McDonald’s Acquisition: Carl Jr. Corporation

Your written assignment is as follows:

1. Locate a publicly traded company in an industry that interests you. Find a publicly traded competitor which is suitable for a merger or acquisition with this firm.
2. Write a ten page double spaced paper (not including exhibits) on why the company should be acquired and what purchase price should be paid. Your analysis should include the “real” reasons behind the merger and not the standard answers. Major topics should include:  A brief background of the industry which the company operates, a background on the company and the management team, the acquisition purchase price (you may want to include a base purchase price and the maximum purchase price your firm would be willing to pay), what makes this merger a good fit, a brief strategy on how the company will operate after the merger, and how the deal would be financed.
3. You have an enormous amount of material to use for this project. Annual Reports and 10Ks can be obtained by contacting the company’s Investor Services Department.

Two of the major evaluation criteria for the paper are:

1)   How well do you apply the financial concepts and analysis for your proposed acquisition.

2)   The quality and originality of the recommendations (and how well they tie to your analysis) of the company.

The paper must follow APA Format. The maximum length of the paper is 15 double spaced pages, excluding references and abstract. You may attach as many pages as appendixes of data, tables, etc. as you need. A financial model with a discounted cash flow valuation is required and should be included in the paper to support your analysis.

You are to complete the research paper using the American Psychological Association (APA) writing style and guideline for references format. Proper attribution is required for all sources.

You can download the student style guide from the American Psychological Association web site or you can purchase the APA style guide from the book store. As most referencing information is available either on the APA web site or in the course documents–the purchase of the guide is not essential. The guide will inform you as how to reference your paper correctly.

Papers in this class are to be RESEARCH PAPERS. Remember that work that you use from other authors MUST be referenced. You should never cut and paste other’s work with the idea of paraphrasing later.  This is an area where students have made academic mistakes in the past.  Remember that even a paraphrased idea must be cited.  Please use the above mentioned APA website for a reference.  If, for whatever reason, you are confused, please contact me and I will be happy to help you.

Also note that the internet is a wonderful tool, but should not be your primary focus for research.  Also note that Wikipedia should not be used or cited as a reference. 

Use the library. You have access to academic journals. Academic research is far more valuable than random internet searches.

ANSWER

McDonald’s Acquisition of Carl’s Jr. Corporation

Introduction

Business managers must find and pursue growth openings to improve their organizations’ financial performance and market position in today’s progressively competitive and financially constrained environment. Growth strategies are multiple, and they include mergers and acquisitions, among others.  Businesses can expand by mergers and acquisitions. A merger is a business expansion strategy whereby two or more entities or corporations combine to form a single new company. On the other hand, acquisition is a business undertaking whereby one company purchases or takes over another company without creating a new company. Generally, a merger and acquisition involve the union of two or more companies to form competitive cooperation (LIN, Lee, & Kuo, 2013). In this paper, McDonald’s plans to acquire Carl’s Jr. Corporation, one of its competitors in the food industry. The current report analyzes this acquisition, such as why Carl’s Jr. Corporation should be acquired and the purchase price payable. The analysis also includes why this acquisition is appropriate and how McDonald’s will operate after the merger, and how the acquisition will be financed. Both companies operate in the quick-service restaurant (QSR) industry, famously known as the fast-food industry. McDonald’s is one of the leading chains in the industry that have gained an international competitive advantage through mergers and acquisitions. On the other hand, the competitive advantage of Carl’s Jr. is effective customer service and product differentiation. Carl’s Jr. operations are largely within the U.S., while McDonald’s operates beyond the borders of the U.S.

The Quick Service Restaurant (QSR) Industry

In the QSR industry, restaurants serve meals at relatively lower prices and usually provide fast services, limited table service, and a limited menu. These establishments are famously known as fast-food restaurants. The QSR industry in the U.S. is one of the most well-established globally (Gilbert et al., 2004). The majority of the biggest international QSR brands originate from the U.S. and dominates a huge global market share. In 2020, the total revenue of the U.S.’s QSR industry was $239 billion, a slight drop from the previous year due to the effects of COVID-19 (Nicola et al., 2020).

