Business Analysis using financial statement

1
Business Analysis using financial statement

• Boston Chicken, Inc.
• Case Analysis

2
Boston Chicken, Inc.Objectives

• To illustrate analysis of assetshow to value the
  loans to the area developers.
• Boston Chicken reported the loans at face
  value, with no allowance for bad debts. How to
  appreciate the loans.
• Comprehensive security analysiscovering strategy
  analysis, accounting analysis and financial
  analysis.

3
Boston Chicken, Inc.Overview

• Boston Chicken developed a new segment of the
  fast food restaurant business, home-cooked food
• The company sought to grow rapidly by signing
  franchise agreements with large area developer.
• The company provided sizable loans to help
  developers finance new restaurant.
• These loans was financed through public stock and
  convertible debt issues made by Boston Chicken.

4
Analysis of Boston Chickens Strategy

• Created a new segment in the highly competitive
  fast-food restaurant industrytake-out
  home-cooked food.
• Engaged in three businessesoperating
  restaurant, selling franchises, and financing
  area developers
• Major competitors
• Existing take-out chains such as KFC few
  barriers to entry, but has a different concept.
• New take-out competitors potential barriers
  for entry
• Supermarkets be unlikely to compete
• Boston Chickens success depends on its ability
  to expand rapidly and develop its brand name.

5
Boston Chicken, Inc.Critical Success Factors

• Rapid growth into new geographic markets.
• The company used franchising to leverage its
  idea. Under these agreements, it sells the right
  to build and operate restaurants to area
  developers and uses the developers financing,
  management talent and local information as a way
  of growing the business
• Management of existing and new store operations
• Incomes come from royalties on system-wide
  franchise sales and from its own store
  operations. Boston chickens success depends on
  both businesses. (I/S)

6
Boston Chicken, Inc.Critical Success Factors

• A number of recent operational changes
• Long term agreements with supplies-locking in
  food price
• Flagship stores
• Adding menu items to increase sales at off--peak
  times
• Store improvement-in store computer feedback and
  drive thru lanes.

7
Boston Chicken, Inc.Risks

• Losing control of the business operations as a
  result of its focus on rapid growth.
• Excess focus on growth could lead to reduced
  quality of operations, increased food wastage,
  and lower profitability of franchise operations
• The growth strategy also puts a heavy strain on
  cash management, since funds are required
• for growth.

8
Boston Chicken, Inc.Key success and risk factors
reflected in the financial statements

• Revenues are recognized for franchise fees and
  development fees when the store opens.
• Revenues from royalties are recognized when the
  store generates sales Pre-opening costs are
  amortized over one year.(notes 2)
• Financing costs on notes receivable to
  franchisees are shown as earned. However, the
  company makes no allowance for defaults on these
  notes. (B/C and notes 8c)

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Boston Chicken, Inc.Analysis of notes receivable
to franchisees

• The notes are structured to give the parent the
  option to convert the loan into equity in the
  franchisee at a 12-15 premium over the equity
  price at formation of the franchise(how do you
  think this option)
• We can estimate the income statement effect of
  changing the assumption for franchisee defaults.

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Boston Chicken, Inc.
Analysis of notes receivable to franchisees(cont.)

• The company shares both the upside and downside
  risk for financed franchise restaurants according
  to agreement of franchise.
• The company avoided consolidating the financed
  developer operations in its financial statements.

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Boston Chicken, Inc.Analysis of notes receivable
to franchisees(cont.)

• The company effectively has control over the
  financed area developers through its option to
  purchaserecommend consolidating.
• How consolidation would change the financial
  statements of Boston Chicken?
• (1) The royalty, franchise fee and interest
  income would be eliminated.
• (2) The company would show its share of the
  sales revenue and cost from the stores.
• (3) The notes receivable would be eliminated and
  the company would report its share of the assets
  and liabilities of the franchisees

12
Boston Chicken, Inc.Are Franchisees Profitable

• Whether franchisees are profitable or not is a
  key factor for accessing the value of the notes
  receivable.
• We can estimates the profitability of store for
  franchisees by the two ways.
• (1) Use data for the company-owned stores
• (2) Use data of franchise profitability
  provided by the company.

13
Boston Chicken, Inc. Use data for the
company-owned stores

• ( in thousand)
• Company operated store revenue
  40,916(P4-32)
• Average number of owned stores
  39.5(3841/2) P4-27
• Revenue per average store
  1,036
• Gross margins(100-15,876/40,916) 61.2
• Less royalty and promotion fees
  10.8(523.75)
• Residual
  50.4
• From this residual margin franchisees have to
  deduct wages and salaries, administrative costs,
  depreciation, interest, and taxes.

14
Boston Chicken, Inc.Use data on franchise
profitability provided by the company.

• The average system sales per week for the third
  quarter of 1995 were 23,388 and EBITDA margins
  were 15-16.( in thousand)(P4-24)
• Annual sales per store 1216(23,38852)
• EBITDA
  194.6(0.161,216)
• Depreciation(see below) (117.0)
• Interest
  (59.3)11,632/(31478)/2
• Net profit before tax 18.3
• Depreciation is calculated as follows
• 1993 Boston Chicken capital expenditure
  49,151(P4-33)
• Number of new owned stores
  28(P4-27)
• Cost per store
  1,755
• Expected life
  15 years
• Annual depreciation per store
  117

15
Boston Chicken, Inc.What additional data would
you request from management

• The analyses indicate that the franchisees are
  profitable at this level of sales(1,216).
• Some franchisees appear to be having cash flow
  problem. Footnote 7 points out Boston Chicken had
  been forced to make advances to franchisees to
  fund local and national advertising.(P4-37)

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Boston Chicken, Inc. What additional data would
you request from management

• The analyses are based on limited information and
  average data is incomplete, since it only takes
  one franchisee to fail, and Boston Chicken will
  incur a large loss in Notes receivable.
• Some additional information
• Same store sales
• Distribution of same store sales
• Late payments by franchisees.
• Security provided by developers such as any
  other assets outside the franchise corporation.

17
Boston Chicken, Inc.How is Boston Chicken
Performing

• Summary ratios for 1993-1994

18
Boston Chicken, Inc. How is Boston Chicken
Performing(cont.)

• Profit margins indicate the companys performance
  for 1994 has improves markedly
• Increase in leverage from the introduction of
  convertible debentures during 1994.(Notes 4
  P4-36)
• Decline in turnover, due to the increase in Notes
  Receivable.(P4-38 notes 8)

19
Boston Chicken, Inc.Future Prospects

• There are wide differences in opinion in the
  market about the companys future prospects. This
  is reflected in the strong growth forecasts made
  by some analysts(as high as 45), and the large
  short position in the companys stock. This raise
  questions of how the market is valuing the
  company
• Analyst forecasts of future EPS are 0.63 in 1995
  and 0.90 in 1996, with 45 growth until 2001.
• But some analysts thought that the quality of
  earnings is very low since all of Boston
  Chickens income comes from fees, royalties and
  interest payment from franchisees, most of whom
  were financed by the franchisers.(P4-24)
• Short interest positions in the stock were at an
  all-time high of 10 million shares, more than 20
  of the shares outstanding and double the short
  interest position at the beginning of 1995.

20
Boston Chicken, Inc.Subsequent Events

• Boston Chicken continued to report increasing
  revenues and earnings in the fourth quarter of
  1995 and throughout 1996
• At the end of 1996, the company provided
  information about loss 128 m
• From May to July 1997 B.C. share price plummeted
  50
• In October 1998 B.C. filed for bankruptcy
• In December 1999 McDonalds agreed to acquire B.C.
  for 173.5 m.