Deal focus: Allegro reheats the pie

Eight years ago, relations between Yum Brands and the sub-franchisees responsible for operating Pizza Hut restaurants in Australia had soured to the extent that the latter launched a class action lawsuit against the former. They claimed Yum left them financially crippled by embarking on a price war with larger rival Domino's. The sub-franchisees lost, but Yum concluded that only a sale could excise the ill feeling.

“They needed someone else to come in and take over as master franchisor for Australia and reset the relationship. You can’t run a network of small businesses when the level of trust has broken down to that point,” said Jeremy Trouncer, an investment director at Allegro Funds. “They also needed someone to lead a turnaround – to get the brand back to a sustainable level and get it growing again.”

Allegro, a turnaround specialist, provided that solution. The private equity firm’s tenure as master franchisor saw a re-engagement of the sub-franchisees, a reinvigoration of the menu, and a ramp-up in Pizza Hut’s digital capabilities. It recently culminated in an exit to Flynn Restaurant Group, a US-centric franchisor – of brands including Pizza Hut – that is making its first foray into international markets.

The size of the investment on entry was not disclosed, although Allegro was typically writing equity cheques of up to AUD 50m (USD 34m) at that time. Trouncer declined to comment on the private equity firm’s return. He noted that Pizza Hut’s network sales in Australia have doubled to AUD 270m, while the business has moved from loss-making into “a strong profitable position.”

Allegro’s priority was mending the business, rather than expanding it. There were approximately 270 locations when it bought Pizza Hut – including 60 picked up from Eagle Boys, Australia’s third-largest pizza chain, which went into administration around the same time – and there are about 260 today. New store openings were offset by efforts to pare the long tail of underperforming outlets.

Reengaging the sub-franchisees involved ending the price war with Domino’s. The brands undercut one another to the point where a pizza cost as little as AUD 4.95, but they were mismatched. Domino’s had twice as many outlets, so it was better positioned to absorb low pricing through economies of scale; the Pizza Hut class action lawsuit claimed the pricing strategy had forced 32 franchises out of business.

Allegro also emphasized product quality. “Once we got the product to people – and we significantly reduced the delivery time through technology – we saw a huge uptick in repeat customers because they recognised it was good pizza at good value,” said Trouncer.

Delivery accounts for about half Pizza Hut’s revenue but the business historically trailed its peers in terms of speed and reliability. While Domino’s showcased its technology through marketing gimmicks like delivery by drone and autonomous vehicle, Pizza Hut’s website was known for crashing during peak ordering hours on Friday and Saturday nights.

Allegro introduced a stable and easy-to-use digital interface. This was demonstrated at the firm’s annual general meeting a few years ago when LPs were invited to place pizza orders and delivery was completed before the end of the session. “It’s not just about digital. You need to build up a franchisee’s capacity to handle those additional customers who are coming through digital channels,” Trouncer added.

With average weekly store revenue rising from AUD 12,000 to nearly AUD 22,000, Allegro received bigger marketing contributions from franchisees, which could be used to grow the network. The 260 stores are run by 220 sub-franchisees, but the improvement in store economics has prompted numerous one-shop operators to expand.

Domino’s remains the dominant local player with over 750 stores and a 40% market share, but Trouncer said Pizza Hut has gained business from Crust and smaller independent operators. Once this became apparent, Allegro began planning its exit, only for COVID-19 to intervene - materials and labour were not available to build new stores. Flynn was one of several parties that approached the private equity firm post-pandemic.

The new owner started out as an eight-restaurant Applebee’s franchise in 1999 and now claims to be the largest restaurant franchisor in the US with more than 2,400 outlets under the Pizza Hut, Taco Bell, Panera, Arby’s, and Wendy’s brands. Annual sales amount to USD 4.2bn. CEO Phil Reed said the latest acquisition represents “the beginning of an exciting new growth chapter for Pizza Hut in Australia.”

The terms of the arrangement between Yum and Allegro reflected the difficulties Pizza Hut faced at the time: Yum offered discounts on royalty fees on the condition that Allegro invested in the network. With Flynn’s arrival, the master franchise agreement has likely reverted to the traditional model, where the franchisor commits to an expansion path and the brand owner reels in the royalties.

“There is a lot of white space to grow unit numbers over here and hopefully the momentum they have coming into it will continue,” said Trouncer, who believes there is scope to reach 350-400 outlets in the medium term. “That’s where Flynn can get a lot of upside.”

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• Topics
• Australasia
• Trade sale
• Consumer
• Australia
• Allegro Funds
• food & beverage