Leverage is Like Alcohol

Friends of Branded!

Happy Saturday and I hope you had a great week.

In a finance class I took decades ago, I remember the professor saying that “leverage is like alcohol, it can make good times better and bad times worse.” Berkshire Hathaway’s Charlie Munger was less two-sided when he compared leverage to alcohol. On this point Mr. Munger famously said, “there’s nothing wrong with alcohol, but too much of it will kill you” (Charlie certainly was subtle, right?).

This week we witnessed a real-world, real-time case study of that lesson playing out in the restaurant industry with the bankruptcy of Sailormen Inc., one of the largest Popeyes franchisees.

To be clear, this isn’t a Popeyes problem and this isn’t a chicken problem. This isn’t even an execution problem.

This is a leverage problem that’s being exposed by a tough operating environment.

Sailormen didn’t suddenly forget how to run restaurants, but they did run into a familiar cocktail (I figure I’d to stick with the alcohol analogy). Restaurant operators are experiencing rising labor costs, higher food inflation, long-inflexible leases, slower traffic growth, and a capital structure that assumed good times would last longer.

This is where Mr. Munger’s analogy becomes painfully relevant: leverage works, until it doesn’t, and when it turns, it doesn’t just hurt, it ends the party.

During the good times, leverage feels great. Sales are growing, labor is available, debt is cheap and same-store sales cover fixed annual costs easily. Let the good times roll!

In this type of environment, leverage amplifies returns, accelerates growth, and makes operators look brilliant.

But that’s not what Charlie Munger was referring to when he warned of leverage. He was referring to what happens next. What happens when conditions change, even modestly? When leverage stops amplifying success and starts amplifying mistakes? This is what we’re seeing now.

Many of my friends believe restaurants are about creativity and of course there’s some truth in that. But the industry is also about math, and you can’t operate your way out of bad math.

Great operators will still lose if fixed costs are too high, b/c debt service eats flexibility and lease terms don’t bend.

Of course, execution matters, but capital structure decides survivability.

Long Leases + High Leverage = Zero Margin for Error!

When sales soften, leverage doesn’t renegotiate, landlords don’t wait and debt clocks don’t pause. Optionality is oxygen and many operators gave it up in order to grow faster (b/c growth was deemed the most desired and important factoid in measuring success).

Scale is NOT a safety net and scale without resilience is fragile. Bigger balance sheets just mean bigger consequences.

What does the bankruptcy of Sailorman mean for Quick Serve Restaurants (“QSR”)?

Great question.

Franchisee economics are no longer a “back-office issue.”

When highly leveraged franchisees struggle, new unit growth slows, remodels get delayed, marketing spend tightens and brand consistency erodes.

Growth fueled by leverage looks great on a page in a power point presentation, until it doesn’t show up in cash flow. Brands that win the next decade will stress-test franchisee models, prioritize durability over speed and design growth plans that survive bad years, not just good ones.

I’m not remotely trying to throw shade at the folks from Sailormen, but I do want to use what I understand about the bankruptcy as an industry-level wake-up call! The Sailormen bankruptcy does NOT mean that the restaurant industry is broken. What it does signal is that the tolerance for leverage has dropped.

Alcohol didn’t change and neither did leverage, but the environment did. And in tougher environments, moderation matters.

Here’s what the C-suite needs to be thinking about. Growth alone isn’t the strategy; survivable growth is the strategy! Cheap debt masked risks for a decade, but that era is over. Leverage deserves the same skepticism as any volatile input cost. Operational excellence can’t offset inflexible capital structures and here’s the punchline, you need both! Finally, if leverage looks like a tailwind in every model, you’re not modeling reality.

Quick sidebar b/c I can’t write about modeling and stress-testing and not give a shoutout to our friends and partners at Bullet Point Network (“BPN”), a full-suite, connected research and analysis platform. Built BY investors FOR investors, the BPN platform combines cutting-edge AI with your team’s expertise to stress-test assumptions and quantify upsides and downsides to help you make confident decisions, quickly and easily.

Now back to our regular programming. 😊

Charlie Munger’s lesson belongs on every restaurant board agenda: leverage makes good businesses look great, but good businesses with excessive leverage fail faster when conditions turn.

