GYG’s IPO - nothing but a shareholder cash in.

Tomorrow, Guzman y Gomez (“GYG”) will publically list on the ASX at a market cap of $2.23 billion.

Steven Marks moved from New York to Sydney back in 2002, leaving a cushy hedge fund role to take risk at starting his own business. Now, you may have guessed that this business ended up being GYG, however initially Marks had plans to build a hotel by a beach.

So how did plans to build a hotel by a beach turn into founding one of Australia’s largest Mexican food chain and why do I think the IPO is overpriced?

Here’s the story:

The Foundations

Marks grew up in a broken family and battled his way to an Ivy League education, which afforded him the opportunity to work alongside hedge fund manager Steven Cohen, the man Billions is based off.

When Marks moved to Australia he went through an array of failed ventures;

• a fashion distribution business (2003),

• a wine bar in Paddington Fiveways (2004), and

• a record label (2004)

All of this just after failing to even get passed legislation to buy the Bondi Beach hotel he dreamed of owning when moving out here.

Throughout this time, he began to miss the great Mexican food that was abundantly available back in NYC, which made him realise that Australians didn’t know what good Mexican food was and were missing out.

Once Marks realised the gap in the market he went all in, poaching the best staff from Latin American restaurants and bringing across chefs from Mexico to start what would become GYG.

Educating The Market

The early days weren’t easy, the lack of Mexican food culture that Marks spotted meant they had to educate the market. Realising that many entrepreneurs make the mistake of going wide and spreading their business too thinly, they instead focussed on “triple A” locations in Sydney and regularly ran free burrito days to win customers and strengthen the brand.

In 2010 GYG adopted the franchise model, allowing rapid expansion. Not only is it capital light, as the franchisee covers most of the upfront costs, but it also enables GYG to open restaurants with dedicated owner-operators who carefully oversee the day-to-day operations of a restaurant. They also use strategic ‘Master Franchisees’ to expand into new markets, where the franchisee holds the exclusive rights to develop and manage the GYG brand within a specified territory.

They have found that Master Franchisees have local expertise which can be used to identify the best sites for restaurants, navigate local regulations, or develop appropriate marketing strategies, significantly reducing GYG’s exposure when expanding.

At the time of the listing GYG has a total of 210 restaurants, broken down as:

• 62 Australian corporate restaurants,

• 123 Australian franchise restaurants, of which 10 are under a master franchise agreement,

• 16 master franchise restaurants in Singapore,

• 5 master franchise restaurants in Japan, and

• 4 corporate restaurants in the US

Master franchises look like a slam dunk, but I think there is an underlying problem.

GYG’s Great?? IPO Strategy

On face value GYG has a great strategy for future growth, revolving around:

• New Australian restaurant openings

• Internationational expansion

• Restaurant sales growth

• Margin improvement

But as I dug into each of these areas for growth, I started to uncover flaws across the strategy.

New Australian openings

Major restaurant chains in Australia have an average distance between restaurants of approximately 3.3km and median populations of approximately 33,000 living within 3km of each restaurant in their network.

In applying these two density criteria and overlaying population growth forecasts, GYG’s implied network opportunity totals 1,000 restaurants. Which provides plenty of room for growth from the current 185 Australian restaurants.

GYG expects to add 30 new locations to the local market in FY25, a 15% increase from FY24. Not bad, but 15% growth isn’t anything to write home about.

International expansion

GYG are forecasting FY25 revenue growth of 24% in Singapore and 31% in Japan, with an average expected sales growth of 4.8% across the group, this means they are expecting strong growth in international restaurant locations.

The issue with this is that GYG has absolutely no control over this due to the exclusivity agreements they’ve provided to the master franchises. These master franchises could choose not to invest further in these markets and international expansion would come to a halt.

Restaurant sales growth

GYG’s strategy of providing a ‘clean’ menu allows them to attract an average spend that is 24% higher than Market Leaders. However their strategy for future sales growth is based around growing breakfast sales - I don’t know about you but when I think breakfast, I don’t think GYG.

Margin Improvement

The two areas for improvement here are the restaurant format mix, food court vs drive through, and a franchise royalty rate uplift. Food court locations typically generate below median restaurant margins, as a result margin will increase as GYG opens new corporate drive thrus. This makes sense.

To further improve margin, GYG has moved from a flat 8% royalty rate to the tiered structure shown above. This has provided a fee uplift from 6.4% of sales to 8.0% but I think this is a mistake. If most of the future growth relies on franchises then wouldn’t it make sense to keep the offering as attractive as possible and take the ‘easy win’ once stability has been achieved?

When Netflix’s revenue soared by 15% following the restriction of account sharing, the share price didn’t jump, in fact it fell 5%, investors realised this is a sign that they are running out of ideas to generate new streams of revenue. I think we’re seeing something similar play out here.

Here’s the Deal

Guzman is raising $335.1m at an implied valuation of $2,230m, with $200m going towards the business and $135.1m to buy out existing shareholders.

With profit forecasted to come in at $6m in FY25, this implied valuation provides an ROI of 1.5%, tiny when you consider the current RBA cash rate of 4.35%.

With such an inflated valuation that is underpinned by the weak story of growth, it’s hard to see how this is anything other than a cash in for current shareholders.

Thanks for reading,

Archie Sampson, Founder of Prepped