investment: $1M-$2.2M

#3 Dunkin' DonutsInitial Investment: $229K-$1.7M

#7 Ace Harware Corp.Initial Investment: $273K-$1.6M

#4 The UPS Store Initial Investment: $159K-$435K

#8 Wingstop Restaurants Inc.Initial Investment: $303K-$923M

#6 Dairy QueenInitial Investment: $361K-$1.8M

#10 RE/MAX LLCInitial Investment: $38K-$224K

#5 Jimmy John'sInitial Investment: $326K-$555K

#9 Sport CLipsInitial Investment: $183K-$352M

Top 10 Franchises – The Biggest Global Players by Number of Units

Source: Entrepreneur Magazine: 2017 Franchise 500 RankingJul 2017

The top three global franchises, which fall under the food and quick service franchising category, are 7-Eleven, McDonald's and Dunkin' Donuts. All three franchises account for nearly 54% of the 177,922 units in the food and quick service franchising category.

7-Eleven holds the top spot with 8,660 units of which 8,335 are franchised in the U.S., and 50,712 units outside the U.S. with presence across 18 countries (Canada, Asia, Northern Europe, and U.A.E).15 Since 2010, the number of 7-Eleven franchise units outside the U.S. has grown from 30,524, a 66% increase, and has been the fastest growing segment of their franchises. The number of U.S. units has remained stable year-over-year.

7-Eleven is seeing demand for convenience stores increasing due to three key trends; including (i) growing demand for private label products, (ii) strategic business initiatives, and (iii) continued trend of eating out.

Though McDonald's holds more U.S. franchises than 7-Eleven at 13,046 vs. 8,335, they have substantially less outside the U.S. at 18,184 units. McDonalds company owns 5,669 units. McDonald’s has similar trends to 7-eleven with the number of domestic franchise units remaining stable, and the number of units outside the U.S. growing year-over year. Since 2010, McDonalds international franchise units have grown by more than 30%.

The number of units drops dramatically as you move to the number 4 spot or below. The UPS Store has 355 franchises outside the U.S. and 4,555 U.S franchises. The number of UPS franchises globally has declined from 1,521 units in 2008 to 355 in 2016.

For large franchise players, future growth will come from continued international expansion.

GLOBAL FRANCHISES

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Dunkin’ Donuts Jan-Pro Franchising Int’l. Cruise Planners Jimmy Johns

The fastest-growing rankings are based on the number of new franchise units added in the United States and Canada from July 2015 to July 2016, with ties broken based on percentage growth.9

Dunkin Donuts added the most units of any franchise with over 373 additional units from July 2015 to July 2016, and over 1,118 Units from July 2013 to July 2016; a 10.3% increase in total number of units.

Fastest-growing Franchises

+3.2% +373 UNITS

+10.3%+1118 UNITS

+4.8% +375 UNITS

+14.5%+1041 UNITS

+17.4% +361 UNITS

+62.1%+932 UNITS

+15.3% +350 UNITS

+48.8%+864 UNITS

Dunkin’ Donuts

1 YearJul 2015- Jul 2016

3 YearsJul 2013- Jul 2016

Cruise Planners Jimmy John's Jan-Pro Franchising International

#1 Dunkin' DonutsInitial Investment: $229K-$1.7M

#2 Jan-Pro Franchising Int'lInitial Investment: $4K-$52K

#3 Cruise PlannersInitial Investment: $2K-$23K

#7 CoverallInitial Investment: $17K-$49K

#4 Jimmy John'sInitial Investment: $326K-$555K

#8 McDonald'sInitial Investment: $1M-$2.2M

#6 7-Eleven Inc.Initial Investment: $37K-$1.6M

#10 SupercutsInitial Investment: $144K-$294K

$5 Taco BellInitial Investment: $1.2M-$2.6M

#9 Jersey Mike's SubsInitial Investment: $193K-$660K

FASTEST-GROWING FRANCHISES



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Source: S&P Capital IQ & Latest 10-Q filings

Source: S&P Capital IQ as of: 8/15/2017Public Franchises Includes: McDonald's Corporation, Hilton, Inc., Marriott International, Inc., Restaurant Brands International Inc., Wyndham Worldwide Corporation, GNC Holdings, Inc.