The next winners in restaurants won’t be the fastest growers, the most leveraged or the most aggressive. They’ll be the ones who treated leverage the way Mr. Munger treated alcohol, with resect, with limits and with humility to know when to slow down.

Again, the Sailormen bankruptcy isn’t about bad operators, but rather about a tough environment where high costs, expensive debt, long leases, and thin margins represent a combination that can break even good businesses.

In tougher environments, moderation matters!

The next era of restaurants will reward margin, flexibility, and resilience, not just unit count. Remember, growth is optional, but survival is not!

It takes a village.

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On my 9-year-old daughter’s Top 5 list of her favorite foods is the hotdog, and her second favorite brand of hotdog is Nathan’s Famous (with Papaya King holding the top spot).

The deal that caught my eye this week was Smithfield Foods acquisition of Nathan’s Famous in an all-cash deal of about $450mm. Smithfield has held an exclusive license in the US for Nathan’s since 2014, and the license was scheduled to expire in 2032. The license Smithfield held allowed the pork processor the right to manufacture, distribute, market, and sell Nathan’s dogs and other products through its retail channel and to manufacture and distribute Nathan’s products through its foodservice channels.

The acquisition of Nathan’s by Smithfield will secure these rights in perpetuity.

If you’re a restaurant operator, Quick Serve Restaurant (“QSR”) brand leader, or C-suite executive, the Smithfield Foods acquisition of Nathan’s Famous isn’t really about hot dogs. It’s about who owns the guest relationship.

For decades, food manufacturers have sat comfortably behind the curtain, literally grinding, processing, packing, and shipping. Restaurants and consumer brands did the storytelling. The manufacturer supplied the product, and the operator owned the guest.

The lines just got blurrier.

Smithfield didn’t just buy volume, they bought heritage, trust, nostalgia, and cultural relevance. Nathan’s isn’t just protein in a casing, it’s Coney Island, July 4^th, Americana, and a century-old consumer promise.

And Smithfield decided that owning that promise, and not just supplying it, was worth $450mm.

The clear signal from this acquisition is that manufacturers want brand equity, not just margin efficiency.

Restaurant operators, your suppliers want to be brands (and some already are). Your food partners want consumer recognition, shelf presence, marketing leverage, and direct demand pull. You therefore have to ask yourself, are your suppliers purely partners or they quietly becoming competitors for mindshare?

Operators who rely on “unbranded” inputs may find themselves at a disadvantage when (i) guests recognize the brand behind the products; (ii) menu callouts (“made with ___”) become marketing assets; and (iii) consumers trust the manufacturer brand more than the house brand.

This doesn’t mean it’s bad, but it does mean you need to be intentional.

The brands that win will control their own story, have flexibility across dine-in, QSR, retail and licensing and avoid being boxed into a single channel.

Nathan’s can live on a grill, in a freezer, on a menu board (this is a nice moment to include our partners at Vistify, right?) and in a grocery aisle. That’s power my friends!

Vertical integration is no longer just for the Big Dogs (pun intended). Historically, owning supply was about cost, but now it’s about brand protection and consistency.

Manufacturers with brands move faster b/c they don’t need permission to market. QSR brands that can’t match that speed risk becoming distributors of someone else’s equity.

This deal marks another example of the Closed Kitchen Economy b/c when transparency is limited, brands with history win, names matter more than processes, and familiar beats functional.

Smithfield didn’t buy Nathan’s b/c it needed better hotdogs; it bought Nathan’s b/c the consumer already believes.

If you’re running a QSR, or a portfolio of brands, ask yourself, are you building brand equity or just operational efficiency? Do you control your most important ingredients, stories, and symbols? If your suppliers started talking directly to your guests, would you be ready?

The next wave of competition isn’t just across the street. It might already be in your freezer!

The Branded portfolio company that this deal made me think about is Brooklyn Dumpling Shop. This brand is already a triple-threat with its (i) restaurants; (ii) consumer packaged goods; and (iii) foodservice verticals. Stay tuned for this company becoming a quadruple-threat and securing greater control over its entire operation (but that’s an update for another time). 😊

To learn more about opportunities with Brooklyn Dumpling Shop, please click here.

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