There has been a steady revenue growth in the QSR industry for the past five years as expedient affordable food was becoming popular among consumers. The stereotypically low price point of QSR industry products classically gives quick-service restaurants a competitive advantage over other foodservice sectors. Increasing household income levels have increased the disposable income of the people and encouraged huge spending on discretionary items; therefore, increasing overall competition. With the rising independent and fast-casual chains quickly gaining market share, major QSR brands have had to modify their menu provisions to compete effectively. The QSR industry will probably continue to play a significant role in the foodservice sector over the next few years. Specifically, various state administrations have begun to lax COVID-19 restrictions to enable restaurants to reopen at a limited capacity (Nicola et al., 2020). In the future, the ability of the industry to offer convenient food at competitive prices will remain widespread as people keep on looking for convenient and affordable food options. Also, as fast-casual eateries become more common, the QSR industry revenue will probably experience sustained growth. Nevertheless, the industry will possibly remain highly competitive, and industry players will need to compete on service quality and price.

McDonald’s Corporation

McDonald’s is the largest resonant chain in the QSR industry, both in the U.S. and across the world. The company was established in California in 1940 as a barbecue restaurant. Presently, the restaurant’s main products are soft drinks, cheeseburgers, breakfast items, ad hamburgers. Currently, McDonald’s serves sixty-five million customers daily across 120 nations globally. The main expansion strategies of McDonald’s include mergers and acquisitions, effective marketing, product differentiation, high-quality products, and competitive customer service. During the initial phase of expanding its business, McDonald’s utilized product differentiation and high-quality customer service as the main marketing strategies to acquire a strong market presence in the U.S. By the 1980s, it was among the biggest QSR brands in the country (Stoy & Kytzia, 2004). The strong local market presence compelled the need to expand to overseas markets. Here, the stronger market presence within the U.S. was necessary to propel the company to the global scene.

Mergers and acquisitions were among the effective strategies for ensuring the company’s rapid expansion. More often, the company utilized acquisitions than mergers because the management believed that it would assist the company in overcoming the challenges of new markets. The company’s main idea was to use the successful business models and the already established market presence of existing companies in new marketplaces. As a result, McDonald’s acquired several firms such as Boston Market, Chipotle Mexican grill, and Donatos Pizza between 1998 and 2000 (Stoy & Kytzia, 2004). These acquisitions are important in the history of McDonald’s because they made it the largest QSR chain in South and North America. Also, these acquisitions were strategic because they augmented the market presence and product line of McDonald’s. The move to acquire Carl’s Jr. is also strategic because it would increase its domestic market presence.

Carl’s Jr. Corporation

Carl’s Jr. Corporation is an American QSR chain headquartered in Franklin, Tennessee, USA. The restaurant is run by CKE (Carl Karcher Enterprises) and has franchisees in Europe, Africa, Latin America, Asia, Canada, Australia, and New Zealand. The corporation began as a hamburger restaurant in 1941 in California. The restaurant was established by Carl and Margaret Karcher as “Carl’s Drive-in Barbecue” until 1956 (Gussoni & Mangani, 2012). The restaurant found it hard to establish itself in Arizona and Texas due to the stiff market competition of the 1990s. The expansion of Carl Jr. has been slow because of its managerial policies that discouraged mergers and acquisitions (Derdak & Pederson, 2004). Another primary challenge to the growth of this firm is the stiff competition from larger QSR brands like McDonald’s that have a stronger market presence within the country. However, the corporation managed to expand and now operates in several countries outside the U.S.