Typically going public costs about $1 million per year, requiring a franchise system to be quite large and should be trying to raise a minimum of $100 million or more. The primary motivation for going public and selling shares is to (i) pay down debt, (ii) buy back stores from franchisees, (iii) acquire a second brand to add to their portfolio, or (iv) realize profit for founders, executives and investment firms who can sell off their shares in the business.

Jeff Rosenfeld, co-founder and managing partner of Minneapolis-based Kessev Finance, which helps franchisees and franchisors raise capital for expansion, has doubts. "You're not going to find a whole lot of reasons for a franchise to have an IPO," he says. "The question for a franchise to ask is: Why go public? It costs a lot, and costs a lot to remain public. And if they raise all that capital, they have to ask what they're going to do with all that money."10

McDonalds holds the top spot year-over-year as the largest public franchise company with a market cap of $96.0 billion and holding a very large separation from the next closest player of Hilton at $22.0 billion. Franchise companies typically avoid going public, but there are situations in which franchise companies do go public.

Public Franchises Analysis vs S&P 500

Public Franchises

PUBLIC FRANCHISES

Company Price 52-Week Market Enterprise EV/Revenue EV/EBITDA Rev. CAGR 2017E Margins Returns

Name 8/15/2017 High Cap. Value (EV) LTM 2017E LTM 2017E '13-'16 '16-'19 GM EBITDA ROA ROE

Public Franchises McDonald's Corporation $157.62 $159.98 $127,672 $153,640 6.4x 6.8x 15.8x 15.2x -3.3% -7.9% 43.2% 44.9% 15.5% nmHilton, Inc. $62.21 $83.85 $20,169 $26,021 3.5x 2.9x 9.3x 13.7x 4.1% 10.5% 45.9% 21.2% 6.9% 8.0%Marriott International, Inc. $100.40 $110.51 $37,391 $45,206 9.9x 2.0x 17.6x 14.4x 4.6% 102.9% 72.1% 13.8% 9.0% 151.9%Restaurant Brands International Inc. $59.78 $62.94 $14,124 $27,565 6.4x 6.0x 14.4x 13.1x 52.3% 7.0% 48.0% 45.8% 5.1% 13.6%Wyndham Worldwide Corporation $99.57 $106.50 $10,234 $15,584 3.0x 2.7x 11.6x 11.0x 1.5% 8.5% 56.0% 24.2% 6.7% 84.5%Hyatt Hotels Corporation $56.90 $61.07 $7,114 $8,365 3.1x 1.8x 11.7x 10.3x -0.7% 24.0% 37.2% 17.6% 2.5% 6.6%Dunkin' Brands Group, Inc. $52.72 $59.70 $4,758 $6,918 8.3x 8.3x 14.9x 14.7x 2.0% 4.8% 83.5% 56.2% 8.1% nmHertz Global Holdings, Inc. $20.18 $52.27 $1,689 $17,357 2.0x 2.0x 42.1x 69.2x -7.8% 2.0% 12.6% 2.9% 0.4% -65.5%GNC Holdings, Inc. $9.32 $22.32 $638 $2,096 0.8x 0.8x 7.5x 7.9x 0.7% -3.0% 32.7% 10.8% 5.9% -258.2%RE/MAX Holdings, Inc. $60.60 $66.10 $1,072 $831 4.4x 4.2x 8.7x 7.9x 3.6% 5.9% nm 54.0% 11.7% 80.2%Noodles & Company $3.80 $7.15 $156 $214 0.4x 0.5x 17.2x 7.5x 9.1% 0.9% 13.4% 6.2% -4.1% -136.1%

