Mod 12-13: Refined valuation Jake Peng

1. Mod 12-13:Refined valuationJake Peng

2. Agenda • Introduction • Lease • Share-based compensation

3. An overview of the QSR industry • Fast Food Hamburger Restaurants (FFHR) • High competitive • High volume, low margin • Compete on cost leadership and market penetration Restaurant industry ($1.75 trillion) Fine dining Quick service restaurant “Fast casual” Others

4. Comparison

5. Overview of Burger King • World’s 2nd largest FFHR • 13,660 restaurants in 80+ countries • 1.1 billion in revenues, 234 million net income in 2013 • Key strategies • Global refranchising program • Menu innovation and image remodeling • International expansion

6. Revenue breakdown (2013) • Sales revenue from Company restaurants will drop to below 10% in 2014. • International markets are growing really fast

7. Global refranchising program • Sell Company restaurants to franchisees • Started in 2011, completed in 2013 • % Franchised stores up from 89% (2010) to 99.6%(2013) • Only retained 52 own stores in Florida for new product testing • Benefit • More profitable (GM% 13% vs. 83%) • Capital efficiency • Focus on marketing, food innovation, and global expansion

8. US and Canada re-imaging program • Re-imaged stores sales went up 10% - 15% • Up from 19% to 30% in 2013. Goal is 40% by 2015 • Lower costs; provide financial support to franchisees

9. Menu innovation • Key differentiator is still Fire-grilled • New, healthier products promotions and limited time offerings • Increasing focus on breakfast

10. International expansion

11. Consolidated B/S - Asset • Largest three items: • Intangibles (including G/W) • Cash • PPE

12. Consolidated B/S - Liability • Observation: • Minimal ST debt, but significant LT debt • Highly leveraged – A/L ratio 74%

13. Income Statement • Observation: • Profitability significantly improved as a result of refranchising.

14. Ratio analysis • Decrease in EPAT and increase in EPM is primarily due to larger percentage of franchise revenue • Franchise is much profitable than self operation (83.5% vs. 12.5%) • Decrease in NFL due to increase in cash and interest rate swap, and decrease in adjusted operating lease liability • Decrease in NEA is due to decrease in PPE (restaurant closure) and decrease in adjusted operating lease liability. • Decrease in sales and EATO is primarily due to decrease in revenue, i.e., substitution of royalty for food sales

15. Ratio analysis (cont’d) • RNEA is improving overtime • RNFL fluctuates due to hedging activities • LEV decreases due to decrease in NFL and increase in CSE (Retained earnings) • ROE significantly improves due to higher EPAT and OCI

16. Estimate Revenue Growth • Revenue ↓ • Reason: Refranchising strategy Franchise and property revenues (F&P) substitutes sales revenues • Result: Historical revenue growth is irrelevant • Alternative: System-wide sales growth • Measures sales of all restaurants regardless of ownership • Royalty = Sales × a% • F&P revenues will account for almost all revenues from 2014 • Sales revenue from Company restaurants can be ignored

17. Estimate Revenue Growth (Cont’d) • For the purpose of forecasting revenue, a proper base-year revenue is needed. • 2013 revenue is a blend of sales and F&P revenues (360 refranchising in 2013), while revenues from 2014 will almost include F&P revenues only. • “Conversion” of 2013 revenues from “blended” to “pure” is necessary • What would 2013 revenue be if all the 360 cases of refranchising occurred at BOY? • Royalty rate of different regions are quite consistent • Royalty rate in US is higher because of more property revenues (leases)

18. Estimate Revenue Growth (Cont’d) • The international growth strategy will become the management’s next primary focus • Estimation assumes the momentum in 2013 will continue in five years

19. Estimate EPM • Historical EPM is irrelevant, as 2013 revenue is “blended”. • From a P/L perspective, there are three major cash expenses • Franchise and property expenses (lease payment) • SG&A

20. Estimate EPM (Cont’d) • Franchise and property expenses • Can be estimated as a percentage of franchise and property revenue • US ratio is highest due to sublease • Comprehensive ratio increased 2.1 percentage in 2013 due to US and Canada re-imaging program, which reduced up-front franchise fee and royalty rate • Estimated rate reflects: • The timing of the re-imaging program (expected to be completed in 2021), and • Greater weight of F&P revenues from other regions that have lower F&P ratio

21. Estimate EPM (Cont’d) • Only two non-cash recurring expenses are relevant: • Selling expenses • Advertising fees contributed by Company restaurants • Management G&A • Salaries of non-restaurant employees and overhead of corporate offices Partial P/L

22. Estimate EPM (Cont’d) • Yearly data is not representative of future because: • Selling expenses significantly decreased as a result of refranchising • Total revenue is blended and “inflated” • Solution: Use 13Q4 figure • Refranchising was substantially completed in 13Q3 • The structure of P/L of 13Q4 most mirror that of 2014 and onwards • Estimation reflects the fact that Management G&A does not necessarily grow with revenues

23. Estimate EPM (Cont’d) • EPM is estimated using effective tax rate

24. Estimate EATO • NEA drops primarily due to: • Decrease in PPE • The trend will not continue because of the decrease seems to result from the sale of equipment • Decrease in adjusted capital lease • BKW decreased estimated future operating lease payment, but did not state reason • Safe to assume no change going forward • NEA does not change in future periods • Given the nature of franchise business, the correlation between NEA and revenues is low

25. Valuation using DCF

26. Questions?