Spilling the beans: A financial teardown of GYG

From burrito bowls to billion-dollar valuations, Jason Andrew takes a look at the financials behind Australia's fastest growing Quick Service Restaurant, Guzman Y Gomez.

I rarely had ‘takeaway’ food as a kid.

For us, it was a luxury.

You see, a cornerstone of Chinese migrant culture is refusing to eat out because “we have food at home”.

Meme that says "Can we get McDonalds? Mom: We have food at home. Food at home: Picture of two apples that look like a burger and fries
Anyway, fast forward to 2024, and it’s not uncommon for my young family to indulge in fast food.

Our go-to? Guzman Y Gomez, or ”Guzzies” as my two-year-old so eloquently puts it.

He friggin’ loves the stuff. In fact, we all do.

It’s by far our favourite Quick Service Restaurant (QSR) food, because it’s healthy, filling and fairly priced.

In case you’re wondering, we usually get the burrito bowls: One pulled beef, one chicken, both with guacamole, and a large fries with no seasoning. It comes to a grand total of $37.70 – our fortnightly indulgence.

Not only is GYG my favourite QSR, but the company is also backed by an investment firm I’ve long admired – TDM Growth Partners in Sydney. I’ve not met Ed and the team there, but they seem like my kind of people.

(If any of you TDM folks are reading this – what’s up? Burritos on me anytime).

Rumour has it GYG is eyeing an IPO. As a long-time customer, I wondered if I should become an owner as well, so I threw a few bucks at ASIC and dove into their financials.

Here’s the financial teardown of Guzzies.

The backstory of GYG

GYG is Australia’s fastest growing QSR. Serving made-to-order, clean and healthy Mexican fare, it operates across Australia, Singapore, Japan and its newest market, the USA.

This culinary gem was founded in Sydney back in 2006 by two Americans, Steven Marks and Robert Hazan. Steven was a former hedge fund manager and Robert had a background in fashion wholesale and retail.

They were both missing the Mexican cuisine they had grown up with in the USA. Inspired by the success of Chipotle, they envisioned building the McDonald’s of the next generation – an alternative option to greasy burgers and fried chicken.

From a single store in Newtown in 2006, GYG today has become a powerhouse with 193 restaurants and Global Network Sales of $758.8M (including franchisees) – an impressive 29% Compound Annual Growth Rate (CAGR) since 2014.

Source: TDM Growth Partners

The GYG business model

Unlike your typical QSR, GYG boasts numerous corporate-owned stores alongside its franchised operations. Whilst the financials don’t delve into the details, a 2020 AFR report suggests GYG had 30 to 40 corporate-owned stores at that time. The number of corporate-owned stores seems to have grown since then – more on that later.

Economically speaking, franchising is an attractive business model for capital-intensive players due to its superior Return on Invested Capital (ROIC).

Alternatively, if GYG were to expand via a 100% corporate-owned model, they’d have to scout suitable locations, secure long-term leases, and pour upfront capital (typically $1.7M to $2M per restaurant, according to GYG’s website) into fitouts and equipment.

Once operational, there’s a ramp-up period before the store reaches profitability – and as the owner, you’re carrying that financial risk.

With a franchise model, GYG is selling an information product to aspiring entrepreneurs in the form of an operating playbook and a coveted brand. Franchisees pay an upfront franchise fee and a percentage of their revenue, and in return, they receive ongoing training, marketing support, and use of the brand assets. Importantly, all the upfront capital costs are on the franchisee’s tab.

This shift from selling brick-and-mortar locations to vending zero marginal cost information products translates to better margins and recurring revenue. Each new franchise sold adds to the incremental margin – and the more you sell, the better your profit margins.

Let’s crunch some numbers comparing the two models.

While I’m not a QSR expert, I’ve connected with a few folks who own/manage them.

The financial profile of a thriving, fully ramped QSR looks something like this:

  • Weekly sales range between $60k to $80k, let’s assume $70k.
  • 30-35% Cost Of Goods Sold (COGS) (food and consumables).
  • 30-35% labour.
  • 10% franchise fee, which comprises of a 7.5% franchise fee and a 2.5% marketing levy.
  • 10% overhead costs (rent, utilities).
  • 15% EBITDA.

