Many Taco Bells Hit By Money Crunch

Numerous Taco Bell Corp. franchisees, squeezed by a drop in sales, are delinquent on loans they took out to buy restaurants from the Irvine chain’s parent company, according to sources familiar with the transactions.

The extent of the delinquency problem isn’t clear, but as many as 1,000 restaurants--one-fourth of the Taco Bell franchised outlets in the United States--could be “at risk unless something is done,” said analyst Damon Brundage at Raymond James & Associates.

He made the assessment after talking with officials of Taco Bell’s parent, Tricon Global Restaurants Inc.

During Tricon’s short life as an independent company, selling stores to franchisees has become almost as important to its well-being as selling pizzas, burritos and buckets of chicken.

The strategy of refranchising Taco Bells and other restaurants, as the practice of converting company-owned restaurants into franchised units is known, has given Tricon’s earnings a hefty boost since it was spun off by PepsiCo Inc. in 1997.

But some of the refranchising effort is now coming back to haunt the company, which also owns the Pizza Hut and KFC chains.

Indeed, bankruptcy filings by some distressed franchisees are a real possibility. In recent months, two large Taco Bell operators did just that.

“Delinquencies have been on the rise,” said Jeffrey Butcher, controller of Bay View Capital Corp., a San Mateo concern negotiating with Tricon on a possible solution.

A Bay View unit had been a major lender to Taco Bell franchisees eager to add outlets.

For Tricon, some of that solution may involve repurchasing units. Brundage estimated that 200 or so stores is a “worst-case scenario.”

The company also may guide franchisees to lenders willing to stretch out loan payments in exchange for higher interest rates. Tricon also may be forced to guarantee debts of franchisees it wants to save, some on Wall Street say.

In addition to slumping sales, the franchisees’ dilemma may have been exacerbated by optimistic sales figures, and consequent premium prices, that some paid for refranchised outlets, sources familiar with the transactions say.

Since being spun off from Pepsi, Tricon has refranchised about 3,900 of its 30,200 Pizza Hut, Taco Bell and KFC restaurants. That activity has generated a handsome cash flow. In 1999 alone, cash flow from refranchising totaled $916 million--$351 million more than net cash from operations.

Tricon badly needed the money. Much of its refranchising proceeds went to pay down the heavy $4.5-billion debt burden Pepsi strapped on Tricon before it became an independent company. That debt is now down to about $2.4 billion.

In 1999, the last year for which 12-month figures are available, refranchising accounted for about 30% of Tricon’s earnings per share. For the nine months ended Sept. 2, the contribution was close to 24%.

Tricon benefited from easy credit and low interest rates during the height of its refranchising. As a result, “in some instances franchisees leveraged up their business to levels that in retrospect weren’t prudent,” Brundage said.

Often franchisees bought stores in bulk, some a dozen or more at a time, perhaps without carefully assessing the earning power and potential problems of each.

Tricon undoubtedly was eager to get many of those restaurants off its books. Indeed, the company used the adjective “marginal” once in an annual report to describe some Pizza Hut units it had refranchised.

One underlying tenet of refranchising is that independent franchisees tend do a better job of running a store than a company employee because the franchisee’s personal wealth is invested in the outlet. And because franchisers like Tricon are paid a percentage of the gross as well as fees, their return on investment can be higher on a franchised store than if they owned it.