Subway is one of the largest restaurant chains by number of units in the world — but it has been deteriorating. Even with a new CEO in 2019 and new menu, delivery, and some digital investments, the medicine has not been strong enough to improve the patient’s health. As a result, the system has been shrinking over the last few years.
There is a need for some new medicine and at a higher dose — Roark has the ability to be the perfect investor, exactly what the doctor prescribed.
The acquisition makes sense for Roark as well, strengthening its position as a leader in the foodservice industry and the fastest-growing restaurant group in history.
SUBWAY RESTAURANTS: TEN YEARS WITHOUT GROWTH
The Average Unit Volume for Subway was flat for a decade at less than $434 thousand sales per restaurant per year, which really goes to show the pressure on margins, with labor and food cost inflation not being countered with any increases in the top line.
In 2022, the average sales per restaurant in the U.S. climbed to $468 thousand. Even with that, the average Jimmy John’s restaurant sells twice what the average Subway sells (in the U.S.).
ROARK ACQUIRES SUBWAY – WHAT DOES IT MEAN FOR THE CHAIN AND FOR THE NEW OWNER?
A few names have come up in discussions of a potential Subway acquisition. In the end, Roark acquired the chain in August 2023. The PE group bought the subs chain at a valuation close to $9.6 billion (including debt and subject to an earn-out). With Subway’s global sales at more than $16 billion (100% franchised, which means Subway gets royalties but does not actually manage the restaurants), that would mean the investor is paying about 60 cents on the dollar per dollar of sales. That is considerably cheaper than peers. Firehouse Subs, for example, was acquired by Restaurant Brands International (parent company to Tim Hortons, Burger King, and Popeyes) in 2021 at an enterprise value of $1 billion — with $1 billion in sales, RBI paid close to $1 dollar in enterprise value per dollar of sales.
This difference in valuation, pricing Subway at a considerably lower valuation than peers such as Firehouse Subs or Jimmy John’s is a signal that this is a distressed brand. If we put it in terms of valuation per restaurant, the investor would be paying $259 thousand per Subway restaurant, which is less than a third of the value per restaurant paid for Firehouse Subs (around $830 thousand) and about a quarter of what was paid per restaurant for Jimmy John’s (around $1.1 million).
On the other hand, even with all the complications in the Subway system, it is a trophy asset (they are in the top 10 restaurant chains in the majority of the largest countries) and it makes sense for Roark. It solidifies its position as the fastest-growing restaurant company in history.
We also suspect there is a possibility that Roark (or Inspire Brands) spins some of its brands as IPOs in the future, and this would be an outstanding opportunity if they are able to make improvements for Subway.
THE CHALLENGE FOR SUBWAY’S RESTAURANTS FUTURE
The biggest hurdle Roark will have with Subway is getting the franchisee base onboard. Whatever the plan, they have to be bought in; there has been a lot of change of direction, a revolving door of people with new ideas and new ways to spend their (very limited) money that did not work, leaving the franchisee base to pay for empty results. At the same time, in a system this big, bureaucracy makes it almost impossible to implement change.
Subway was the biggest restaurant chain globally by number of units until 2020 when it was surpassed by McDonald’s. How did they do it? It was the easiest franchise to get into, with the lowest cost of entry — allowing many people to become franchisees. However, most of these franchisees would not have the financial wherewithal to make big capital investments. Even if the new owner has the best idea and plans.
Roark has several things in its favor. They can leverage how successful they have been with other brands (especially the Inspire portfolio). For Subway, the only thing left is to build the top-line. Some of the playbook we suspect may be implemented would include:
- Bringing more resources to the system. The Roark portfolio is highly successful and has an outstanding management team – and growth attracts opportunities. The lessons learned in the history of these brands can be applied to Subway with greater credibility than any other private equity firm (which would typically clean the financials and spin the company back out).
- They will look for synergies in purchasing and supply chain and will wield that power to improve margins.
- A heavy focus on technology investments, including automation and maybe even robotics. The problem here is that the low AUVs don’t support such investments.
- Financing will have to be part of it, to make it affordable for the franchisees.
- Focus on off-premise, following the Panera playbook, Chipotle, and of course, Jimmy John’s.
- Using some of the tools from Dunkin’ — which has AUVs just at the $1 million mark but is run with a profit.
- There is a potential for bolt-ons in combination with Subway.
- Buying back a lot of the franchisees, which may mean some of the units end up closing to clean up the system. We would not be surprised if the new owner ends up buying 20% of the system (historically Subway’s parent company only runs one restaurant) and running those for credibility.
- Improving the menu offerings, becoming more competitive, finding new ways for people to come back in. The premiumization component needs to be figured out because Subway restaurants are often in low-income communities where the consumer is coming in because is considered healthier than other fast food options. Subway has gotten away from that by focusing too much on trying to make it as cheap as possible.
- The brand and messaging are also a challenge to get the AUVs up.
- The restaurant economic model is fundamentally broken and that has to be fixed in a multi-stage approach.
It’s often the case with a new owner that there will be a three-horizon framework — though many of the initiatives would happen in concurring paths:
Horizon 1: the first six months. Start with the menu in ways that don’t require CAPEX. Looking at the revenue drivers and asking which buttons to push that won’t cost a lot of money and can be done fast. Quick wins so the press and media recognize the team as the right management and franchisees see and feel that momentum. About half the focus has to be on the franchisees’ internal communication.
Horizon 2: from month six to 18 months in. More capitalized investments but with quick payback.
Horizon 3: 18 months or more to get the return on investment. These are larger capitalized investments tackling bigger and more systemic issues, largely related to tech.
No matter how good the plan is, it is going to cost money. CAPEX will be required after the initial purchase. Roark may be a knight in shining armor but there is still a lot of romancing that needs to happen with the franchisees to show them the way. Can Roark make it attractive for a younger generation, for the employee base, and for the franchisee base? They will have to show a more tuned-in approach than what has been done in the past.
About Aaron Allen & Associates
Aaron Allen & Associates works alongside senior executives of the world’s leading foodservice and hospitality companies to help them solve their most complex challenges and achieve their most ambitious aims, specializing in brand strategy, turnarounds, commercial due diligence and value enhancement for leading hospitality companies and private equity firms.
Our clients span six continents and 100+ countries, collectively posting more than $300b in revenue. Across 2,000+ engagements, we’ve worked in nearly every geography, category, cuisine, segment, operating model, ownership type, and phase of the business life cycle.