Private equity has sucked out the cash

The private equity crowd has flipped Burger King like a Whopper for a decade.

Along the way, they've loaded it with debt and sucked out huge amounts of cash -- money that could have instead gone to improve the company. That's the opposite of the McDonald's story, and it has left Burger King far behind.

Here's a brief history of how Burger King has been flipped on the private-equity griddle over the past decade:

Goldman Sachs (GS) and the private equity firms TGP and Bain Capital (famous for being co-founded by GOP presidential contender Mitt Romney) took control of Burger King in 2002. Four years later, they took it public, extracting a $448 million dividend in the process. Next, Burger King was taken private by 3G Capital in 2010. Now it's public again, though 3G Capital retains a 71% stake.

The upshot: In total, private equity has sucked $1 billion out of Burger King along the way, estimates Howard Penney, the managing director at Hedgeye, a stock research firm. "It's been a party for Wall Street," says Davidowitz. "The private equity guys have made a fortune." But like all parties, this one has come at a cost. "They've been jerking the company around, making a fortune. The problem is the company is a cadaver."

Davidowitz says that while much of Burger King's cash went to private equity fees over the years, McDonald's has used its cash to remodel restaurants, develop its menu and expand abroad. The contrast shows up in the numbers.

  • Burger King sales fell 6.8% to $2.33 billion last year. And 2011 sales were lower than sales in both 2009 and 2008, as well. In contrast, McDonald's sales grew 12% last year, to $27 billion.
  • Burger King has a return on equity, a common profitability measure, of 9.2%, compared with 38.2% at McDonalds.
  • Burger King's market share has fallen to 12% from 17% over the past 10 years, while the share for McDonald's has risen to 50% from 42%, says Davidowitz.

"McDonald's has gotten to 50% market share because it is in the business of serving the customer," says Davidowitz. "Burger King has been in the business of serving private equity. As long as I have followed them, they have been starved for cash."

Sure, but that's history, and investing is all about the future, right? So what about the future?

Here, there are challenges, too, and you can blame the same culprits. Despite the protests of the spin-meisters for Romney, it really is a pretty common trick of private equity firms to load a company with debt to support their fees before taking it public as a stock.

A look at the filings shows this is exactly what happened at Burger King.

Before 3G Capital bought it in 2010, Burger King had $888.9 million in debt. Now it has debt of $3.12 billion. To put that in perspective, Burger King now has a debt-to-equity ratio (which compares debt to shareholder investments) of 280, compared with 87 at McDonald's.

And all that debt constrains what Burger King can do now.

  • For one thing, by its own admission, it won't be offering shareholders a dividend any time soon. In contrast, McDonald's pays a 3.2% yield, which helps attract investors and support the stock.

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  • More important, the debt constrains Burger King in terms of growth prospects. It makes it tougher to remodel stores, develop original menu items or expand into emerging markets. "McDonald's has better resources to attack faster-growing markets," says David Abella, portfolio manager of the Rochdale Dividend & Income Fund (RIMHX), which gets a five star rating from Morningstar and counts McDonald's as its second-largest holding.

Stocks mentioned in this article include: Starbucks (SBUX), Burger King Worldwide (BKW) and McDonald's (MCD).