One of Canada’s most recognizable fast-food chains—and the country’s strongest brand—has a new recipe for a significant corporate restructuring.
The fast-growing and successful North Vancouver-based A&W Food Services of Canada Inc. plans to consolidate its operations, buy the A&W Revenue Royalties Income Fund (TSX:AW.UNP) and pursue an initial public offering.
A timetable for this process is not yet available, but should be released soon according to executives at A&W, which independent brand-valuation company Brand Finance earlier this year ranked as Canada’s strongest brand for the second year in a row.
A&W Food Services CEO Susan Senecal said voting instructions will be mailed to unit holders and filed on Sedar in a management information circular, likely in September. Regulatory approval could follow this fall.
A&W has tangled corporate structure
While many if not most Canadians are aware of A&W’s burgers, famous root beer and Root Bear mascot, less well known is the company’s somewhat convoluted corporate structure.
Since 2002, its trademarks and intellectual property has been owned by the A&W Revenue Royalties Income Fund, which trades on the Toronto Stock Exchange.
Investors in that venture own a vehicle that gets its revenue through royalty payments.
More than 98 per cent of A&W Food Services’ restaurants are in a business segment the company calls a “royalty pool.” The income fund gets three per cent of the gross sales generated by restaurants in the royalty pool, and almost all of that money is distributed to unit holders.
In exchange, A&W Food Services’ restaurants and franchisees can use A&W trademarks, such as branding, menu-item names and mascots.
A&W Food Services’ business, in contrast, is largely as a franchisor: 1,052 of 1,062 A&W restaurants across Canada are franchised. Its only corporately owned restaurants are 10 in Ottawa, which launched in the 1990s and were intended to show potential franchisees in Eastern Canada that the company had some skin in the operating game. These locations are also used to test new products.
A&W Food Services charges franchisees a $55,000 one-time fee for each 20-year agreement to operate an individual A&W-branded restaurant, and a recurring six-per-cent royalty fee, which is broken into a 3.5-per-cent service fee and a 2.5-per-cent marketing fee.
The company requires all franchisees to spend one per cent of gross sales on community initiatives and marketing.
A&W Food Services derives some revenue—a single-digit percentage—from selling canned and bottled A&W-branded root beer to a variety of vendors, such as restaurants and grocers, Senecal told BIV.
It also recently became the master franchisor for Canada for the London, England-based grab-and-go sandwich giant Pret A Manger.
One Pret A Manger test store operates in Toronto, and A&W Food Services is “active in terms of determining what will be the next locations and how we want to expand,” Senecal said.
The result of this divided corporate structure is that the only public option to invest in A&W is to buy units in the income fund.
That has become a problem because income fund investments act more like bonds than stocks.
Before the proposed takeover was announced, unit holders received monthly distributions that amounted to $1.92 per unit, for a 6.7-per-cent annualized return.
The Bank of Canada’s rapid increases in interest rates, starting in March 2022, have prompted bond yields to rise in tandem. The result is that income investors now have more options to get strong-yielding returns, Senecal explained to BIV.
That dampens interest in buying units in the income fund, and the performance of the income fund has lagged what would have been the new company’s combined adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), according to an A&W presentation.
The income fund’s trustees realized this, and “started to have conversations” with A&W Food Services shareholders about combining their fund with A&W Food Services’ operations, Senecal said.
The latter has four main shareholders, she added. They include the private-equity firm TorQuest, the income fund’s chair and former A&W Food Services CEO Paul Hollands, A&W Food Services’ chair emeritus and former CEO Jeff Mooney and one shareholder whom Senecal declined to name. Together, those four investors own a majority stake, and they agreed that combining the two A&W entities was desirable, Senecal said.
“It all came together quite quickly is my sense,” she said.
If the amalgamation goes ahead, it will attract more institutional investors, analysts and stock liquidity, she said, adding that the company could also then likely trade with a valuation similar to those of other large fast-food chains.
What the future could hold
If the business merger and IPO go ahead, shareholders in what is now dubbed Newco would own a stake in the entire business, and—instead of only being exposed to how much royalty-pool restaurants generate in gross sales—they would also be exposed to the overall business’ profits or losses.
If operational costs of servicing franchisees rises faster than the incoming fees from franchisees and other revenue streams, the overall business may post a net loss, and the venture’s share price would likely face downward pressure.
Senecal, however, said she foresees investors doing much better under a combined A&W.
This is because they would be exposed to new restaurant openings, she said. They would also reap business synergies and bigger profit margins from a larger-scale franchisor.
An investor presentation describes A&W Food Services as a “high-margin, capital-light franchisor business” that has “high free cash flow conversion.”
This is all before franchising for the Pret A Manger brand takes off in earnest.
If the transaction goes ahead, the income fund unit-holders can either opt to dispose of their units, have the units converted into A&W Food Services shares or a mix of both.
The $37-per-unit value is approximately a 30-per-cent premium compared with what the units were worth before the proposed merger was announced.
A&W Food Services is only prepared to lay out $175.6 million to buy units, so if there is more demand from unit-holders to cash out, they may be stuck with having to convert some units into A&W Food Services shares, which they could later sell.
The units that A&W Food Services buys will be pro-rated so all unit-holders who want to sell some units would be able to do that.
The $175.6 million is enough to buy nearly 4.75 million units, or 32.5 per cent of the units not already owned by A&W Food Services.
Management has stressed that its planned structural change will not impact operations. That means no executive shake-up, and a new publicly listed company slated to be based in North Vancouver.