Mean 4.4x 3.5x 15.5x 16.8x 6.0% 14.2% 44.5% 27.0% 6.2% -12.8%Median 3.5x 2.7x 14.4x 13.1x 2.0% 5.9% 44.6% 21.2% 6.7% 8.0%

31.5%26.1%

-15.0%

-5.0%

5.0%

15.0%

25.0%

35.0%

8/15/2014 12/15/2014 4/15/2015 8/15/2015 12/15/2015 4/15/2016 8/15/2016 12/15/2016 4/15/2017 8/15/2017

S&P 500PublicFranchises

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FRANCHISE SPOTLIGHT: STARWOOD HOTELS AND RESORTS

Starwood Hotels and Resorts has entered into three hotel agreements in Cuba, marking the first U.S. hotel company to do so in nearly 60 years. Starwood received authorization from the U.S. Treasury Department to operate existing hotels in Cuba. The Hotel Inglaterra (Havana) will join Starwood’s Luxury Collection; The Hotel Quinta Avenida (Havana) will become a Four Points by Sheraton; The Hotel Santa (under LOI) is slated to become part of the Luxury Collection property.

“With Cuba’s rich history, natural beauty and strong culture, there is no question the entire U.S. hospitality industry has watched Cuba with great interest, and we are thrilled to lead the charge and bring our sophisticated, high-end brands into the market at this inflection point,”

- Starwood CEO Thomas Mangas

Marriott has also received Treasury approval, but hasn’t announced any deals. Starwood is positioning itself as it considers potential buy-out opportunities. Starwood denied a $12.2 billion bid from Marriott to take over the company in favor of a $13 billion all cash offer from a Chinese insurance company Anbang. If the Starwood-Marriott merger takes place it would be the largest hotel company in the world.11

M&A ACTIVITYMulti-brand roll-ups continue to spur M&A activity within the franchise world. Multi-brand growth is a lucrative way to grow an organization providing economies of scale, differentiation, and market reach; it demands skilled, knowledgeable, experienced professionals sand team member who can operate under diverse requirements, marketing conditions, and consumer profiles and tastes. The reward: large financial and real estate payoff.12

Fitness/Wellness Hotels Comm./Residential

NYSE: HOTMarket Cap:14.5BP/E ratio:25.2

NYSE: SERVMarket Cap:4.6B

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Source: S&P Capital IQ & Latest 10-Q filings

Date Seller/Target Buyer Description Deal Value($ MM)

TEV / Revenue

TEV / EBITDA

03/27/17 Cheddar's Casual Cafe Darden Restaurants Operates a chain of restaurants under the brand name Cheddar's Scratch Kitchen 780.0 - 10.4x

02/21/17 Popeyes Louisiana Kitchen, Inc. Restaurant Brands International Franchise Operations and Company-Operated Restaurants 1,827.1 6.8x 20.5x

08/07/16 Mattress Firm Holding Steinhoff International Mattress Firm Holding Corp., through its subsidiaries, operates as a specialty retailer of mattresses 2,981.7 1.2x 16.0x

06/02/16 BoConcept Holding 3i Group Operates furniture retail chain worldwide. The company develops, supplies, and distributes furniture 230.1 1.1x 9.8x

05/25/16 Kahala Brands MTY Food Group Engages in franchising quick-service restaurants 339.9 2.4x 10.4x

05/09/16 Krispy Kreme Doughnuts Cotton Parent Retailer and wholesaler of doughnuts, coffee and other complementary beverages 1,348.3 2.5x 18.1x

03/31/16 Groupe St-Hubert Cara Operations Owns and operates restaurants, bars, and grocery stores in Quebec, Ontario, and the Maritimes 414.1 0.9x 12.0x

02/29/16 Nordic Service Partners Holding AB LGT Capital Partners; Crown Co-Operates restaurants under the Burger King, TGI Fridays, and Kentucky Fried Chicken

brand names 54.3 0.5x 7.9x

05/18/15 ANN INC. Ascena Retail Group Women’s apparel, shoes, and accessories under the Ann Taylor and LOFT brands 2,206.1 0.8x 8.4x

