The Better-Burger Business Model

Last week I popped “burger” and “private equity” into Google, and the first hit returned was not Burger King Holdings Inc. (NYSE:BKC) — the No. 2 U.S. burger chain, whose PE backers TPG Capital, Bain Capital LLC and Goldman Sachs Capital Partners have enjoyed fat returns from after buying it from Diageo plc in 2002, reviving it, taking it public and selling down their stakes. The oft-toted PE success story was not first on Google; with top billing on the page was the latest news from Smashburger Development Co., the Denver, Colo., eatery founded by and backed with $15 million from Consumer Capital Partners that promises “the best burgers you ever tasted.”

The company’s approach to the premium burger involves choice ingredients and, as Houston Chronicle blogger Alison Cook puts it, a “splat-and-frizzle cooking gimmick” — or smashing the meat down on the griddle to lock in juiciness. The company’s approach to building a business involves a rather aggressive growth-by-franchise tear.

So, is this growth model a good one for the recession? And what of the niche/upscale/better burger market in general?

Smashburger on May 11 announced its latest franchise agreement with a group in Texas. The deal adds 10 restaurants to its system, brings the number of total franchisees to 177 and moves the company along on its five-year-path to 500 restaurants — 150-200 corporate-owned and the balance franchises — according to Smashburger chairman and Consumer Capital managing partner David Prokupek. Smashburger, so far, operates in Colorado, the West and Midwest, and with its franchise agreements, it will be near-national by year’s end.

Burgers overall, Prokupek says, are a $100 billion market. And better burgers, he says, are as a $30 billion category within five to 10 years. Smashburger hopes to be a leader in the space, alongside Five Guys Enterprises LLC (Five Guys Burgers and Fries), and of the handful of other smaller players, he expects a few to rise the ranks. The economy, Prokupek says, is playing into the company’s growth plan as real estate prices have tumbled, making for lower rents, and likely more options. Further, “consumers are just stepping back,” he says, from opting out of dining everywhere from big steak houses to casual spots like Chili’s Grill & Bar and Applebee’s.

Additionally, Tom Forte, a director and senior research analyst with Telsey Advisory Group, says that given the tight credit markets, it’s hard for some franchise models to get credit, like Domino’s Pizza Inc. (NYSE:DPZ), so those that are well-capitalized may be at an advantage. Indeed, there are examples of niche dining concepts — like frozen yogurt chains Pinkberry Inc. and Red Mango Inc. — that despite the pullback are expanding, Forte says. These two, for their part, are fresh off funding rounds. Pinkberry in April announced a $9 million round of funding from undisclosed new and return investors with plans to open stores in the Middle East and to expand domestically, including in Northern California. The company in 2007 took a $27.5 million Series A round led by Maveron LLC. Red Mango in November took a $12 million round from CIC Partners LP’s CIC Advantage Holdings LLC. Smashburger, Prokupek expects, will be cash-flow-positive by year’s end, well-funded through ’09 and may seek other financing options in 2010.

And what about the competition? Five Guys, born in the Metro D.C. area, and smaller players like New York’s Goodburger are competitors in premium burger niche. Lorton, Va.-based Five Guys spread outward from the D.C. area — also on a growth-by-franchise tack — to now have more than 300 locations in more than 25 states. Both companies are in the better burger space, Prokupek says, but he sees points of differentiation — Smashburger with a more loungey feel than Five Guys’ peanut-shelled floor and a broader range of offerings.

The premium hamburger concept, Forte says, certainly has a market. McDonald’s Corp. (NYSE:MCD) is getting into it with the angus burger, Burger King’s in there as well, and it’s something Carl Jr.’s has always been good at, he notes. He concurs there is an expanding market opportunity as customers tone down their dining.

So is this a recipe for success? For some in the restaurant business, things are pretty tough out there right now. For other burger-restaurant-recession-related news, mine The Deal Pipeline and you’ll find:

May 18: OSI Restaurant Partners LLC (parent of Outback Steakhouse) sold Cheeseburger in Paradise to Steve Overholt, the chain’s president, for $2 million.
May 7: Burger King franchises for sale, others going bankrupt
April 9: Fast-food chain Fatburger Corp. has put two subsidiaries into Chapter 11 to restructure debt and reject costly leases and contracts.
Feb. 9: Madison Square Park’s Shake Shake is a tech dealmaking hot spot