Lane Cardwell

...until morale improves. An old line with modern day connotations. One of the advantages of attending more than my fair share of industry conferences, while defending myself from accusations that I am underemployed, is that I get to constantly take the pulse of our industry's CEO's and other leaders. Within the past month the mood out there has shifted from pessimistic to fearful. Why? There is a growing realization that this perfect storm of industry problems may be with us longer than was first assumed. 

 

Earlier this year the consensus was that, while times were tough, we only had to hold out till mid-summer and then things would start to improve. That hope has left most of us. What? You want me to give you economic references and historical industry benchmarks to validate that statement? Sorry, I am just passing on what I hear. Gossip Guy. 

 

Here is what is different this time around than the last time we had industry issues: the larger role of private equity firms. It used to be that the public companies envied the private companies during tough times, because they could weather the storm without a stock price acting as a barometer for their difficulties. Every company has owners, and owners don't like losing financial ground, but public companies have to endure the financial paparazzi following their every stumble.

 

That no longer seems like such a bad thing compared to what companies with private equity owners are facing these days.  Don't get me wrong, private equity ownership has been a very good thing for many companies in our industry.  It has brought access to capital when there was no other source.  It has brought some very sharp minds into our midst, and helped us make better business plans, and sharper capital allocation decisions.  It has brought turnarounds and vitality to some underperforming brands.  But it has also brought leverage.

 

Leverage is when you can borrow 2, 3, or even 4 times what you invest to buy something. During good times it acts as a turbocharger on the return on investment. During bad times it can cause you to lose the business, or make decisions that will make you wish you had lost the business. Leverage is another word for being deep in debt, and having to live up to bank covenants that dictate how profitable you will be in order to avoid paying significant penalties. Many CEO's would rather bust an artery than bust a covenant.

 

Private equity firms have owners, too.  They supply the money that is invested by the private equity firms.  They supply it with the understanding that they will make returns high enough to make credit card companies look philanthropic. To complicate matters, many private equity firms will only hold an investment for about 5 years before selling it to the next buyer, often another private equity firm. This ticking clock will cause some extraordinarily short term decisions to be made to avoid selling at a loss. 

 

In the past month I have heard horror stories of mandates coming from these financial owners that include quality cuts in product, steep price increases, marketing cuts, overhead cuts beyond the ability to support the business, refranchising of company units, and a short term mentality designed to make it to the next quarter and past the current covenants.  The implication is that we will be a very different industry coming out of this cycle with many of our more popular concepts.

 

We are not just suffering financially in this downturn, we are in many cases having to mortgage our future viability to pay our current mortgages. In the meantime, the beatings will continue.

 

 

Industries: Emerging Chains, Expansion, Operations