Saturday, September 24, 2011

Carlyle Group's Cheese Hedge: Franchisee vs. Franchisor

The Carlyle Group is in talks with Bank of America to buy NPC International, the largest Pizza Hut franchisee in the world.  BOA needs Tier 1 capital and Carlyle has lots of cash to put to work.  The deal price is reported around $800 million.

Carlyle owns Dunkin' Brands, which served as the franchisor for Dunkin's Donuts and Baskin-Robbins.  Carlyle's Dunkin' saw lawsuits against franchises soar.  Will Carlyle's lawyers have to change hats and legal tricks in the case of Pizza Hut?

NPC offered an interesting item in it's 10-K:

Commodity prices such as cheese can vary. The price of this commodity can change throughout the year due to changes in supply and demand. Cheese has historically represented approximately 30%-35% of our cost of sales. We are a member of the UFPC, and participate in cheese hedging programs that are directed by the UFPC to help reduce the volatility of this commodity from period-to-period. Based on information provided by the UFPC, the UFPC expects to hedge approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases for fiscal year 2011 through a combination of derivatives taken under the direction of the UFPC.
Lehman Brothers failed due to "off balance sheet" derivatives gone sour and high leverage. 

Carlyle and NPC share a love for leverage:

NPC is “highly leveraged,” which could hurt the firm’s ability to raise capital or repay debt, the company said in a February regulatory filing. The operator said it had $402.4 million in loans at year-end, $44.2 million in cash and $58.1 million available under a credit facility. 
Oddly, NPC's 10-K stated the company had roughly $600 million in capitalization.  Total assets of $825 million include nearly $200 million of goodwill. 

Deal details remain to be seen, but rest assured Carlyle plans to make money multiple ways from any deal.  Might Chinese Yashili milk make Pizza Hut cheese?  Could CP Pokphand provide pizza toppings?  Might the crust be fortified with David Rubenstein's NBTY muscle builder?  Expenses must be cut to fund Carlyle's annual management fee.