In 2016, Entrepreneur, a firm that ranks the general financial strength, stability, as well as growth rate for the first 500 franchises throughout the U.S., listed Carl’s Jr. as number fifty-four on their top five hundred franchises list. Presently, Carl’s Jr. has over 3,700 franchisees in forty-four states across the U.S. and thirty-nine countries globally (Ganti, 2019). For instance, the corporation has over two hundred restaurants in Mexico alone. Carl’s Jr. is famous for its high-quality burgers, which are much better than most other QSR brands. Also, unlike other fast-food chains, Carl’s Jr. offers partial table service (Hoffmann & Schaper, 2001). The headquarters management team of Carl’s Jr. comprises the individuals listed below, with their respective positions held in the company.

Table 1: Executive management team of Carl’s Jr. Headquarters

Analysis of the Acquisition

First, the acquisition of Carl’s Jr. corporation by McDonald’s is a good fit for the acquirer, and this is because of various reasons. As a strategic move, McDonald’s would be able to strengthen its domestic and overseas market presence. McDonald’s would improve its accessibility to customers in new markets and improve access in current markets. McDonalds would also essentially change its market position, for instance, by moving the company from a subsidiary position to a more dominant role (Hitt, Ireland, & Hoskisson, 2013). The acquisition would allow McDonald’s to gain access to or improve relationships with significant referral sources, including specific service providers. Also, the company would increase operational efficiencies. By acquiring Carl’s Jr., McDonald’s would facilitate reorganized service distribution and operations to meaningfully lower operating costs.

Most importantly, the company would improve its financial and credit position. By improving its financial performance and credit rating, McDonald’s would improve its access to capital and reduce the cost of capital. To achieve these economic and strategic benefits, McDonald’s leadership assessed the company’s present ability to acquire Carl’s Jr. and found that such capabilities were appropriate (Ganti, 2019). Generally, the acquisition would enable McDonald’s to raise its revenue since Carl’s Jr. is a profitable company with vast resources distributed across the U.S. and other foreign countries.

Carl’s Jr. is a good target for acquisition because its line of business is similar to McDonald’s corporation. Both companies are burger-focused quick-service restaurant chains. Still, McDonald’s is much famous and bigger than Carl’s Jr. For instance, McDonald’s serves 55 million customers daily across 120 countries globally. In contrast, Carl’s Jr. serves fewer customers than McDonald’s daily across 39 countries internationally. Carl’s Jr has also attained a significant growth rate since its establishment (Nicola et al., 2020). The vision of Carl’s Jr. is to be “the most delicious fast-food company in the world, providing outstanding service.” The mission is to “offer delicious and fantastic food, meeting the highest standards of quality, health, and fresh products. Provide its guests with excellent service by demonstrating social and professional work.”

The company’s objective is to ensure that their customers get the value of their money, meaning that the customers get good quality products. The company also ensures that its customers get the services they desire. It is for this reason that the company’s expansion strategies include product differentiation and quality customer service. Carl’s Jr. has conducted sufficient research on their customers, and so it understands what the customers need and how their products can meet these needs and fit within the company’s business goals. The profitability of Carl’s Jr. can be attributed to its strong market share and good growth prospects. As earlier discussed, the corporation operates over 3,700 franchisees in forty-four states across the U.S. and thirty-nine countries across the world. Most importantly, the company is led by a team of skilled and experienced executives, who make sure that the reputation of the company’s customer service is not tainted (Lovelock, 2007).

Valuation of Carl’s Jr.

Every business entity is so inimitable that it is hard to put a justified value on it. All the processes that make up a business or a company have a cost or a value associated with them. According to Goedhart, Koller, and Wessels (2010), some assets are so unique that it is very hard to allocate them an even range of value. However, various acceptable methods can be utilized to valuate a business. These methods include multiples of future revenues, discounted cash flows, the sum of parts, net asset value, and much more. For this report, we will employ discounted cash flow (DCF) to value Carl’s Jr. to come up with the acquisition purchase price. We can get a base purchase price and the maximum purchase price that McDonald’s may be willing to pay from the valuation. DCF is an analysis method used to estimate the value of a business entity based on projections of the amount of money the business will generate in the future. To carry out a DCF analysis, one must make assumptions about various factors, such as the profit margins, forecasted sales growth, the interest rate on the initial investment, the cost of capital, as well as possible risks to the company’s current value. Nevertheless, it is simpler to do the analysis if one has more insight into its financials (Goedhart, Koller, & Wessels, 2010). A formula for a simplified DCF analysis is shown in figure 1 below.

