Subway may be valued at over $9 billion but there is a catch

Subway, founded in 1965, is undergoing operational overhauls to address challenges like outdated decor and profit erosion among franchisees. The company launched a menu revamp and aggressive marketing campaign, contributing to a sales uptick. These have led to a 9.85 percent increase in same-store sales in the first half of 2023 and its 12-month earnings before interest, taxes, depreciation, and amortisation are estimated to be around $800 million.

The largest chain by US locations was exploring a sale that could value the company at $10 billion plus. But there is news now that says private equity firm Roark Capital is emerging as the top contender to acquire the sandwich chain and this deal is likely to value Subway at around $9.6 billion. This would be far below big quick service restaurants (QSRs) like McDonald's, Starbucks and KFC but would put the sandwich chain much above Pizza Hut, Taco Bell and Burger King.

Even for that $9.6 billion valuation, Roark Capital has introduced specific conditions, known as an earn-out, which would involve deferring a portion of the deal consideration, according to a report by Reuters quoting individuals familiar with the matter.

Under this arrangement, the complete payment would be contingent upon Subway's cash flow achieving predetermined milestones during a specified period subsequent to the deal's finalisation.

An earnout is a contractual arrangement between a buyer and seller in which a portion or all of the purchase price is paid out contingent upon the target firm achieving predefined financial and/or operating milestones post transaction-close.

This innovative earn-out approach has effectively addressed a valuation gap between the DeLuca and Buck families, who are the proprietors of Subway, and the competing buyout firms. The DeLuca and Buck families, desiring to capitalise on Subway's robust brand and global expansion, sought a price exceeding $10 billion. In contrast, the private equity firms, citing saturation in Subway's US business, proposed a lower valuation.

The financial landscape characterised by high-interest rates and difficulties in securing leveraged buyout funding further complicated the sale process. A consortium comprising TDR Capital, Sycamore Partners, and Goldman Sachs' private equity arm, while offering less than Roark for Subway, also incorporated an earn-out into their proposal.

The consortium has advanced the argument that Roark's ownership of other restaurant brands, including sandwich chain Jimmy John's, might lead to US antitrust concerns. Nonetheless, the families behind Subway have contended that the restaurant market's fragmentation would mitigate such competition worries.

The negotiations are ongoing, and a deal might be reached this week. The Wall Street Journal reported on Monday that Roark Capital was nearing an agreement to acquire Subway for approximately $9.6 billion.

Roark Capital already holds control over Inspire Brands, the owner of various chains including Jimmy John's, Arby’s, Baskin-Robbins, Buffalo Wild Wings, Dunkin’, Rusty Taco, and SONIC Drive-In. While Jimmy John’s boasts more than 2,600 restaurants across 43 states, Subway's presence extends to over 37,000 restaurants spanning more than 100 countries.

(With inputs from Reuters)