Subway, which announced earlier this year it was exploring a sale, continues to court buyers, including private equity groups, in a deal that reportedly values the sandwich chain between $7 billion and $10 billion.
Who ends up buying Subway and when a new owner is named remain the big unknowns as the long-anticipated deal to sell the world’s largest restaurant brand is apparently being held up by a potentially inflated price tag and perhaps just bad timing, an expert on large-scale restaurant franchise deals told Franchise Times.
“This sale has been going on since the start of the year, and the fact that here we are in June now and nothing has been announced yet is not a good sign” for all sides involved in the auction, said John Gordon, founder of Pacific Management Consulting Group in San Diego, which specializes in chain restaurant earnings and economic expertise analysis and advisory services.
“The longer this process goes on, the more complicated it gets,” Gordon said.
John Gordon of Pacific Management Consulting Group
Meanwhile, the Miami-based sandwich giant (it opened a new global headquarters this year), which has nearly 37,000 restaurants in more than 100 countries even after closing about 7,000 shops since its peak in 2015 and shedding 2.7 percent of its shops in the United States in 2022, continues to bring more large-scale operators into the franchise system. It’s a move that was likely made to strengthen its position for a sale.
Subway recently announced deals with five multi-unit franchising groups in Texas, Florida, Arizona and the mid-Atlantic states that have so far consolidated or acquired 230 restaurants. Joining the Subway franchise are two operators in the restaurant industry with experience running other leading QSR brands and an existing franchisee that the brand said amassed 100 additional stores to bring its total number to more than 140 restaurants.
Among the new operators is EYAS Capital, an investment banking firm in El Segundo, California, that looks for brands in the hospitality and real estate businesses. Founder Tim Foley has owned and operated Truxton’s American Bistro, Wendy’s and Pat & Oscar’s.
Subway declined a request from Franchise Times to name the other franchisees that were part of the latest consolidation, but instead provided the following statement from Nelson Faerber, vice president of sales:
Nelson Faeber, vice president of sales for Subway
“As part of our multi-year transformation journey, Subway is focused on smart growth and delivering a consistent, high-quality guest experience. (The) key to achieving this is ensuring restaurants across the system are in the right location, image and format, and that we’re working with the right franchisees who have operating expertise and passion for the Subway brand. This includes identifying existing franchisees within our system that have the resources and drive to expand their Subway portfolio, through both transfers and new restaurant openings, as well as attracting new, experienced and well-resourced multi-unit and multi-brand owners to join the Subway brand.”
Among the Franchise Times Restaurant 200, a ranking of the 200 largest restaurant franchisees in the U.S. by revenue in 2022, only three have Subway units in their portfolios: Rottinghaus Co., with 290 Subway stores; GS Dallas Group, with 145; and Marwaha Group, with 137.
Subway hopes the remodels and relocations, along with potential for new locations, can help improve operator profitability and its overall market position as it continues to court buyers, including private equity groups, in a deal that reportedly values the chain between $7 billion and $10 billion.
On the international front, Subway announced June 6 it signed a master franchise agreement with Shanghai Fu-Rui-Shi Corporate Development Co. to open nearly 4,000 restaurants in mainland China. The agreement, which Subway said is being funded by a consortium of private investors, including Asia Investment Capital, is the largest master deal in the company’s history and the latest of a handful of international agreements signed in the last 18 months including in Turkey, Malaysia and Brazil.
Turnaround still underway
Armed with that $5 billion debt financing package set up by Subway’s financial adviser, JPMorgan Chase & Co., potential buyout firms will be able to borrow enough money to close the acquisition and still end up with an enticing deal, sources told Reuters. JPMorgan’s financing package, which is a blend of bonds and loans that equals 6.75 times Subway’s 12-month earnings before taxes, depreciation and payback of about $750 million, also would allow the buyer to choose a preferred-equity component with an interest rate of approximately 15 percent, Reuters reported.