Figure: A simplified DCF analysis formula (Reyneke, Abratt, & Bick, 2014)

The main idea behind DCF is that a dollar today is more valuable than a dollar in the future; Thus, we discount the value of the future cash flows to their projected value in today’s dollars.

10-year estimate of free cash flow (FCF)

Present value of 10-year cash flow (PVCF) = US$2.2b

Having calculated the present value of future cash flows in the first 10-year period, we have to calculate the T.V. (terminal value). T.V. accounts for FCF (future cash flows) beyond the first stage. We used a growth rate that does not exceed the nation’s GDP growth. Here, we used the ten-year government bond rate of (1.7%) to approximate future growth. Similarly, as with the ten-year “growth” period, we use a cost of equity of 9.1% to discount future cash flows (FCFs) to today’s value.

TV (Terminal Value) = FCF₂₀₂₉ × (1 + g) ÷ (r – g) = US$463m× (1 + 1.7%) ÷ 9.1%– 1.7%) = US$6.4b

PVTV (Present Value of Terminal Value) = TV / (1 + r)10= US$6.4b÷ (1 + 9.1%)10= US$2.7b

The total equity value is obtained by adding the “cash flows for the next ten years” with the “discounted terminal value.” For the case of Carl’s Jr., this is $4.9b. The last step involves dividing the equity value by the number of outstanding shares to get the price per share. This calculation highly depends on two assumptions: the discount rate and the cash flows. Also, the DCF does not put into consideration the possible cyclicality of the industry or the company’s future capital requirements. Therefore, it does not provide a full representation of Carl’s possible performance (Reyneke, Abratt, & Bick, 2014). From this analysis, the total equity of Carl’s Jr. is $4.9b. The total value of Carl’s Jr. assets is $5.04b, as given in the company’s financial reports. Therefore, McDonald’s would be able to pay between $4.9b and $5.04b as the acquisition purchase price.

Financing the Deal

To any business entity, funding remains a significant issue that has to be addressed with great care. Any organization’s funding sources are a vital element that calls for strategic managers to protect them to guarantee business growth. Conventionally, business funds come from the sales proceeds. Nevertheless, the unstable nature of the market makes it essential for businesses to invent reliable sources of funds to avoid redundant losses in case of an unforeseen drop in sales. Thus, while the primary objective of all companies is to obtain revenue from sales, it is also vital to reinvest some of the profits to other income sources to protect the business for some eventuality.

Funding sources for McDonald’s in acquiring Carl’s Jr. will come from three major categories: internal, external, and long-term sources of finance. Internal sources of finance include the proceeds from the sales the company makes. These proceeds are used for the expansion of the business, such as through acquisition. Savings also falls under internal sources. Another significant source is royalty fees from franchisees (Ganti, 2019). Generally, McDonald’s would use retained profits and retained earnings as a source of finance. External sources include the finances McDonald’s can get from partnership ventures. Business partners contribute capital for the company, which it can use to finance the acquisition. Also, the company can obtain loans from banks. Long-term sources of finance include leasing, whereby a leasing company gets or hires fixed assets and pays an agreed amount of money. Here, McDonald’s can use its assets to finance the acquisition (Mujtaba & Patel, 2007). Considering the three sources of finance, McDonald’s can finance the acquisition internally from working capital, retained earnings, and other internal finance sources available.

