On The Money: Value Proposition

An operator turned investment banker says stick to the basics.

By David Farkas, Senior Editor -- Chain Leader, 7/1/2007

R. Wallace Hite, a principal in Nashville, Tenn.-based Strategic Advisory Partners, is a different kind of investment banker—he once operated restaurants. We recently caught up with the former Sonic Corp. official after hearing a presentation he made about restaurant valuations in Chicago. Chain Leader asked him to elaborate on several of the points he raised.

You mentioned that by focusing on the basics, companies can positively affect their values. Give a real-life example.

I can’t disclose names, but I can tell you about a small company, under 10 units, that developed judiciously and concentrically. They focused on same-store sales and unit economics. They kept their [general and administrative costs] at a level commensurate with their sales. They built a company as if they would own it forever. They sold at 9.5 times EBITDA.

You also advised operators to fully understand prime margin. Why is this important to valuations?

Because it is a key component in unit economics, which drives the investment. There is a great deal of art in our business, but it’s a business and it needs to make a return for the investors both on their money and their time.

Here’s another way to view prime margin: It tells you how many dollars are available for debt service or fixed expenses. Obviously there are other controllable expenses, but they are usually in the 10 percent range of sales.

What should prime margin be?

[Meeting host Brad Saltz of SS&G Financial Services] made a compelling argument that the number needs to be at least 40 percent to realize a respectable ROI. I would add that 40 percent or better—but never at the expense of the customer—takes risk out of the investment and indicates the potential for continued growth and a stable company.

It caught my attention when you praised an operator who has put up 30 percent of the investment in each of his 147 units.

Many of the troubled companies I deal with share a common error. They leverage the restaurant at 100 percent or more. The only sure thing in the restaurant business is that something unexpected is going to happen. Equity allows for the unexpected. The company I referenced in my talk has been in business for over 30 years and is now valued in the hundreds of millions.

So why don’t others in this business follow suit?

Patience. We’re in a hurry to get to the finish line, and most operators don’t have the unencumbered cash for a 30 percent equity injection. I am not even sure if 30 percent is the best number, but 20 to 25 percent is a good range for equity.

What attracted you to investment banking after a career running restaurants?

As a partner in taking a public company [Sonic] private and then taking it public again, I had to interact with bankers frequently. Their perspective was always from the outside looking in, rarely understanding their impact on the organization. The opportunity to bring a fresh perspective to the industry coupled with the diversity of clients and client situations was very compelling and challenging.