Given the growing concerns about what’s been called the incredible shrinking ASX – a phenomenon caused by the combination of a jump in takeovers and mergers and dearth of floats – you may have thought the Guzman y Gomez IPO would have been broadly welcomed by investors keen for fresh meat.
But instead, we’ve seen something very different.
IPOs can be polarising, especially when private equity or venture capital firms are involved. But several seasoned observers say the emotional response to the float has been unlike anything they’ve seen before.
What’s the big deal?
The divide between the believers and sceptics seems wider than in the past, the reactions more intense, the opinions bordering on vitriolic. As one investor put it: “The market has lost its tiny mind over this one.”
In speaking with a range of people across the market, including dealmakers, investors (bulls, bears and those who claim not to have a dog in the fight), and those inside the Guzman y Gomez tent, a few common threads emerge to explain the reaction.
First, this deal is a rarity: the first really big float in three or four years, one of the biggest IPOs in the past 10 or 15 years, and the only float of any size currently in front of investors. With capital markets generally quiet, all eyes are on this deal.
Second, Guzman y Gomez is a consumer business that many in the market have had exposure to as a customer. It’s hardly surprising that views on Guzman y Gomez’s food and broader offering will colour views on the business. Or as a very senior member of the Guzman y Gomez camp says: “People feel they know the business better than they do.”
Ghosts of history
Third, this is a float led by a private capital investor in TDM Growth Partners, which owns 29.7 per cent of Guzman y Gomez today, and will retain 26.2 per cent after the float.
Private equity and venture capital-led floats have a mixed record in Australia, and the ghosts of duds like Myer, Dick Smith and the middling performance of TDM-led floats, such as Baby Bunting and Tyro Payments, hang heavy over this deal.
That Barrenjoey’s private capital arm holds a stake only heightens the sense among some investors that the deal will make big winners out of the smartest guys in the room.
Fourth, there’s the fact that Guzman y Gomez has been on a path to a float for a number of years, with the company even adopting an unlisted public company structure as part of its preparation.
Add in a passionate, big-talking American co-founder in Steven Marks, and you have a hype machine that has undoubtedly rankled with some in the market.
Fifth, you have a deal that has been very carefully structured by TDM, with a small capital raising of $335.1 million, and just $200 million of that to be injected into the business to fund future growth.
There is no public offer to retail investors, and with existing investors, including Aware Super, Cooper Investors, Hyperion Asset Management, Firetrail Investments and QVG Capital all increasing existing stakes, and US giant Capital Group coming on board late in the piece, local institutional and investors and brokers have been left scrambling for a small pool of shares.
That’s ensured strong demand, with the deal 20 times oversubscribed. While the Guzman y Gomez camp points out the free float on the first day of trade – that is, shares not subject to escrow – will sit somewhere between $900 million and $1 billion, the reality is that a relatively small number of shares are likely to change hands, likely resulting in a strong first day of trade.
Of course, the small number of shares available has also left plenty of investors on the sidelines – and unafraid to throw mud.
The thing that matters
Finally, there’s the biggest point of contention around this float: Guzman y Gomez’s valuation.
To be fair, this is exactly where the attention of investors should be focused. But the five factors above have raised the debate around the pricing of this IPO to fever pitch.
Guzman y Gomez and TDM Growth Partners did themselves few favours by releasing a prospectus that contained multiple ways to value the business: 32.5 times pro forma EBITDA on an enterprise value basis; and 38.2 times what Guzman y Gomez calls segment underlying EBITDA, which excludes share-based payments and lease liabilities.
Clearly, it’s a punchy valuation compared to the closely locally listed peers, Collins Foods (10.8 times EBITDA/EV) and Domino’s Pizza (17.8 times EBITDA/EV), although the Guzman y Gomez camp argues that these companies are franchisees, and points to US Mexican fast-food giant Chipotle (48.9 times EBITDA/EV) and Mediterranean fast-food business Cava (136 times EBITDA/EV) as better points of comparison.
There are a few elements to Guzman y Gomez’s growth pitch, including driving more revenue from each restaurant by getting a bigger share of the breakfast trade and the late-night food market, extracting economies of scale from the back-end infrastructure it has built, and eventually growing offshore.
But investors who have worked hard to strip away the emotion from this float – yes, there are some – are basically ignoring those growth opportunities, and instead focusing on Guzman y Gomez’s Australian store-opening plans: not its long-term vision of 1000 stores in 20 years, but its medium-term plan to add to its 183-store network with 30 restaurants per annum over the medium term (compared with 26 in 2023), rising to 40 stores within five years.
The company has 95 sites in its property pipeline, and 82 per cent of those are drive-thru stores, which offer the best economics.
Existing Guzman y Gomez investors argue that, at its heart, Guzman y Gomez is a story of strong returns on incremental capital and consistently strong growth in underlying earnings, a combination that has proven to produce ASX winners for decades.
For example, a drive-thru restaurant owned by Guzman y Gomez (not a franchisee) costs about $2 million to set up, and delivers annual earnings of $1.1 million, for a return of 55 per cent. The company targets a return on investment on franchised drive-thru and strip stores of 30 per cent, while the return on a corporate strip store is about 30 per cent.
Apply those returns to the proposed store rollout, and Guzman y Gomez is forecasting total revenue growth of 31.1 per cent in the 2024 financial year and 26.1 per cent in 2025 financial year, with EBITDA to rise 46.8 per cent and 39.3 per cent in those years.
The bulls are betting that growth continues out to 2029 and beyond, as store openings increase.
“The forward multiple doesn’t capture the value because it’s really about what the business can make in three, four and five years,” one investor says.
Growth questions
Of course, that means there’s much riding on Guzman y Gomez’s ability to deliver on those store opening projections. And that’s where legitimate questions about its valuation kick in.
Given Guzman y Gomez has 95 sites secured and a large property team working to keep its pipeline well stocked, company insiders are confident the growth projections can be met.
But as the prospectus itself shows, the only fast-food chains to build networks of more than 270 stores have been going for three decades or more: McDonald’s, Subway, KFC, Domino’s, Hungry Jack’s, Red Rooster and Pizza Hut.
None of the newer, healthier fast-food options in this market, such as Grill’d, Roll’d, Schnitz, Sushi Sushi and fellow Mexican chain Zambrero, have managed to get past 240 stores.
Does that suggest these alternatives to mature, cheap and greasy fast-food options have a natural ceiling? Can the local market sustain a chain with 350-odd stores by 2029?
The importance of those two questions is emphasised by the underlying growth trajectory of the business. Like-for-like sales, which strip out the impact of new stores, are set to fall from 15 per cent in 2023 to 7.4 per cent in 2024, and 4.8 per cent in 2025.
By comparison, the Guzman y Gomez prospectus says the Australian quick-service restaurant market is forecast to grow at a compound annual growth rate of 5.9 per cent.
Guzman y Gomez’s float is likely to trade well on Thursday when it hits the board. It will be a good day for Marks, co-CEO Hilton Brett, and TDM Growth Partners, led by Tom Cowan.
But strip away all the emotion about this IPO – the memes, the hoodies, the claims of revolutionising fast food, the barbs of the bears and the zealous belief of the bulls – and we get back to one key question: Can Guzman y Gomez open enough stores to grow into its valuation over the next five years?
That’s the debate the market should be focused on. And it will rage for a while yet.