05/15/15 New Look Retail Group Limited Brait Mauritius Limited New Look Retail Group Limited operates a chain of retail stores that sell apparel and

footwear 3,258.9 1.4x 9.3x

03/10/15 UNY Group Holdings FamilyMart UNY Holdings Retail business in Japan and internationally, managing general merchandise stores and supermarkets 4,430.8 0.5x 8.1x

10/01/14 Dudalina S/A Restoque Manufacture, marketing, retail, franchising, export, and import of garments in Brazil 535.8 3.1x 10.1x

05/08/14 Retail Zoo Bain Capital Sells food, beverages, and coffee. It manages Boost Juice, Salsas, and Cibo franchise entities 187.4 6.0x 18.4x

Mean $1,430.3 2.3x 12.3x

Median 780.0 1.3x 10.4x

Recent Transactions

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DEAL PROFILE: THE RIVERSIDE COMPANY ACQUIRES THE DWYER GROUP

On August 18, 2014, The Riverside Company acquired The Dwyer Group, Inc. for an undisclosed amount from TZP Partners.

• Transaction Value: Undisclosed• Buyer: The Riverside Company is a global private equity firms investing in growing

businesses valued at up to $250 million• Seller: TZP Group is a private equity firm with assets under management of over $500

million focused on investments in North American-based business and consumer services companies.

Highlights:• The Dwyer Group, based in Waco, Texas, serves as a holding company for seven residential

and commercial franchise service brands• The franchise network includes more than 1,600 franchisees operating in the United

States and seven other countries• The Dwyer Group also owns and operates 35 full-service glass stores in Maine, Vermont

and New Hampshire (combined, the service brands account for almost $1 billion in annual system-wide revenues)

• Riverside first purchased The Dwyer Group in 2003, taking the company private and working with company management to accelerate growth through acquisitions of new brands, expanding facilities at corporate headquarters, and aggressive development of existing franchise brands

“We're extremely excited to welcome

The Dwyer Group back to The Riverside

Company and to become involved once

again with franchisees and associates

dedicated to a strong Code of Values.” — Sarah Roth, Partner of The

Riverside Company

ACQUIRED

August 18, 2014

The Riverside Company purchased Dwyer Group Inc. for the first time in 2003 and a second time in August of 2014 from the TZP Group. Dwyer Group has become a leading franchise operator through the rollup of 15 separate companies since 1980.

Source: Dwyergoup Press Releases

1980 1990 1992 1994 1994

19961998Acquires Dwyer Group Inc.

2003Oct. 21, 20132010

Acquires DWYER Group 2010

Re-acquires Dwyer Group Inc.2014 2014 2015 2016

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DEAL PROFILE : RESTAURANT BRANDS ACQUISITION OF POPEYES LOUISIANA CHICKEN – MULTI BRAND ROLL UP VALUE

On February 2, 2017 , Restaurants Brands International (RBI) acquired Popeyes $1.8 billion.

• Transaction Value: $1.8 billion • Buyer: Restaurant Brands International, Inc. • Seller:

Highlights:• Restaurant Brands International Inc., based in Ontario Canada, owns, operates and

franchises quick service restauarants under the Tim Horton’s and Burger King brand names

• As of December 31, 2016 RBI owned or franchised a total of 4,613 Tim Horton’s restaurants and 15,738 Burger Kind restaurants in approximately 100 countries and U.S. territories worldwide

• RBI will pay $79.0 /share for the Popeye’s restaurant chain and will bolster RBI’s strong roster of restaurants

• The Popeyes acquisition would provide RBI a concept that provides steady organic and unit growth in both the North American and International Market, and Popeyes has shown stronger performance worldwide over the past two years when compared to ‘Burger King and Tim Horton’s Chain’

-Bandera Partners LLC - employee owned hedge fund sponsor based in NYC -BlackRock Fund Advisors - privately owned investment manager based in San Francisco, CA-Renaissance Technologies Corp. - privately owned hedge fund sponsor based in NYC

“With this transaction, RBI is adding a brand that has a distinctive position within a compelling segment and strong U.S. and international prospects for growth.”