While Gordon is not directly involved in the JP Morgan lead sale process, he said he understands from multiple sources that Subway’s negotiators recently adjusted its current worldwide EBITDA higher, to around $800 million a year.
“Many due diligence issues, questions about the strength of the brand in the U.S., franchisee relations and in international markets and the all-important much higher cost of debt now take center stage,” Gordon said.
The restaurant consultant noted Subway’s brand has been weakened greatly in the last 15 years by a number of poor decisions made by the franchisor. They include an over-expansion model, outdated operations, and décor and old menus that weakened the product. Gordon also pointed out that the $5 footlong sub deals the franchisor introduced in the early 2000s, while a boost to sales at first, also decreased franchisee profits to the point that it became unsustainable for single-unit operators to survive. The chain has fewer drive-thru locations than other QSRs, also putting it at a disadvantage in an industry changed dramatically by COVID.
Miami-based sandwich giant Subway (it opened a new global headquarters this year) has nearly 37,000 restaurants in more than 100 countries even after closing about 7,000 shops since its peak in 2015 and shedding 2.7 percent of its units in the United States in 2022.
“Even during the best of times, single-unit owners, after paying their rents and employees, might have been making $40,000 to $50,000 per year. That’s just not going to cut it in franchising,” said Gordon. “And when you add in the fact that Subway has no company-operated units, that’s a real problem. Anybody who knows this business knows that you have to have skin the game if you want to succeed.”
The company, which took a big PR hit when longtime spokesperson Jared Fogle pleaded guilty to child pornography charges in 2015 and is serving a 15-year prison sentence, launched a turnaround plan under CEO John Chidsey, which included a new menu and advertising campaign.
Related: Subway Refresh Is Biggest Update ‘In a Decade’
Subway does not provide financial performance information on U.S. units in its franchise disclosure document, but its AUVs for U.S. units have ranged in the mid $400,000, according to restaurant research cited by Gordon, who pointed out that sales figure is far lower than its sub sandwich sector peers. Jersey Mike’s Subs, for example, has an AUV of $1.2 million at its traditional franchise restaurants, while at Jimmy John’s the AUV is $907,848.
Analyzing franchisee reports, Pacific Management Consulting Group determined that Subway’s store-level EBITDA on average is low, in the upper single-digit range. “That does not attract active multi-unit operators from other brands,” Gordon said.
But Gordon pointed out that Subway has made some progress in 2023.
“To be sure, there have been some recent sales improvements at Subway U.S. Subway has introduced about 20 new sandwich compositions and given them names. This product orientation was sorely lacking at Subway for years, and sales are up somewhat,” he said.
In April, Subway announced its ninth consecutive quarter of positive sales, and its strategic development campaign designed to “boost franchisee profitability and protect the brand’s position in the market.” The company’s goal is to increase new location openings in North America by approximately 35 percent in 2023 versus 2022, according to a news release. Subway finished 2022 with 20,576 units in the U.S. and is ranked No. 7 on the Franchise Times Top 500, with estimated global systemwide sales of $17.5 billion.
“This year, an additional 3,600 locations across North America are expected to be remodeled, taking the total number of restaurants in the current Subway image to more than 10,000 by this summer. As a result of its efforts, in April 2023, the brand achieved its highest weekly average unit volume since 2010,” the news release stated. Notably, the company did not announce the sales volume figure.
Gordon said suitors of the brand via the JP Morgan sale process are looking at the franchisor’s projected cash flows, including international growth prospects. Two of their greatest concerns are how potential buyers could finance the transaction profitably with elevated interest rates, and what an exit plan looks like if their gamble doesn’t pan out.
“A hint at the interest rate problem—and the leverage on this deal was revealed by JP Morgan itself, that offered a $6 billion loan platform to get the deal started at 15 percent interest rate. So that 15 percent has to be paid by the eventual buyer. Will it all pencil out?” Gordon said.
“Subway has a lot of issues no doubt, but my take is that this was a bad time to sell this brand, with interest rates being where they are now and so much uncertainty in the economy,” Gordon said.