The best hamburger I’ve ever eaten in my life was at a Whataburger in Dallas, Texas within driving distance of the DFW Airport. For like three bucks and tax, you would get this huge piece of meat that was larger than anything that you could find at another restaurant. And for a few more pucks, you get a huge dollop of fries and a gigantic soda. I loved it. The guy who founded the place, Harmon Dobson, famously stated that his goal was to make a burger so big that you’d have to hold it with both hands to eat.
The basis for the burger chain’s business success is because nothing about it seems like it was run by MBA graduates and generic corporate executives. In a world where alternatives like McDonald’s have specific instructions for the single funnel of salt on the fries or the single pump of chocolate for a McFlurry, Whataburger is the business that tries to make you full rather than run an “efficient restaurant.”
There are reasons why this is the case. If you are the Hobson family, you are sitting on 820+ locations generating $2 billion in sales and $500 million in annual profits. When there is $41 million rolling into your family’s bank account every month, you pay close attention to the integrity of your business. You know people love the ketchup that hasn’t been watered down, the huge burgers that are bigger than anywhere else, and the giant fistfuls of fries. There is no real temptation to do something stupid to cut costs because you are drowning in cash and the status quo is propelling you towards the richest one hundred families in the world.
When a private equity firm such as BDT Capital takes over, the view of the business becomes different. You are no longer satisfied just bringing in tens of millions in profits per month, you need to have growth in those profits. The higher the number the better. I think McDonald’s famously hit a point in the 1990s where, across its 30,000 restaurants, it became true that one less bit of Coca-Cola syrup in the soda fountain meant costs were lowered by $1 million across the entire system.
A Whataburger patty is 122.4 grams (about 4.3 ounces), a bit larger than a quarter-pound patty that you’d see at McDonald’s which is about 113 grams. If you are BDT, it is really easy to look at Whataburger’s hamburger and say, “Gee, if we decrease the size of the patty from 122 grams to 117 grams, we are still 4 grams bigger than what McDonald’s got, but now profits of $41 million per month will be $42.5 million per month.”
In short, the shift from family-owned to private equity ownership means that the company’s focus will inevitably shift from taking actions that grow its competitive advantage to trying to take actions that will boost profits without losing customers. That’s a dangerous tight-rope that is one step away from weakening the business.
In particular, I would be very curious to know what type of debt burden BDT Capital had to take on in order to acquire the majority stake in the company. Large franchises are valued at between 15-20x profits. If Whataburger earns around $500 million in profits per year, we are talking about a $7.5 billion to $10 billion total valuation for the firm. If BDT has a majority stake, it could have had to borrow $4-6 billion to fund the transaction.
What happens if you borrow $5.5 billion at a 4% interest rate that needs to be repaid over 15 years? You have $40 million per month debt payments. Borrow for twenty years, you have $33 million per month payments. Whatever the terms of the financing may be, there is now a claim on Whataburger’s cash flows that didn’t exist beforehand (to be fair, Whataburger could have carried sizable debts during the Dobson family’s ownership for all I know since it is a private company and its financial figures are not disclosed).
With this claim on Whataburger’s cash flows due to the debt necessary to fund the takeover, there is now a reason to squeeze the customers for every little bit of extra profit. Debt forces companies to cut costs in an attempt to boost profits for the short term at the risk of cheapening the brand in the eyes of its customers’ over the long run.
I understand that right now, Whataburger is reassuring all of its regulars that there will not be changes to their dining experience. I think every major corporate takeover of any beloved franchise has always resulted in the same declarations. Usually, what happens is the private equity company takes over, is quiet for a year or two and waits for people to move on and forget that the takeover really occurred, and then get down to work making their changes that make each franchise location more profitable.
The odds are high that your 2022 Whataburger meal will be smaller and more expensive than your 2019 Whataburger. Whataburger came to exist because McDonald’s and White Castle became too stale and corporate for Texas, and if Whataburger becomes McDonalds-ized, the joy of capitalism is that some young Texan with a dream of starting his own burger joint might find the competition a little easier.