— Daniel Schwartz, CEO of Restaurant Brands.

Premium franchisor and franchisee value creation continues to be driven by multi-brand or multi-franchise roll-ups. In February of 2016, Restaurant Brands International’s (RBI), owners of Burger King and Tim Horton, agreed to acquire Popeyes Louisiana Chicken. RBI’s acquisition of both Tim Horton and Popeyes, has driven significant results; at the announcement of RBI’s acquisition of Popeyes, RBI’s shares gained 6.86% and Popeyes’s stock price rose 19.0%. Analysts provide very optimistic outlook of RBI’s future growth opportunities through ongoing cost reduction, continued global development of Burger King, and potential upside from the global roll-out of Tim Hortons. 13, 14

ACQUIRED

February 2, 2017

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1. Cubukcu, C. (2016, November 12). Franchise vs. Start-up: Which One Works for You? Retrieved August 01, 2017, from https://www.entrepreneur.com/article/285035

2. Hayzlett, J. (2016, August 05). Franchising 101 -- 4 Key Questions Before You Step into the Arena. Retrieved August 01, 2017, from https://www.entrepreneur.com/article/279993

3. IHS Economics 20174. What is a Franchise. (n.d.). Retrieved August 01, 2017, from http://www.franchise.org/what-is-a-franchise5. McCreary, Matthew, Grace Reader, Greg Lacour, Tracy Stapp Herold, Dustin Myers, Bob House, Jim Judy, Lydia Belanger, and Dan

Bova. "Franchises." Entrepreneur. N.p., n.d. Web. 01 Aug. 2017.6. Daley, J. (2016, August 22). Franchising's 4 Hottest Categories Offer Small Costs and Big Payoffs. Retrieved August 01, 2017, from

https://www.entrepreneur.com/article/2787557. Herold, T. S. (2014, December 17). The Fastest-Growing Sectors in the Franchise Industry. Retrieved August 01, 2017, from http://www.

entrepreneur.com/article/2407208. Staff, E. (2017, January 10). Top 2017 Franchises By the Numbers (Infographic). Retrieved August 01, 2017, from https://www.entrepre-

neur.com/article/2872909. 2017 Fastest Growing Franchises. (n.d.). Retrieved August 01, 2017, from https://www.entrepreneur.com/franchises/fastestgrowing10. Daley, J. (2014, January 16). Why Are These High-Profile Franchises Suddenly Going Public? Retrieved August 01, 2017, from https://

www.entrepreneur.com/article/23031311. Trejos, N. (n.d.). Starwood: 1st U.S. company to run Cuba hotels in decades. Retrieved August 01, 2017, from https://www.usatoday.

com/story/travel/roadwarriorvoices/2016/03/19/starwood-become-first-us-hotel-company-run-cuba-hotels-decades/82040434/12. Pipes, K. (2012, April 20). More Are Better: Multi-Brand Franchising Continues To Grow. Retrieved August 01, 2017, from http://www.

franchising.com/articles/more_are_better_multibrand_franchising_continues_to_grow.html13. Whitten, S. (2017, February 21). Restaurant Brands in deal to acquire Popeyes Louisiana Kitchen for $1.8 billion. Retrieved August 07,

2017, from http://www.cnbc.com/2017/02/21/restaurant-brands-in-deal-to-acquire-popeyes-louisiana-kitchen.html14. Wall Street Research, BMO Capital Markets Initiating Coverage Report, October 13, 201615. Global Data. (n.d.). Retrieved August 11, 2017, from http://www.globaldata.com/

CITATIONS:

WHAT’S NEXT FROM HEADWATERS? Upcoming reports on the following:

Private Equity increases funding into Franchise industry

Food/Quick Service + Maintenance & Services

Children’s businesses

Top 10 fastest growing franchises

1 2 3 4

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