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Burger King: Where's The Beef?


On a sunny September day in 2004, Burger King Corp.'s new CEO, Gregory D. Brenneman, drove into the parking lot of the company's Miami headquarters dressed up as the fast-food chain's well-known mascot, the King. After a pep rally to congratulate the 700 assembled employees for their role in Burger King's nascent turnaround, Brenneman and other execs handed out burlap bags stamped with big dollar signs. The sacks were stuffed with bonus checks. And they were three times larger than the previous year's. It was a gesture that endeared the new boss to his troops.

Now Brenneman is trying to win over a much tougher crowd: Wall Street investors. Sometime this spring, Burger King's owners, a group of private-equity firms that includes Texas Pacific Group, Bain Capital Partners, and Goldman Sachs Funds, plan to raise up to $600 million in an initial public offering. Assuming the IPO is successful, the private-equity guys will have nearly doubled their original investment -- while retaining a majority stake in Burger King. Not bad for about three years' work.

The coming Burger King IPO offers a window onto the clubby world of cash-rich private-equity players and how they make their billions. During the 1980s, firms such as Kohlberg Kravis Roberts & Co. and Blackstone Group LP borrowed heavily to buy companies, broke them up, and sold off the pieces at huge profits.

"LIPSTICK ON A PIG"

Nowadays private-equity firms often spend hundreds of millions of their own money on an acquisition (BW -- Feb. 27). Just as often, though, they load up the companies with debt and use the money to pay themselves special dividends and other fees that allow them to profit even if the company itself struggles. Then the backers take the company public, often pocketing the lion's share of the offering.

That is basically how the Burger King saga is unfolding. For investors hoping to get in on the IPO, the question is whether the burger chain is really on the road to recovery. Critics argue that since an initial rebound in traffic after private-equity players bought the company from Diageo PLC, Burger King's sales growth again is starting to lag rivals.

And they contend that the company paints an overly rosy picture in press releases and its recent Securities & Exchange Commission filing, in part by changing the way sales are tracked to give the appearance that they are on a solid upswing. What's more, Burger King is far more indebted than rivals McDonald's Corp. (MCD) and Wendy's International Inc (WEN). That limits the fast-food chain's ability to reinvest in new products and restaurants. "This is as close to putting lipstick on a pig as you get," says a prominent Wall Street analyst who asked not to be identified.

Both Burger King and Texas Pacific declined comment on these and other matters, citing the restrictions against companies talking during the "quiet period" imposed by the SEC before IPOs. But some analysts and investors believe Texas Pacific and its partners are rushing Burger King to market before it's ready.

It's no secret why they want to get this deal done. Recent restaurant IPOs such as Chipotle Mexican Grill Inc. (CMG) and Wendy's spinoff of the Tim Hortons Inc. (THI) doughnut chain were scorchers. And if there's any firm that knows when and how to buy and sell companies, it's Texas Pacific. Founder David Bonderman, a former bankruptcy attorney, made his name managing the oil wealth of Fort Worth's well-known Bass family. In the 1990s, Texas Pacific scored big with investments in Continental Airlines (CAL), Seagate Technology (STX), and Oxford Health Plans. The firm was so successful that when Bonderman turned 60, in 2002, he hired the Rolling Stones to perform at a private bash in Las Vegas.

By all accounts, Bonderman and his investing partners got a great deal for Burger King in 2003. Diageo originally sought $2.26 billion for the burger chain, but Bonderman and his LBO partners succeeded in knocking the price down to $1.5 billion. What's more, analysts believe Texas Pacific, Bain, and Goldman kicked in just $325 million of their own money, opting to borrow the rest.

Then this past February, Burger King borrowed an additional $350 million so its owners could pay themselves and its two partners a special $367 million dividend. In addition, Texas Pacific and the other investors are getting $30 million more to end a contract in which they received $9 million a year in management fees from Burger King.

Assuming the private-equity owners use part of the $600 million raised in the IPO to pay down the $350 million loan, that leaves as much as $250 million. Add that to the $367 million dividend and the $30 million kill fee, and their take totals $647 million, nearly double their original investment. It's all good for the owners, but Burger King ends up with $1 billion in long-term debt -- or more than double the relative debt loads carried by rivals like McDonald's, Wendy's, and Yum! Brands. That leaves Burger King in junk territory.

