On the Margin

Development pressure hits Freshii

Blog: As investors demand unit growth, projections can get aggressive

This post is part of the On the Margin blog.

Earlier this week, Freshii Inc. stunned investors and analysts by cutting its projections for unit growth by as much as 44 percent.

Investors responded by t. 

The story of Freshii’s revelation on development is an unfortunate symbol of modern industry reality: Over-hyped valuations from investors in the fast-casual space are pushing companies to make rosy growth promises that are getting harder to keep. 

Investors have poured money into the fast-casual space in recent years. While IPOs are suddenly non-existent as public equity investors look at the business with a more skeptical eye, private equity funds and other companies continue making bets on small, fast-casual growth chains.

These investments come with a caveat: The business has to grow. And that growth comes from more locations.

Freshii is a perfect example, albeit one that did so with a public offering. The fast-casual healthy food franchise went public in Canada earlier this year. The company promised massive growth.

Those projections included another 150 to 160 locations this year, a substantial increase for a chain that had 244 locations at the time of its January initial public offering. 

That growth was expected to continue, with Freshii saying it would have between 810 and 840 locations by the end of 2019. That’s a compound annual growth rate of about 83 percent.

Franchising by its nature can lead to such insane growth because brands get many different investors to finance growth. There are numerous examples of brands that have grown rapidly using the business model — but even then Freshii’s growth projections were remarkably aggressive. The company has used unique marketing and other strategies to help drive that unit growth.

This is what investors were banking on with the January IPO. The chain’s stock went up to nearly $15 a share in March, as investors put their money behind a fast casual concept that was seemingly going to be everywhere very soon.

I’m not sure if Freshii could have generated the interest from investors without those rosy prognostications. Investors are looking for companies of a certain size. If Freshii had gone public saying it would get to 500 locations by the end of 2019, the company might have had a tougher time getting investment bankers who were willing to jump on board its IPO.

Less than a year into its life as a public company, it’s clear that Freshii doesn’t have the infrastructure in place to support that kind of growth. In resetting expectations this week, the franchise said that its development team was “stretched” and that multi-unit franchisees were being more deliberate with development than they expected. That, and 18 Freshii locations inside Target locations were closed due to poor performance.

There’s a lot of pressure on chains to grow at rates faster than their competitors. Companies as a result push the envelope on development and unit growth.

There is plenty of evidence that this aggressive development, with all these chains doing it at the same time, is keeping down industry traffic and same-store sales. It is also driving up lease costs because of competition for real estate.

Ultimately, absent something that pulls up consumer spending en masse and leads them to eating out a lot more, the same-store sales challenges will continue. And with the higher lease costs that could put a further dent in companies' development and unit-growth demands. 

Jonathan Maze, Nation’s Restaurant News senior financial editor, does not directly own stock or interest in a restaurant company. 

Contact Jonathan Maze at [email protected]

Follow him on Twitter: @jonathanmaze

TAGS: Finance
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