Given the $1.7M capital investment for a GYG store, this yields a Return on Investment (ROI) of 22% – a pretty decent return.

Now, let’s run the same scenario for a corporate-owned store.

The EBITDA is 10% higher, because they don’t incur the variable franchise fee. Return On Invested Capital (ROIC) is 37% – even better.

Now, let’s look at the returns on a franchisor business model.

In this model:

  • The income comes through the franchisee, a 10% royalty on sales.
  • COGS are a portion of head-office costs to administer the franchise arrangement, let’s assume 5%.
  • 2.5% of the franchise fee is a marketing levy that the franchisor uses to spend on marketing.
    The resulting EBITDA is SaaS-like – an impressive 87%!

The best part is that there’s no capital outlay for each new franchisee signup, making the ROIC, well, pretty spectacular!

Meme of QSR, Franchised QSR, Corporate owned QSR and Franchise fees

Yes, there are some overhead costs incurred by the franchisor not included in this P&L, but the point is that every new franchisee signed up is at an incremental margin. Fixed head office costs will reduce as a percentage of group sales as more franchise fees are generated.

Anyway, this is why franchise business models are so very wonderful: capital-light, recurring revenue, super high gross margins. It’s a great business to be in.

As investors, the million-dollar question we need to ask ourselves is: Is GYG in the business of franchising, or in the capital-intensive Mexican restaurant business?

Let’s look at what the numbers reveal.

The financial teardown

Here’s a snapshot of the P&L since 2018, sourced from their financial statements.

A few things to note:

  • GYG’s revenue is on a nice growth trajectory, at 54% Compound Annual Growth Rate (CAGR) since FY18.
  • Gross margins remain consistent at 73% – although I expected this to increase with the franchise model operational leverage (more on this later).
  • The business is EBITDA positive from FY21, marked by ongoing investments in admin costs, primarily geared towards international growth.

Overall, the business looks pretty promising. Now let’s dig a bit deeper.

Revenue breakdown

GYG’s income stream flows from two main sources:

  • Store sales: Revenue generated from company-owned restaurants.
  • Franchise fees: Fees collected from franchisees.

The table below summarises the breakdown of these revenue streams, and how they’ve changed over time.

What’s particularly interesting is that most of the revenue growth stems from company-owned stores, not franchise fees. In fact, the revenue contribution from franchise fees is actually on the decline.

In FY19, franchise revenue contributed 20% of total revenue. In FY23, it decreased to 16%. 84% of FY23’s revenue was driven by company-owned stores.

It’s not reported in the financial statements how many GYG stores are company-owned vs franchised, but based on the data, it’s clear that GYG’s revenue growth is coming from company-owned stores.

What’s even more interesting is that this company-owned revenue isn’t all ‘new growth’; instead, GYG appears to be buying businesses from its franchisees.

In FY23, the company acquired a number of stores, equating to approximately $20M of annualised revenue and contributing $2.2M annualised Net Profit After Tax (NPAT). This acquisition represented nearly a third of FY23’s revenue growth.

GYG bought $3.1M of EBITDA, which translates to a 15.5% EBITDA margin – a pretty decent operating margin for a QSR.

Source: GYG financial statements

The company paid $6.4M to buy this $20M of revenue and $3.1M of annual EBITDA, meaning they bought these stores from franchisees for a bargain at a 2x EBITDA multiple.

So, why would GYG buy businesses back from franchisees when their core business is selling them?

Well, it’s common practice for corporate entities to repurchase franchises, especially if they underperform, or if there’s misconduct on the part of the franchisee. HQ aims to safeguard their brand reputation above all else.

But for well-performing stores like these, transitioning them back to company-owned status is largely due to strategic reasons – like pumping up the numbers in preparation for an IPO.

This is called a multiple arbitrage, and the playbook goes something like this:

Step 1: Sell the story that you’re a fast-growing, capital-light franchise business. Set ambitious growth targets that hype up the market, securing a stellar listing multiple at IPO.

