Normally the decision of Wendy's/Arby's Group (NYSE:WEN) to sell off Arby's to a private investment group would not interest me all that much. After all, it's a struggling (and not notably well-run) business selling off a non-core asset that itself has seemingly spent more years struggling than thriving since its founding.
And yet, there is something interesting about this story that investors in the restaurant sector probably should not ignore. Not only is there is a lesson about the durability of brands, but also just how difficult it is to crack into the rarefied air of those chains that really matter.
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The Long Strange Trip of Arby's
There are more than a few weird stories in the annals of restaurants - from flatulent tortoises at Rainforest Cafe (now owned by Landry's), weird animatronics, lawsuits and bankruptcies at CEC Entertainment's (NYSE:CEC) Chuck E. Cheese's, and the mass-market success of Hooters. Nevertheless, Arby's still manages to stand out.
The concept was pretty successful almost from the start in the mid-1960s and the company nearly launched an IPO in 1970. Unfortunately, the IPO market died, the company ran out of cash, the banks came in, gutted the business and then ran it into bankruptcy. The founders regained control, got the company growing again and then sold it to Royal Crown Cola ... who had good luck with it until the original managers decided to retire in 1979.
From that point, the story of Arby's is a story of constant rise and fall; an apparently successful underlying food concept being ruined over and over again by inept or greedy management (or ownership), underinvestment, and the lack of a consistent vision for the business. Even this latest round of relatively more stable ownership has been little different - Arby's has languished with an expensive menu and no clear defensible niche of its own. (For more, see Sinking Your Teeth Into Restaurant Stocks.)
New Owners and a New Plan?
Wendy's/Arby's Group announced that it would sell a little more than 80% of Arby's to Roark Capital Group, a private equity company that already operates other food chains like Cinnabon, Moe's Southwest Grill, McAlister's Deli, and Schlotzsky's (another food company with an "interesting" corporate history). Wendy's/Arby's is getting $130 million cash in the deal, while also getting rid of $190 million in debt, and the two companies talked of a total deal value of $430 million.
Now it remains to be seen what Roark can do differently. From the outside, it would seem that Roark does not try to apply a "one size fits all" template to its restaurants - Schlotzsky's is still a fixer-upper as it tries to compete with Subway and Quizno's, Moe's is a growth chain, and Cinnabon is solid steady-state business.
More than anything, Arby's needs to become competitive and relevant again. Compared to McDonalds (NYSE:MCD), Subway or Yum! Brands' (NYSE:YUM) line-up of Taco Bell, KFC and Pizza Hut, Arby's is expensive and the company was late to the game with a value menu. What's more, unlike chains like McDonalds or CKE Restaurants' (NYSE:CKE) Hardee's and Carl's Jr. there is no clear identity to Arby's - it's just sorta there; offering a line of products somewhere between fast food burgers and sandwiches.
The Right Concept, Done Right
Certainly there room for recovery in the restaurant space. Dunkin' Donuts (owned by Dunkin' Brands, which recently filed to go public) has recovered and did so with the seemingly improbable strategy of going straight at Starbucks (Nasdaq:SBUX) in the coffee business. Domino's Pizza (NYSE: DPZ) has trounced Papa John's (Nasdaq:PZZA) in the stock market by refocusing itself not on being the cheapest pizza around, but on actually making pizza that was of higher quality, and Panera (Nasdaq:PNRA) emerged from the weirdness of the Au Bon Pain story to become a real player in the growing trend of fast casual food with a healthier angle.
That suggests that there is plenty of room for Arby's to recover. Sure, Jack In The Box (NYSE:JBX) and Sonic (Nasdaq:SONC) are still floundering, Sbarro has declared bankruptcy, and Long John Silver's has a dicey history of recovery as well (especially now that Yum! Brands is throwing in the towel on it), so it is not as though it is easy. But what Dunkin' Donuts, Domino's, and Panera do prove is that customers will gravitate to a selection of food they like at attractive prices. Sure, it sounds obvious, but the roll call of failed restaurants suggests that it is not easy.
The Bottom Line
What can investors learn from any of this? For starters, be cautious of companies that acquire well-established but under-performing restaurant chains - turnarounds are difficult and take a lot of time. By the same token, at least demand to hear a new story; a clear sense from management about why the business hasn't been working and how the new plan will change things. Last and not least, don't be afraid to just stick with the winners - at the right price, a stock like McDonalds, Yum! Brands, or Chipotle Mexican Grill (NYSE: CMG) gives investors well-run businesses that don't need much (if any) fixing.
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