Why Buffalo Wild Wings Just Spent $160 Million to Buy out a Franchisee

By Markets Fool.com

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Source: Buffalo Wild Wings.

In a single deal, Buffalo Wild Wings just boosted its company-owned store base by almost 10%. The restaurant chain announced last week that it is buying out a franchisee's 41 B-Dubs locations across Texas, New Mexico, and Hawaii.

That deal will put the restaurant count at 550 company-managed locations, compared to about 600 franchised stores. In fact, B-Dubs is now close to tipping the scales into over 50% of its restaurant base being company-owned (versus just 39% four years ago).

Source: Buffalo Wild Wings Financial Filings.

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The franchise model is a tempting trade-off for restaurant companies. On the plus side, franchisees kick in steady, predictable revenue in the form of rent, fees, and royalty income. They also make it easier for a company to quickly grow its store base.

That's why McDonald's owns less than 20% of its restaurants -- with over 80% run by franchisees. As the fast food king explains in its 10-K, "Cash from operations benefits from our heavily franchised business model as the rent and royalty income we receive from franchisees provides a stable revenue stream that has relatively low costs." McDonald's, like many other fast food restaurants these days, is raising money by selling company-owned locations to franchisees.

But you give up important operational control over things like hiring in exchange for that easy cash. And that can make it difficult to ensure a consistent, top-notch experience for your customers. Here's how Wendy'sdescribes the risk in its 10-K:

"While we try to ensure that the quality of our brand is maintained by all of our franchisees, we cannot assure that these franchisees will not take actions that hurt the value of our intellectual property or the reputation of the Wendy's restaurant system."

That risk is a big reason why Chipotledoesn't franchise any of its 1,800 locations.

B-Dubs is moving away from the McDonald's and Wendy's approach and toward Chipotle's. It has two good reasons for the shift. First, B-Dubs' company-managed restaurants simply perform better. Comparable-store sales at those locations beat their franchisee counterparts for the seventh quarter in a row to start off 2015. Q1 Comps were up 7% at B-Dubs' owned restaurants and 6% for franchisees. In a conference call with investors, management credited the company's guest-experience captains, a new position in place at all B-Dubs' corporate locations, as a key driver of that outperformance.

And second, thanks to surging results lately, Buffalo Wild Wings has the money to fund this massive purchase without taking on significant debt. Sure, the $160 million buyout price is above the $113 million in cash that B-Dubs had on its books at the end of April. But the company is generating cash flows that, together with existing cash, could fund this entire deal. Annual operating cash flow was $200 million last year, up from $145 million in 2012.

While hurting the balance sheet and earnings in the short term, shifting these locations into the company-owned pool should help the overall business. That's likely why the stock jumped higher by 3% on the day this deal was announced. Investors apparently agreed with B-Dubs' expectation that this purchase is in shareholders' best interests. "We believe that the acquisition of these Buffalo Wild Wings locations will provide our shareholders with additional long-term net earnings growth," CEO Sally Smith said in the press release announcing the deal.

The article Why Buffalo Wild Wings Just Spent $160 Million to Buy out a Franchisee originally appeared on Fool.com.

Demitrios Kalogeropoulos owns shares of Apple, Buffalo Wild Wings, and McDonald's. The Motley Fool recommends Apple, Buffalo Wild Wings, and Chipotle Mexican Grill. The Motley Fool owns shares of Apple, Buffalo Wild Wings, and Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.