Burger King buyer faces huge challenges

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,"…

San Francisco Chronicle
September 13, 2010

Burger King buyer faces huge challenges
Diane Brady


Burger King, the No. 2 hamburger chain, is a distant runner- up to McDonald's, which has over 20,000 more restaurants. Robyn Beck / AFP/Getty Images

When it comes to the pitfalls of operating a fast-food chain, Burger King has experienced them all: falling profits and sales, angry franchise owners, mediocre innovation, growing competition, and a razor-like focus on the very customers who have been hit hardest during the recession.

So when a little-known investment outfit called 3G Capital said it would buy the chain for about $4 billion on Sept. 2, an obvious question was: Why?

Burger King may be the world's No. 2 hamburger chain, but it's a distant runner-up, with 12,174 restaurants worldwide compared with 32,466 for McDonald's. The Golden Arches averages about twice the sales volume per U.S. outlet, and its stock has far outperformed that of its rival on the strength of new products such as coffee drinks and smoothies.

$1 double cheeseburger
Burger King, in contrast, has seemed fixated on hawking a $1 double cheeseburger - now $1.29 after a bitter court fight with franchisees who claim it's a money loser. The chain has also narrowed its target audience, chasing young men with cheeky ads, while McDonald's has gone for broad family appeal.

Sources close to 3G say the partners are betting they'll be able to trim costs (though no more than 10 percent) and ramp up international expansion to make the deal work.

Most of 3G's money comes from three Brazilian billionaires: Jorge Paulo Lemann, Marcel Herrmann Telles and Carlos Alberto da Veiga Sicupira. They've offered investors $24 per share, 46 percent more than Burger King's Aug. 31 closing price.

If the deal goes through - which is likely, given the support of the board and the private equity firms that hold 31 percent of shares - the chain will go private for the second time in less than a decade. TPG Capital, Goldman Sachs Capital Partners, and Bain Capital bought Burger King from Britain's Diageo for $1.5 billion in 2002 and took it public in 2006.

Burger King declined to comment beyond public releases.

The company's first priority, given the Brazilian investors' past record, is likely to be a rapid-fire push to cut costs. That's certainly been the case at Anheuser-Busch InBev, the world's largest brewer, which Lemann's group helped create when InBev, the Belgian brewer it had a stake in, completed a hostile takeover of the American brewer two years ago.

Lemann, Telles and da Veiga Sicupira all sit on the board of the merged company. After the merger, former Anheuser-Busch employees soon lost perks ranging from business-class flights and BlackBerrys to free cases of beer. About 1,400 quickly lost their jobs.

Through a spokesman, 3G issued a statement saying, "Any potential opportunities for cost efficiencies will be managed with the overall benefit of the company in mind, without compromising the franchisees."

A person familiar with 3G's plans for Burger King says the company is ripe for cost-cutting, especially at company-owned restaurants, which are typically less profitable than those operated by franchisees. This person says labor costs are high at these restaurants, as is overhead at the Miami headquarters.

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.

Franchisees' burden
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," said 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 company stops advertising them.

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 and Barclays to lend it about $2.8 billion of the $4 billion price.

It's also taking over at a time when Burger King is branching out: On Sept. 7, the chain announced nine new breakfast items. 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.


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