Business Analysis using financial

statement
Boston Chicken, Inc.
Case Analysis

Boston Chicken, Inc.

Objectives
To illustrate analysis of assetshow to
value the loans to the area developers.
Boston Chicken reported the loans at face
value, with no allowance for bad debts.
How to appreciate the loans.
Comprehensive security analysiscovering
strategy analysis, accounting analysis and
financial analysis.

Boston Chicken, Inc.

Overview
Boston Chicken developed a new segment of the
fast food restaurant business, home-cooked food
The company sought to grow rapidly by signing
franchise agreements with large area developer.
The company provided sizable loans to help
developers finance new restaurant.
These loans was financed through public stock
and convertible debt issues made by Boston
Chicken.

Analysis of Boston Chickens Strategy

Created a new segment in the highly competitive fast-food
restaurant industrytake-out home-cooked food.
Engaged in three businessesoperating restaurant, selling
franchises, and financing area developers
Major competitors
Existing take-out chains such as KFC: few barriers to entry,
but has a different concept.
New take-out competitors: potential barriers for entry
Supermarkets: be unlikely to compete
Boston Chickens success depends on its ability to expand
rapidly and develop its brand name.

Boston Chicken, Inc.

Critical Success Factors
Rapid growth into new geographic markets.
The company used franchising to leverage its idea.
Under these agreements, it sells the right to build and
operate restaurants to area developers and uses the
developers financing, management talent and local
information as a way of growing the business
Management of existing and new store operations
Incomes come from royalties on system-wide franchise
sales and from its own store operations. Boston
chickens success depends on both businesses. (I/S)

Boston Chicken, Inc.

Critical Success Factors
A number of recent operational changes:
Long term agreements with supplieslocking in food price
Flagship stores
Adding menu items to increase sales at off-peak times
Store improvement-in store computer
feedback and drive thru lanes.

Boston Chicken, Inc.

Risks
Losing control of the business operations as a
result of its focus on rapid growth.
Excess focus on growth could lead to reduced
quality of operations, increased food wastage, and
lower profitability of franchise operations
The growth strategy also puts a heavy strain on
cash management, since funds are required
for growth.

Boston Chicken, Inc.

Key success and risk factors reflected
in the financial statements
Revenues are recognized for franchise fees and
development fees when the store opens.
Revenues from royalties are recognized when the
store generates sales Pre-opening costs are
amortized over one year.(notes 2)
Financing costs on notes receivable to franchisees
are shown as earned. However, the company
makes no allowance for defaults on these notes. (
B/C and notes 8c)

Boston Chicken, Inc.

Analysis of notes receivable to
franchisees
The notes are structured to give the parent
the option to convert the loan into equity in
the franchisee at a 12-15% premium over
the equity price at formation of the
franchise(how do you think this option)
We can estimate the income statement effect
of changing the assumption for franchisee
defaults.

Boston Chicken, Inc.

Analysis of notes receivable to franchisees(cont.)
Net income before tax
Bad debt expense on $202,500
notes receivable
Adjusted net income before tax
Percent Change

1% allowance

3% allowance

$20,450
2,025

$20,450
6,075

$18,425
-10%

$14,375
-30%

5% allowance

$20,450
10,125
$10,325
-50%

The company shares both the upside and downside risk for
financed franchise restaurants according to agreement of
franchise.
The company avoided consolidating the financed developer
operations in its financial statements.

Boston Chicken, Inc.

Analysis of notes receivable to franchisees(cont.)
The company effectively has control over the financed area
developers through its option to purchaserecommend
consolidating.
How consolidation would change the financial statements of
Boston Chicken?
(1) The royalty, franchise fee and interest income would be
eliminated.
(2) The company would show its share of the sales revenue and cost
from the stores.
(3) The notes receivable would be eliminated and the company would
report its share of the assets and liabilities of the franchisees

Boston Chicken, Inc.

