Once 3G Capital completes its purchase of Burger King Holdings Inc., the Brazilian-backed investment fund and the fast-food chain’s franchisees may face a $3 billion tab to renovate aging U.S. restaurants.
Last month, Chief Executive Officer John Chidsey told analysts that 85 percent of Burger King’s 7,200-plus locations in the U.S. need to be remodeled. Modernizing stores with the company’s new “20/20” redesign will cost about $500,000 each, he said in June, with some going as high as $1.1 million. That could push the cost past $3 billion.
“The image is 20 years old,” Charles Fallon, president of Burger King’s North American business, said in a telephone interview. “We’re working hard on making the economics work.”
Among Burger King designs still in use is a 1999 layout featuring metal chairs and bright blue booths. That compares with newly remodeled McDonald’s Corp. restaurants that showcase low lighting, cushioned stools and bossa nova music played through ceiling speakers.
“McDonald’s is more uplifting,” Joyce Jacaruso Castillo, 69, said upon leaving a revamped three-story McDonald’s on New York’s 6th Avenue. “Burger King is so blah.”
Persuading franchisees to shed that “blah” image may not be easy. Slowing sales at the world’s second-largest hamburger chain have made many store owners reluctant to spend on renovations, Steve Lewis, who owns 36 outlets near Philadelphia, said in a telephone interview.
3G Capital may need to chip in funds through Burger King to spur remodeling, said Jordan Krolick, president of the Marietta, Georgia-based consulting firm Tound & Drowth LLC.
“It’s the hidden cost in any restaurant acquisition, and should be planned for as an addition to the initial investment,” said Krolick, who previously ran mergers and acquisitions for Oak Brook, Illinois-based McDonald’s.
Outlets without drive-throughs will be cheaper to remodel, and franchisees also can remodel with the old look, which is less expensive, said Susan Robison, a spokeswoman for Miami- based Burger King. She declined to provide an estimate for a total renovation cost.
On Sept. 2, Jorge Paulo Lemann and his partners at 3G, Marcel Herrmann Telles and Carlos Alberto da Veiga Sicupira, agreed to buy Burger King for $3.3 billion, the biggest restaurant acquisition in at least a decade. Burger King is seeking $1.9 billion in loans to back the buyout, according to people familiar with the discussions.
Lemann, a former financial columnist, tennis champion and stockbroker, is Brazil’s second-richest man, according to Forbes magazine. He and his partners own stakes in Anheuser-Busch InBev NV, the world’s biggest brewer, and Lojas Americanas SA, Brazil’s largest discount retailer.
“It’s premature to talk about whether 3G’s going to provide funding or what the cost will be” for restaurant upgrades, said Steven Lipin, a spokesman for 3G Capital.
Burger King fell 1 cent to $23.79 at 4 p.m. in New York Stock Exchange composite trading, while McDonald’s fell 49 cents to $74.64. Burger King shares have gained 26 percent this year, compared with a 20 percent increase for McDonald’s.
Burger King’s aging U.S. stores put them at a considerable disadvantage against McDonald’s, Matthew DiFrisco, an analyst at Oppenheimer & Co., said in a telephone interview. McDonald’s, which owns much of the real estate underlying its franchises, fuels renovations by matching 40 percent of funds put up by its franchisees on average, spokeswoman Lizzie Roscoe said in a telephone interview. Its stores are about 18 years old on average, she said.
This year an average McDonald’s store generated almost twice the sales of an average Burger King in the U.S., according to industry tracker Technomic Inc. In the quarter ended June 30, sales at U.S. Burger King stores open more than 13 months fell 1.5 percent, while McDonald’s U.S. comparative sales rose 3.7 percent.
Burger King sales began flagging in 2002, according to Technomic, the same year TPG Capital, Bain Capital LLC and Goldman Sachs Capital Partners bought Burger King from Diageo Plc for $1.5 billion. The three private-equity firms introduced a cheaper design for new stores to increase the chain’s profitability, according to Fallon. Renovations amounted to “paint and touch-up work, and repair and maintenance catch-ups,” he said.
By the time Burger King became a public company in May 2006, market share had slipped by 2.7 percentage points against competitors like McDonald’s, according to Chicago-based Technomic.
Burger King introduced its “20/20” redesign two years ago. The name is intended to set the tone until the year 2020 and beyond.
Since then, more than 300 restaurants worldwide have been outfitted with chrome-trimmed booths, brick walls, LCD menu screens, red and black paint and “flame” chandeliers meant to evoke the chain’s flame-broiled burgers.
Franchisees, who own about 90 percent of Burger King’s stores, are responsible for their own renovation costs, and must remodel stores every 10 years to Burger King’s specifications.
Some franchise owners say they won’t pay for the extensive 20/20 renovations. Lewis, the Philadelphia-area franchisee, said three or four of his restaurants have come up for contract renewals in the past two years, and he has opted for less expensive renovations, such as adding carpeting in the dining room and computer terminals with Internet access.
“I’m doing whatever the minimum is,” Lewis said.
Doing the Minimum
At a conference in May, Burger King managers played a video to motivate franchisees to renovate their stores. In it, consumers explained why they had just eaten at a remodeled McDonald’s, and not the Burger King across the street. Remodeling stores lifts sales 12 percent, and tearing down a restaurant and rebuilding it (a $1 million to $1.1 million investment) results in a 25 percent sales increase, according to Burger King.
Shoukat Dhanani, who operates 61 Burger Kings in the Houston area, built the first 20/20 restaurant in the U.S. in May 2009. So far sales are 40 percent higher than at his other locations, Dhanani said in a telephone interview. Some customers couldn’t believe the sleek new location was actually a Burger King, he said.
“Customers were like ‘Wow, this is nice!’” he said. “’Are we in the right place?’”