Finshots Special-The Burger King IPO

We’ve been bombarded with questions about the Burger King IPO. So we thought we could answer all your queries with this one story.

The Story

If you’re new to this IPO, we have to clarify something for you. This isn’t Burger King USA. This is Burger King India — owned by another company QSR Asia. And these people were accorded the exclusive rights to develop, establish, operate and franchise Burger King branded restaurants in India. In return, Burger King India is required to pay a one-time outlet opening fee of $25,000 coupled with a monthly royalty of 2.5%–5% of sales to Burger King Asia Pacific.

It’s kind of confusing but it’s a neat arrangement, especially considering the fact that Burger King is a well-recognised brand in India. More importantly, it’s  a quick-service restaurant (QSR) chain, where the motive is to optimize operations and serve as many customers as possible. It’s a growing market. And while Burger King might be a late entrant (debuting in 2014), compared to the likes of Domino’s and McDonald’s, they’ve made up for it by growing rapidly in the past six years. Just look at the numbers. They have 261 outlets today compared to 12 outlets they had back in 2015. Their revenue has more than doubled in the last three years. And they have a 5% market share within the QSR segment, trailing behind McDonald’s (11%) and Domino’s (21%).

Perhaps the only downside is that despite being in business for all this while, they are yet to turn profitable. Employee costs, lease payments and other fixed expenses have been eating into their margins.

And while this might look like a bit of a bummer, they are still young and growing. So if you are looking at this IPO seriously, you have to stop nagging about the past and ask yourself — Where does Burger King India go from here?

And…to be honest with you, that might be a slightly more complicated question than you think.

When you’re a QSR chain trying to slug it out in a competitive market, you are mostly focusing on growth. However, not all growth is equal. Some companies grow by sheer brute force. They open a bunch of new stores each year and extract growth by foraying into new locations. And look, there’s nothing wrong with opening new stores. In fact, it's eminently desirable. But this strategy of banking on new store sales growth can be an expensive affair. You have to work out lease agreements, furnish the stores, man the desks and invest quite a bit before you can have customers walking in. And to compensate for this investment, you have to keep pulling customers in droves.

So analysts often turn to another metric, called Same-Store Sales Growth (SSSG) to separate the wheat from the chaff. Think of it this way. If you have a store operating for more than a year, you can look at how it's performing and growing each year and you can tell a lot about how these older stores do once they’re fully up and running. So effectively you’re only looking at growth coming in from stores older than one year. And if you tabulate these results, you will see Burger King performing quite well. In 2019, their same-store sales growth tallied up to 29% compared to Westlife’s 17% (Westlife operates McDonald’s stores in Southern and Western India).

So you might be inclined to think Burger King stores do pretty well once they mature. However, there is a problem. This comparison is slightly misleading since Westlife operates a lot more stores. In fact, as of 2019, they had close to 300 stores compared to the roughly 200 stores Burger King boasted. And since the company runs a tight ship with fewer stores, it’s much easier to boast a larger SSSG.

Which brings us to the next point.

What happens when you expand? Will same-store sales growth stagnate? Will Burger King meet the same fate as McDonald’s? And will profitability forever remain elusive? Well, we don’t know. But what we do know is that walking this tightrope can be extremely tricky especially when you are forced to expand based on a pre-written contract. Let us explain.

So usually you foray into new locations because you see an opportunity to make money. It’s a strategic decision, so to speak. But as part of Burger King’s franchise agreement, they are obligated to open at least 700 stores by December 2026. And while this isn’t some over-ambitious target, it does put the company in a tough spot. Even if the same-store sales growth stagnates, they can’t pause and re-calibrate. They have to expand, no matter what. They have to keep going. And when you’re doing this, your margins can suffer if you’re not too careful. Even worse, you could put the make-or-break target in jeopardy.

Just look at what happened with Covid.

During the six months between March and October, Burger King’s revenue tanked 68% compared to the sales figure last year. Their same-store sales growth decreased by 57%. A lot of their food inventory had to go to waste considering stores were closed for long periods and a full recovery isn’t on the cards yet. Granted they did much better than other restaurants that couldn’t ramp up their delivery operations, but like most companies in this line of business, they did suffer a body blow. In fact, the original target was to meet the 700 stores target by December 2025. But with Covid, the company managed to renegotiate and pushed it to December 2026.

Bottom line — You’ll have to keep a close eye on how the company manages to shore up its margins during this aggressive expansion phase or else, you’re just gambling here.

But, having said all that, Burger King is still Burger King. It's got a lot of brand recall. It’s a decent food outlet? It’s still young and growing. And India’s burgeoning working-class population will inevitably want to dine out and dine quick. So, if you believe in the company’s growth story, we wouldn’t fault you.

Also, a small note on the actual IPO. So right now the company is trying to raise ₹810 Crores. Some of this money will go to the owners. Some of this will go towards reducing debt. And some of this will probably go towards helping the company navigate the pandemic. And while the asking price isn’t too much, investors still don’t take kindly to loss-making companies. On the flip side — Considering there are very few shares on the offering for the likes of you and me, retail investors are likely going to lap up the IPO anyway.

So the only question here is — Are you subscribing or are you letting this one slide?

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Until next time...