Private equity aims at franchising sector as industry growth slows

A leading franchising expert says private equity firms are actively looking to buy into Australia’s franchising sector, as a new survey shows growth in industry is slowing.

Stephen Giles, franchising partner at law firm Norton Rose, says private equity firms are hunting for suitable acquisitions in the franchising sector, with an emphasis on franchisors with strong brands, good local growth opportunities and international growth options.

“The private equity and capital markets have discovered franchising and they’ve seen that franchisees can deliver profitability and growth,” he says.

In one deal currently on his desk, Giles says a private equity firm is looking to buy an anchor franchise brand, and then add other franchise brands in a similar sector and drive economies of scale by negotiating better deals from suppliers. The private equity firm is also keen to take the brands to international markets, given franchisee recruitment in Australia remains a huge issue.

Giles says the private equity action is part of a wider trend towards consolidation in the franchising sector, with mergers and acquisitions high on the agenda of many big franchisors.

“I would have half a dozen deals on my desk where franchises systems are looking to buy other franchise systems, buy other companies, or vertically integrate, or look for other distribution methods.”

The driver for this is the fact that growth in the franchising sector is stagnant, or falling.

A new survey of the franchising industry by Griffith University’s Asia-Pacific Centre for Franchising Excellence shows total revenue for the sector in 2010 was $128 billion, down from $130 million in 2010.

In addition, the number of franchisors declined 7% over the last two years, from 1,100 in 2008 to 1,025 in 2010.

“The franchise sector in Australia is mature now and the periods of exponential growth are over,” Giles says bluntly.

Report author, Professor Lorelle Frazer, argues this maturity is not necessarily a bad thing and that Australia is better off having 1,000 strong franchise systems than having an extra 200 systems that are poorly run and at risk.

“We’ve been saying for awhile that Australia had too many franchise systems that are too small. Australia has been painted at being the global capital of franchising, but we don’t have the population to support many more franchises.”

She says the maturity is manifesting itself in other ways. Despite the obvious problems finding franchisees, the average franchise system has managed to grow from 18 to 23 units, suggesting franchisors are looking at innovative growth strategies such as multi-unit franchising.

And while the average franchise system managed to recruit just five new franchises in 2008-09, Frazer says franchisors are being discerning.

“Another sign of maturity is not just taking anyone they can get. You have to get the right franchisee.”

The report shows 28% of franchisees have operations overseas, and Frazer and Giles expect this number to grow.

Giles says he is currently helping a number of franchisors look at overseas markets and says the strength of the Australian dollar means researching a foreign market and setting up a pilot program is much cheaper than it was 12 months ago.

However, he is urging maximum caution and says the old model of heading overseas and selling a master franchise to a local isn’t a guarantee given the current state of many economies.

“Australian franchisors should not underestimate how depressed those foreign markets are,” Giles says.

He is recommending joint ventures with local companies, small pilot programs and extended market research as the best strategies to explore offshore expansion.

While Giles says smart franchisors can find prime acquisition targets in the current market – he cites 7-Eleven’s recent purchase of Mobil’s retail fuel business as a perfect example – he is more cautious about the model whereby franchise brand managers or even private equity companies simply buy up various brands and stick them under the same umbrella.

“The roll-up has to be done very thoughtfully. The private equity market sometimes thinks it’s a bit easy to do that.”