Step 2: Amp up the growth story by acquiring well-performing stores from franchisees at a steal – 2x EBITDA, to be precise. IPO shortly after at a dazzling 50x EBITDA.

And voila! You’ve just turned water into wine for your shareholders. It’s financial engineering at its finest.

Am I sounding a bit cynical? I’m by no means insinuating that they’re in the same boat, but we’ve witnessed similar activity in the lead-up to the F45 IPO – a significant chunk of F45’s revenue came from lower-margin gym equipment sales, rather than high-quality, recurring franchise revenue. And we all know how that story played out…

That’s just one possibility, however. The other explanation for acquiring stores from franchisees could offer an insight into GYG’s longer-term strategy.

Are they contemplating ditching the franchise model?

Look at GYG’s US competitor, Chipotle. They own 100% of their stores, with no franchisees in the mix at all. Chipotle started as a franchise model back in 1993, but shifted gears from 2006 onwards, gradually buying back all their stores.

Why would they do that?

Franchising means relinquishing control over how restaurants are run, potentially affecting the end customer’s experience. Chipotle’s business model now is so strong (a current market cap of US$62.3B and 3,182 stores) that they would rather not sell off revenue to franchisees in exchange for only a small cut.

GYG’s long-term play might follow a similar path, and ditch the franchise playbook altogether. After all, the biggest risk with the franchise model is maintaining quality and aligned franchisees. Corporate ownership ensures quality control for the brand. Of course, it’s a lot more work, but if running the business in-house proves more effective than relying on franchisees, they might be better off owning the whole damn thing.

This also explains the query I had earlier about gross margins. I would have expected gross margins to increase with higher franchise fee revenue. They don’t, because the majority of revenue and gross profit is stemming from company-owned stores, not franchisee sales.

The funding journey

The business has raised a few rounds of capital over its journey, with around $104M of issued capital in the books.

Here’s a timeline I scraped together:

  • 2018: TDM Growth Partners led the way with a $44M investment.
  • FY20: An additional $14.95M equity was issued, presumably a follow-on round from TDM, bringing their total stake to 40% and suggesting a valuation of approximately $150M or 1.7x FY20 revenue.
  • FY21: Another round saw $35.6M equity raised. Embattled financial firm Magellan, in December 2021, invested $86.8M for a 11.6% stake, valuing the business at $870M. A secondary transaction, estimated at ~$50M, took place.
  • May 22: Magellan sold its 11.6% stake in a secondary sale for ~$140M, valuing GYG at $1.2B or 6.5x FY22 revenue.
  • September 22: A secondary sale of $150M indicated a $1.6 billion enterprise valuation. Aware Super entered the scene with a $100M investment at a $1.35B valuation, roughly 4.8x FY23 revenue.
  • FY22 and FY23: More equity was issued, primarily involving vested options.

As of the last valuation round, GYG was priced at $1.35Bn – roughly 5x FY23 Revenue.

What valuation could they achieve in a potential IPO?

Let’s look at some comparables:

  • The average LTM/EV multiple of ASX-listed franchisors is 2.16x.
  • US-listed Chipotle is by far the behemoth, valued at USD$64B with over 3,180 restaurants and still growing at a 14% CAGR.

With a possible IPO on the cards, TDM recently said they could see a valuation for the company of more than $2B, based on some similar high-growth US fast food chains.

So could GYG really be valued at $2BN?

While GYG’s growth rate is much higher than the comparables above, the challenge for investors lies in justifying an 8x revenue multiple – a multiple 2x higher than Chipotle, but with 94% less restaurants and 98% less revenue.

I dunno about you, but I think it’s pretty toppy…

The GYG investor team will be selling a growth story at IPO, and are banking on hitting a home run in the USA.

Still, entrepreneurs have a saying: “If you can make it in Australia, you can make it anywhere.” It’s not an easy country to do business in, with high minimum wage, complex award rates, and a high tax corporate system.

Australia is a really tough place to do business. For GYG to build a successful brand in such a short space of time is nothing short of extraordinary.

Hopefully they can replicate that success in the USA.

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