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Subway, which has around 37,000 different outlets in 100 countries and 20,810 in the United States, adds to a growing list of Roark Capital–owned franchises.
Yesterday, Subway announced a sale. Not of their $5 footlongs, but a $9.6 billion sale of the business to investment fund Roark Capital, which beat out two rival private equity firms for the prize. Yes, Roark Capital is named after Howard Roark, the fictional lead character of Ayn Rand’s The Fountainhead. But while Roark was an architect, Roark Capital has a strong foothold in something more downscale than building design.
Subway, which has around 37,000 different outlets in 100 countries and 20,810 in the United States, adds to a growing list of Roark Capital–owned franchises. The firm is eating up virtually every fast-food and fast-casual lunch spot in the country. Arby’s, Jimmy John’s, Dunkin’, Mister Donut, Buffalo Wild Wings, Sonic, and Baskin-Robbins are under a subsidiary called Inspire Brands; Auntie Anne’s, Carvel, Cinnabon, Jamba, McAlister’s Deli, Schlotzsky’s, and Moe’s Southwest Grill are under a separate banner called Focus Brands; there’s still another umbrella called CKE Restaurants that includes Carl’s Jr., Hardee’s, and Green Burrito; and even separate from that, Roark also owns The Cheesecake Factory, Jim ’N Nick’s BBQ Restaurants, Nothing Bundt Cakes, and Miller’s Ale House, with a minority investment in Culver’s.
Corner Bakery, Il Fornaio, Naf Naf Middle Eastern Grill, and Wingstop were formerly all Roark portfolio companies, too.
Most of these purchases were made a while ago, but the Subway investment shows that Roark still has plenty of money to roll up the places where Americans go to eat. The firm also has significant penetration in business lines like car parts and service, home maids, pet food sales, sports camps, and more. Roark has $37 billion in assets under management, and claimed 69,000 locations from their companies even before the Subway purchase.
Private equity firms and hedge funds have troubled many over their practices affecting workers and competitor businesses, but the way that America works is that the interests of investors more frequently get the attention of regulators. And for years, investors have complained that they don’t realize all the financial value from sprawling operations like this, and in fact private equity investments primarily enrich the fund managers.
That’s the subject of a sweeping new set of rules advanced this week by the Securities and Exchange Commission on a 3-2 vote. The so-called “private funds rule” attempts to attack a number of opaque financial-engineering practices used by private equity.
Under the new regime, private funds will have to send quarterly financial statements to investors that include fund performance and all expenses. They will also be subject to annual audits. The costs of investigations for violations of the Investment Advisers Act of 1940 will not be allowed to be funneled through to investors to pay. Advisers will have to disclose certain restricted activities and in certain cases obtain consent from investors.
The so-called “private funds rule” attempts to attack a number of opaque financial-engineering practices used by private equity.
While this is mostly disclosure, investment firms fought these measures for years, claiming that they would “reduce investment opportunities.” I’m not sure anyone would miss the opportunity for more private equity investments, given the damage they’ve foisted on the nation. But unfortunately, these arguments were moderately successful in getting these rules watered down from the initial proposal. In that proposal, some fee charges for services that were never performed were going to be prohibited, and fund managers and advisers were also going to be restricted from limiting their own liability; both of those went away. Some lobbying groups have said they could live with the modified rules; the threat of a lawsuit has weakened, and that’s probably what got the SEC to bend.
Even in their weaker state, the rules should make a difference. Traditionally, private equity firms have claimed that the institutional investors upon whom they rely—public pension funds, endowments—were sophisticated enough to understand the markets they were getting into. But it’s often the case that union reps or college officers either don’t have a finance degree, are justifying their value by entering into complex deals, or are laying the groundwork for future entry into the industry, where their salaries can explode. This combination has led to a real bounty for private funds over their investors.
In fact, investors typically have to negotiate for any scrap of information. The fees they pay are high and sometimes without much basis, and they’re also uneven, with some investors getting better deals. All this for investments that do not beat a plain-vanilla index fund on a consistent basis.
The asymmetry of information is one of the things the SEC rules attack; in particular, so-called “side letters,” which give preferential treatment to certain investors, either to withdraw funds before the end of a lockup period, or to provide information about fund holdings. Side letters would now have to be disclosed when they include “material economic terms,” which isn’t as tough as the initial demand for full disclosure to all investors. But if the side letter offers special redemption rights (meaning the terms for withdrawing the investment) or more information, that would have to be offered to all other investors in a particular fund as well.
Another more interesting provision involves “fairness opinions.” Investment advisers currently can offer investors in a private fund the option of converting their investment into a new vehicle that the adviser is involved with. The valuations are often vague, meaning that investors don’t know whether they’re actually getting ripped off if they roll their investment into a new fund. Now, the adviser would have to get an independent “fairness opinion” in order to make the offer.
What’s interesting here is that there have been trends in the industry of creating “continuation” funds that essentially sell private equity–owned companies to themselves. What happens is that a private equity firm creates a new fund, and that fund then buys companies from the old funds of the same private equity firm (hence selling to themselves). This newly popular practice is done in part to avoid a real market valuation for companies that haven’t attracted interest from buyers, in part to liquidate the old fund to distribute cash to the fund managers, and in part to reset a new round of fees on the new fund. The investors are told that they can roll over their investment into the new fund, but previously there was no requirement for a fairness opinion. Now there could be more opacity on these deals.
A similar but separate kind of deal involves one company being sold from one fund to another that has the same fund manager, which is known as a general partner–led fund. There could be several reasons to shuffle around companies this way: to make the old fund look good by getting a bad company off its books, by selling high so the old fund is flush with cash. Traditionally there’s been a hands-off policy on these deals, but now investors at least have a tool to get some scrutiny on them.
There is a ton more that really needs to be done to deal with private equity’s business model and what it is misshaping across the economy. The SEC rules are a bare minimum. In an industry that usually doesn’t even get that, however, they are at least a start.