Are Franchisees Profitable

Whether franchisees are profitable or not is

a key factor for accessing the value of the
notes receivable.
We can estimates the profitability of store
for franchisees by the two ways.
(1) Use data for the company-owned stores
(2) Use data of franchise profitability
provided by the company.

Boston Chicken, Inc.

Use data for the company-owned stores

($ in thousand)
Company operated store revenue
$40,916(P4-32)
Average number of owned stores
39.5[(38+41/2) P4-27]
Revenue per average store
$1,036
Gross margins(100%-15,876/40,916)
61.2%
Less royalty and promotion fees
10.8%(5%+2%+3.75%)
Residual
50.4%
From this residual margin franchisees have to deduct wages and
salaries, administrative costs, depreciation, interest, and taxes.

Boston Chicken, Inc.

Use data on franchise profitability provided by the company.

The average system sales per week for the third quarter of 1995 were 23,388
and EBITDA margins were 15%-16%.($ in thousand)(P4-24)
Annual sales per store
$1216(23,388*52)
EBITDA
194.6(0.16*1,216)
Depreciation(see below)
(117.0)
Interest
(59.3)[11,632/(314+78)/2]
Net profit before tax
18.3
Depreciation is calculated as follows:
1993 Boston Chicken capital expenditure $49,151(P4-33)
Number of new owned stores
28(P4-27)
Cost per store
$1,755
Expected life
15 years
Annual depreciation per store
$117

Boston Chicken, Inc.

What additional data would you request from management

The analyses indicate that the franchisees

are profitable at this level of sales($1,216).
Some franchisees appear to be having cash
flow problem. Footnote 7 points out Boston
Chicken had been forced to make advances
to franchisees to fund local and national
advertising.(P4-37)

Boston Chicken, Inc.

What additional data would you request from management

The analyses are based on limited information and

average data is incomplete, since it only takes one
franchisee to fail, and Boston Chicken will incur a
large loss in Notes receivable.
Some additional information
Same store sales
Distribution of same store sales
Late payments by franchisees.
Security provided by developers such as any other
assets outside the franchise corporation.

Boston Chicken, Inc.

How is Boston Chicken Performing

Summary ratios for 1993-1994

Ratios
ROE(Ending equity)
=profit before tax/sales
*(1-average tax rate)
=after-tax profit margin
*sales/assets(end)
*asset/equity(end)

1994
6.2%
21.3%
79.1%
16.8%
0.23
1.64

1993
1.7%
3.9%
100%
3.9%
0.39
1.16

Boston Chicken, Inc.

How is Boston Chicken Performing(cont.)

Profit margins indicate the companys

performance for 1994 has improves
markedly
Increase in leverage from the introduction
of convertible debentures during 1994.
(Notes 4 P4-36)
Decline in turnover, due to the increase in
Notes Receivable.(P4-38 notes 8)

Boston Chicken, Inc.

Future Prospects
There are wide differences in opinion in the market about the
companys future prospects. This is reflected in the strong growth
forecasts made by some analysts(as high as 45%), and the large
short position in the companys stock. This raise questions of how
the market is valuing the company
Analyst forecasts of future EPS are $0.63 in 1995 and $0.90 in 1996,
with 45% growth until 2001.
But some analysts thought that the quality of earnings is very low
since all of Boston Chickens income comes from fees, royalties and
interest payment from franchisees, most of whom were financed by
the franchisers.(P4-24)
Short interest positions in the stock were at an all-time high of 10
million shares, more than 20% of the shares outstanding and
double the short interest position at the beginning of 1995.

Boston Chicken, Inc.

Subsequent Events
Boston Chicken continued to report increasing
revenues and earnings in the fourth quarter of 1995
and throughout 1996
At the end of 1996, the company provided
information about loss $128 m
From May to July 1997 B.C. share price plummeted
50%
In October 1998 B.C. filed for bankruptcy
In December 1999 McDonalds agreed to acquire B.C.
for $173.5 m.