The Challenges Facing Burger King Buyer 3G Capital

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Burger King has had a turbulent history. Under Diageo, a former chain executive says, it was largely left alone and milked for cash, with the unit treated as an outpost for leaders in training. Once it moved into private equity's hands, the focus switched to differentiating the brand from McDonald's, with a focus on young men, for whom high-calorie burgers and ads with dancing chickens or a creepy-looking king seemed cool. The investors also focused quickly on returns: They initially kicked in $325 million of their own money, collecting more than that in special dividends. With added fees, funds from the initial public offering, and proceeds from the current sale, Burger King has been an investment winner even as its sales lagged behind rivals.

Franchisee Woes

Franchisees say they've shouldered the burden of efforts by Burger King management to keep the chain competitive amid the recession. That includes the controversial double cheeseburger. "Margins were crushed," says Steve Lewis, who operates 36 Burger King franchises in the Philadelphia area. Moreover, he says, sales of new, premium-priced menu items like the Steakhouse XT burger haven't kept up once the brand stops advertising them. "Overall menu development has been horrible," Lewis says, adding that the chain has come up with little besides the bargain burger to woo customers into stores: "We disregarded kids, we disregarded families, we disregarded moms." Franchisees have also disregarded their aging restaurants, says Jordan Krolick, president of consulting firm Tound & Drowth, who has held senior positions at Arby's and McDonald's. "You can change the menu, you can change the advertising, but you're not going to get customers to see those changes without fresh, new, clean-looking facilities," he says.

Brand experts add that the chain doesn't match McDonald's for customer loyalty. Chris Malone, chief advisory officer at Relational Capital Group, recently completed a study that showed McDonald's significantly outperformed in both "warmth" and "competence" in consumers' minds. He argues that Burger King has "put a lot of energy into gimmicky advertising" at the expense of products and service. Mark Kalinowski, an analyst at Janney Montgomery Scott, adds that the brand simply isn't unique in consumers' eyes, noting "it's not enough these days to be an alternative to McDonald's."

Despite its challenges, there are some positives for 3G. Because the chain has stable cash flow and modest capital investment needs, 3G was able to get JPMorgan Chase (JPM) and Barclays (BCS) to lend it about $2.8 billion of the $4 billion price. It's also taking over at a time when Burger King is innovating more: On Sept. 7, the chain announced nine new breakfast items, including blueberry biscuits and a pancake platter. And 3G's experience and connections in Brazil could help Burger King expand in that market, where many U.S. chains have had difficulty finding qualified franchisees.

That won't happen overnight. Yet, sources close to the company say, unlike typical private equity firms that often try to squeeze a return on their investment in five years, 3G's investors are willing to wait a decade to get their money out.

1954: James McLamore and David Edgerton found Burger King in Miami

1967: Founders sell the company to baking giant Pillsbury

1997: Burger King becomes part of Diageo, after the British company buys Pillsbury

2002: Diageo sells Burger King to private equity investors for $1.5 billion

2006: Burger King goes public, after an IPO that values the company at about $2.3 billion

2009: BK adds the Buck Double to its Value Menu, sparking lawsuits from franchisees

2010: BK announces sale to investment firm 3G Capital for $4 billion

The bottom line: Burger King is facing its second private equity buyout in a decade. The chain's new Brazilian owners likely won't see a quick turnaround.

Brady is a senior editor for Bloomberg Businessweek. With Burt Helm and Zachary R. Mider in New York.

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