Conclusion/Recommendation

The newly acquired corporation will assist McDonald’s acquire resources that are not possible to get or produce internally due to cost factors. Here, the synergies from the resources of the two corporations will form more value. Also, the deal provides a huge opening for exchanging expertise and skills. The two corporations will exchange valuable information for developing new ideas. Following the acquisition, McDonald’s will minimize its taxes, get diversified, and handle competition appropriately. The company will achieve economies of scale, and it will better control parent and tax advantages.

After the acquisition, McDonald’s will take over all the company-run restaurants of Carl’s Jr., as well as all the company’s franchises across the world. McDonald’s would then re-brand these restaurants. Effective branding will attract the attention of new customers in these markets, providing a competitive advantage against other QSR players in these environments. Most importantly, McDonald’s would retain the local leadership of the acquired restaurants and their strategies that have so far made them prosperous. The local leadership understands their business environment well and is better positioned to manage the restaurants than other managers that the company may decide to bring in. The company will also continue operating as a franchiser.

References

Derdak, T. & Pederson, J.P. (2004). “McDonald’s”. In Derdak, T & Pederson, J. (Eds.), International directory of company histories. 3rd Ed (pp. 108-109). New York: St.James Press. https://ivypanda.com/essays/mergers-acquisition-and-international-strategies-in-mcdonald-and-carls-jr-corporations/

Ganti, A., 2019. How McDonald’s Makes Money: Monetizing the Demand for Fast Food. [online] Investopedia. Available at: <https://www.investopedia.com/articles/markets/032015/how-mcdonalds-makes-its-money-mcd.asp> [Accessed 22 April 2021].

Gilbert, G. R., Veloutsou, C., Goode, M. M., & Moutinho, L. (2004). Measuring customer satisfaction in the fast food industry: a cross‐national approach. Journal of Services Marketing.

Gussoni, M. & Mangani, A. (2012). Corporate branding strategies in mergers and acquisitions. Journal of Brand Management, 19, 772-787.

Hitt, A., Ireland, D., & Hoskisson, E. (2013). Strategic management: Concepts and cases: Competiveness and globalization. Mason, OH: South-Western Cengage Learning. https://www.cengage.com/c/mindtap-for-strategic-management-competitiveness-and-globalization-13e-hitt/9780357033838

Hoffmann, W. & Schaper W. (2001). Acquire or Ally? A Strategy Framework for Deciding Between Acquisition and Cooperation. Journal of Management International Review, 41(1), 131-159.

Goedhart, Koller, T., M., & Wessels, D. (2010). Valuation: measuring and managing the value of companies (Vol. 499). john Wiley and sons.

Lovelock H. (2007). Developing marketing strategies for transnational service operations. Massachusetts, USA: Lovelock Associates

LIN, L., Lee, C. F., & Kuo, H. C. (2013). Merger and acquisition: Definitions, motives, and market responses. Encyclopedia of finance, 541. https://scholar.google.com/citations?user=TmihCW0AAAAJ&hl=en

Mujtaba, G.B. & Patel, B. (2007). McDonald’s Success Strategy And Global Expansion Through Customer And Brand Loyalty. Journal of Business Case Studies, 3(3), 55-66.

Nicola, M., Alsafi, Z., Sohrabi, C., Kerwan, A., Al-Jabir, A., Iosifidis, C., … & Agha, R. (2020). The socio-economic implications of the coronavirus and COVID-19 pandemic: a review. International journal of surgery.

Reyneke, J., Abratt, R., & Bick, G. (2014). What is your corporate brand worth? A guide to brand valuation approaches. South African Journal of Business Management, 45(4), 1-10.

Stoy, C. & Kytzia, S. (2004). Strategies of corporate real estate management: Strategic dimensions and participants. Journal of Corporate Real Estate, 6(4), 353-370. https://www.emerald.com/insight/content/doi/10.1108/14630010410812432/full/html

Appendix: Levered DCF of Carl’s Jr.

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