This would be bad enough if the company was cooking up beefy profits and sales gains. But that isn't happening. Burger King's profit margin for the fiscal year ended last June was just 2.4%, vs. the 5.9% earned by Wendy's and 12.7% at McDonald's in calendar year 2005. Meanwhile, the average BK restaurant still generates just a little more than half the sales of a typical McDonald's. "They've turned the train around," says Dennis Lombardi, executive vice-president at WD Partners, a Columbus (Ohio)-based restaurant development firm. "But I'm not sure it's out of the tunnel."

To be fair, Brenneman, who helped get Continental Airlines airborne again during the 1990s, hasn't exactly been sitting around watching the grass grow. A hard-working son of Mennonites, who spent summers as a teen shoveling hay on his grandfather's Kansas wheat farm, Brenneman got busy the moment he became CEO in August, 2004. The goal was to go public by 2006, so Brenneman had little time to show results.

SKIMPY PROFITS

He dove into the job, getting new products such as Chicken Fries, the Angus Steak Burger, and the Tendercrisp chicken sandwich out into restaurants. To boost morale and improve communication with the troops, Brenneman, 44, delivers folksy voice mails every Friday, updating employees and franchisees about the latest results and initiatives.

Helping franchisees earn more money was another priority, so he boosted group purchasing and commissioned the design of a smaller prototype store that is more than 25% cheaper to build. And to solidify Burger King's standing with highly coveted "superfans" -- men aged 18 to 34 -- Brenneman rolled out a new male-oriented ad campaign that depicts the King mascot playing in NFL games.

The initiatives seemingly have paid off: After earning just $5 million in the fiscal year ended June, 2004 -- Texas Pacific's first full year of ownership -- Burger King reported profits of $47 million in the following 12 months.

But for a company that raked in $1.9 billion in revenues in its last fiscal year, that's a pretty skimpy return. And it's fair to ask whether Burger King achieved its numbers by whacking advertising. According to TNS Media Intelligence, a New York media-tracking service, Burger King spent $268.7 million on national advertising in 2005. That's $54 million less than the year before and $120 million less than in 2002, the last year Diageo owned the company, albeit with slightly more restaurants. Had Burger King spent what it did in 2004, its $47 million profit would have been lower.

Brenneman & Co. also claim that sales at stores open more than one year -- a common industry measure -- have been rising steadily for seven straight quarters. But heads turned in restaurant industry circles when Burger King last year started reporting sales on a quarterly basis instead of monthly. Many chains, including McDonald's, report same-store sales every month. And some analysts wonder whether Burger King's switch was an attempt to mask a sales drop during some months. After a 6.7% rise in same-store sales during April, the last month that Burger King disclosed monthly numbers, the company reported second-quarter sales rose just 1.8%, suggesting that sales were negative in May or June.

It doesn't help matters that Burger King's relations with the chain's franchisees have been less than stellar. While some praise Brenneman for his efforts to boost sales, others complain that Texas Pacific hasn't done enough to help struggling operators get back on their feet. They and their lawyers say Burger King has pushed struggling franchisees who filed for bankruptcy protection to close their underperforming stores and go out of business.

Matters grew so acrimonious that, last October, the company severed ties with the National Franchisee Association Inc., which represents the operators of about 6,000 Burger King restaurants. In a letter to the association, John W. Chidsey, Burger King's president and chief financial officer, blasted the group's leaders for failing to support plans to expand hours, promote a value menu, gift cards, and other initiatives.

OPPORTUNE TIMING

In the months since, Burger King has tried to sideline the NFA by holding separate discussions with the franchisees it deems more cooperative. The company began talking to the NFA again in February. The group's new head, Joseph D. Anghelone, praises Brenneman and his team as being "very professional and dynamic," but he notes that Burger King is still in arrears on $1.7 million in support payments owed to the association. Burger King in its prospectus says relations are improving.

In the end, the Burger King IPO will likely succeed. Given the heavy demand for the IPOs of Chipotle and Tim Hortons, some investors think Texas Pacific picked an opportune time to begin unwinding its stake in the fast-food chain. "I've learned to never bet against Texas Pacific," says Peter L. Goldman, a portfolio manager at Chicago Asset Management Co., which oversees $750 million in investor funds. "They've created value in tough circumstances. Failing that, they've always succeeded in easing out of their mistakes."

But for investors, the question remains whether Burger King's owners have truly set the company on a sustainable path or are simply trying to pawn off a business with less beef than bun.

By Dean Foust, with Brian Grow and Coleman Cowan in Atlanta, Michael Arndt in Chicago, and David Henry in New York


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