MTY's High Franchise Failure Rate
Updated February 3, 2022
MTY admits it uses kickbacks to enhance its revenue albeit in cloaked and sanitized language. Its 2020 Annual Report discloses that kickbacks “are recognized as revenue… and are recorded in other franchising revenue” (PDF pg. 66). Cold Stone’s 2021 federal disclosures, for example, reveals that MTY charged franchisees more than $24M (“approximately 12.5%… of revenue”) in kickbacks that may be used in MTY’s “sole and absolute discretion” (PDF pg. 54).
Kickbacks are paid by franchisees in addition to royalties and advertisement fees. As such, they can be deadly to a company’s franchise network and thus, twice a burden to franchisees with zero benefits. They are a quick cash source for franchisors. Because they are added to the company’s revenue, they may also give the appearance that management is performing at a high level.
Kickbacks can be viewed as a corporate line of credit that is not repaid in cash, but in store closures. They may also be viewed in the context of a bigger stronger kid taking lunch money from his classmates simply because the victims can’t fight back. Franchisees have little or no defense against the franchisor’s unrestrained kickbacks other than to close their unprofitable stores, which is exactly what’s reflected in MTY’s high failure rate. While kickbacks benefit the company’s largest shareholders like MTY’s chairman Stanley Ma, they also disproportionately—negatively impact most long-term stakeholders without inside information.
In 2016, MTY acquired 2,879 locations from Kahala for the questionable price of $394.2M (PDF pg. 11). Since then, in just five years, MTY has taken $239M in kickbacks and closed 2,594 MTY locations as of Q2, 2021. That’s only 285 locations shy of Kahala’s original count. A total of 1,769 (68%) MTY locations were closed in the four-year period before the pandemic, therefore, Covid was not the issue. During that period, the company averaged 442 closures each year between 2016-2019, and averaged 619 closures per year between 2016-2020. This rapid closure rate has had a devastating effect on MTY’s underlying finances.
During its Q4, 2021 investor conference, MTY CEO Eric Lefebvre committed to addressing MTY’s franchisee profitability issue. Nearly two years, later during his Q3, 2021 investor conference on October 8, 2021, he acknowledged MTY franchises are struggling and that “getting our franchisees to renew is certainly a challenge.” He also admits, MTY’s closures are due to a lack of profitability among its franchisees. He says he still has no timeframe for reversing the negative growth. However, he did not discuss the company’s reliance on kickbacks, which was 82% of the company’s earnings in 2020. This money comes out of the pockets of franchisees and makes them less profitable. Nor did he discuss Chairman Stanley Ma’s $43 million insider trade, which was a part of an elaborate scheme that increased Ma’s already substantial wealth by $214M during the pandemic alone.
Because kickbacks may be viewed as a quick, non-reimbursable source of millions in cash, irresponsible franchisors sometimes misuse or over rely on them to resolve financial gaps. Quiznos is the restaurant industry’s most infamous example of a franchise network collapsed under a kickback scheme. Between 2007-2017, the company declined 427 locations on average each year before it was sold for salvage value. Just as Quiznos relied on kickbacks to pay its $800M debt, MTY uses kickbacks to increase revenue and earnings in order to improve the appearance of management performance.
The demand for franchisees within a franchisor’s damaging kickback scheme is similar to the demand for investors within a Ponzi scheme. It turns out, kids don’t like having their lunch money stolen. As a result, when word spreads that investments are failing, even franchisees that would have stayed and struggled on, cry foul and leave the system. Word also spreads to potential franchisees and the pool of new investors dries up. The exodus of current investors and the lack of new investors causes the scheme to fail. As MTY CEO Eric Lefebvre put it, “there will always be some store closures and—but hopefully, we’re going to have better store openings… things are going to go well.” Things are clearly getting worse.
A lot of current and prospective franchisees contact us through the website or by other means. They express tremendous concern about MTY’s false statements, cover-up, kickbacks and high failure rate. The sequence is almost always the same. They fall in love with a concept usually because they patronize it and then conduct online research. After finding and reading our website, most likely look to other franchising companies or contact us for guidance. We’re not aware of one potential investor that has gone forward, so we don’t think things are going well.
On the other hand, just as Quiznos is proof that kickbacks are deadly, they are also proof that, when kickbacks are eliminated, the franchise network can grow.
Thus, as word of MTY’s closure rate of 11.1% through year-end 2020 begins to reach more potential franchise investors through our website and by other means, we have little doubt MTY’s pool of potential investors will dry up. At that point, MTY will likely look to acquisitions to force, perhaps resistant pools of franchisees that know of the company’s failed business model, into their network. Nevertheless, closures and litigation will almost certainly accelerate.
We believe that a lack of new investor interest, store closures, litigation and perhaps regulatory and prosecutorial investigations will shrink MTY to a fraction of its current size. Long term stakeholders (i.e. franchisees, institutional investors, lenders, etc.) will likely pay the largest toll in the end.