When Restaurant Brands International (QSR -0.46%) CEO Josh Kobza announced his company's plan to buy Carrols Restaurant Group (TAST), he said in a press release, "The strategic merits of this acquisition are very compelling and consistent with our objective to invest our capital in long-term, high-return opportunities."
But the truth isn't quite as simple as that. While management may be painting the transaction in as positive light as possible, Restaurant Brands really didn't have a choice in buying out Carrols as the former hopes to reinvigorate its Burger King business.
Burger King needs a facelift
Restaurant Brands' portfolio includes Burger King, Tim Hortons, Popeyes, and Firehouse Subs. The company openly admits that Burger King is the "challenger brand" in the burger category relative to fast food industry heavyweight McDonald's.
Image source: Getty Images.
To put the company's position in context, Burger King has approximately 19,000 locations worldwide, trailing McDonald's more than 40,000 restaurants. And for years, Burger King's comparable-sales growth has trailed that of its larger rival.
With Burger King making up just over 60% of Restaurant Brands' total store count, the company needs a thriving Burger King business to fuel its growth. That's one of the reasons the company announced its "Reclaim the Flame" plan in Sept. 2022. A key part of that effort is to aggressively modernize Burger King locations to make the brand more relevant with consumers, which sets the stage for the Carrols acquisition.
Is Burger King reclaiming the flame or saving its own hide?
According to the company's 2022 announcement, the Reclaim the Flame plan "includes Burger King investing $400M over the next two years, comprised of $150M in advertising and digital investments to 'Fuel the Flame' and $250M for a 'Royal Reset' involving restaurant technology, kitchen equipment, building enhancements, and high-quality remodels and relocations." The company added: "This investment will work to enhance ongoing franchisee investments to modernize the Burger King restaurant portfolio."
The important information with regard to Carrols is that Burger King has been expecting franchisees to pitch in for this overhaul in the form of investments in their own restaurant assets. But Carrols faces an obstacle here because it's already managing a sizable debt load. In late 2019, Carrols agreed to buy a company called Cambridge Franchise Holdings for $238 million.
The company's debt-to-equity ratio rose from about 1.5 in 2019 to 3.1 in early 2023. To be fair, by the end of last year, that metric had dropped to 2.6, but that's still well above where it was before the Cambridge acquisition.
Data by YCharts.
So even though Carrols is the largest Burger King franchisee in the U.S., its financial priorities aren't necessarily the same as those of Restaurant Brands. Indeed, balance sheet improvement and debt reduction have been key callouts during Carrols' quarterly earnings updates. Companies trying to pay down debt have to pull that cash from somewhere, and in this case, it likely affected the pace of Carrol's restaurant investments. In its last earnings report prior to the acquisition news, management said the company would renovate just 45 of its more than 1,000 locations in 2024.
But post-acquisition, Restaurant Brands intends to ramp up Carrols' annual redevelopment pace from 45 stores to 120. And once it has the redevelopments complete, the next step is to put the updated restaurants back into franchisees' hands. The move is a tacit admission that Carrols was an impediment to Restaurant Brands' Reclaim the Flame plan because of its weak financial state. Burger King is keeping the overhaul plan on track by acquiring the slow-moving franchisee that owns 15% of its U.S. stores.
Not a bad plan, but it comes with its own issues
The Carrols acquisition isn't necessarily a bad idea. It quickly solves a problem for Restaurant Brands' most important restaurant banner. However, the move requires Restaurant Brands itself to take on $750 million in debt, so there are reasons for investors to keep a close eye on what's going on here.
Assuming everything goes smoothly, the sale of remodeled restaurants to new franchisees should help raise capital for debt reduction. But if Burger King's business slumps before that can happen, Restaurant Brands could be buying itself a headache rather than a solution.
