Sonic's Refranchising Thrust: Many Moving Pieces

Yesterday, the Wall Street Journal reported on Sonic Corporation's (SONC) refranchising thrust. The article did a good job pointing out the issues and problems of the day. However, there is more to the story.

In their June 25 2008 Q3 earnings call, company executives took considerable time to explain why the company operated units (Partner Drive Ins) had negative same store sales trends and underperformed the franchise group's results.

They talked the "Happy Hour" promotion and its negative effect on average check, and management problems. Analyst Sharon Zackfia was uncertain why the company operated stores weakened so much through the quarter. The company indicated the problem was greater in the "developing" markets. The CEO said he didn’t understand it either. Analyst Nicole Miller noted that restaurant level margins had fallen from earlier in the decade about 500 bpts. The company said not to forget about the minority interest accounting line, which was a small factor.

Then on September 23, Sonic announced a lower 2008 earnings outlook and the refranchising thrust. Actually, they also said they would slow company unit development (pretty smart) and sell/refranchise about 230 company units over four years (jury open).

The issue isn’t simple—2007 company average sales unit (AUV) trails franchisee sales by about 10% ($1017K vs., $1132K). Some years the company stores had higher sales comps, other years the franchisee operators did.

Sonic's prospects are very much tied to where they are penetrated now and where they hope to develop, later.

Franchisees do not operate stores better than company operators or vice versa, necessarily. It depends.

It's important to note that some currently toxic markets--Florida, Nevada and Arizona--where restaurant sales are falling-- are developing markets. A switch to less well capitalized franchisees might not be smart. There are only about 93 company units there, so that means some of the company unit sales comes from the core markets (US Southeast, Texas). There is underlying real estate under some.

You also have TV market efficiency, franchisee development schedules, G&A span of control, credit market and commercial real estate market trends to consider.

The point: do the analysis right. This is important.

Disclosure: none