Subway's $10 billion price tag is tough to swallow

Subway has made some significant changes over the last few years. Under new Chief Executive Officer John Chidsey they revamped their menu, remodeled stores.

At a time when the value of an increasing number US companies are exceeding the once unthinkable $1 trillion mark, it feels odd to ask whether businesses can be too big to be profitable. And yet that’s the very question sandwich chain Subway Restaurants Inc. is asking itself right now — and it may not like the answer.

Although its distinctive green and yellow signs have become a fixture of American fast casual dining, the closely-held Milford, Conn.-based franchise has yet to find a buyer six months after putting itself up for sale, asking $10 billion. It’s not so much the price tag that’s the issue — McDonald’s Corp has a stock market value of about $213 billion — but rather Subway’s growth-at-any-cost business model. From a few hundred restaurants in the 1970s, it now has nearly 37,000 around the world. At one point a decade ago it even surpassed McDonald’s as the world’s largest chain of restaurant franchises. Under a be everywhere and anywhere strategy, it seems like the company thought any venue was ripe for one of its sandwich shops, from schools to laundromats and even churches.

Here’s the rub: Subway doesn’t own any of its outlets, which means that to increase profits it either has to add new franchisees or raise fees charged to those franchisees. That helps to explain why the company put one of its sandwich shops in a house of worship. But how to reduce concern among potential franchisees about oversaturation? The answer is low startup costs. It costs anywhere between $207,050 and $476,900 to open a Subway,according to the company. That’s well below the cost of opening a McDonald’s restaurant, which can be anywhere from $1 million to $2 million. To be sure, Subway’s royalty fee of 8 percent of gross sales and its 4.5 percent advertising fee are high compared with competitors such as Jersey Mike’s, which charges a 6.5 percent royalty and  5 percent for advertising.

So while the startup costs look attractive, it’s the fees that really hurt franchisees, especially when franchisees are not given any exclusivity when it comes to a specific territory. “There are no radius restrictions or minimum or maximum population requirements which limit where we can license or open another Subway Restaurant, unless otherwise provided under applicable state law,” according to the company’s 2021 franchise disclosure. A few coffee shops within four blocks of each other in a dense urban city is probably not a problem in terms of competition, but it is when you’re selling a foot-long sandwich or anything similar.

For a time, Subway fostered the idea that it was the “healthy” alternative to fast food, whose horrors for your health spread through films like Fast Food Nation. But as consumers became increasingly aware of food ingredients, additives and fillers, Subway was slow to evolve along with them. It drew
scrutiny over the ingredients of its bread, the freshness of its vegetables and the contents of its tuna. Subway’s reputation took a serious blow in 2015 when its spokesperson Jared Fogle was convicted of sex crimes against children.

Fast forward to today and the company closes one store for almost every one it opens. This trend is, naturally, bad for royalties by keeping them flat. And when combined with rising borrowing costs and uncertainties around the economic outlook, none of this bodes well for Subway’s $10 billion asking price. JPMorgan Chase & Co, which is handling the sale, is dangling a $5 billion debt financing package to help entice skittish buyers worried about where they’d get the money to buy the company, according to Reuters. It’s no small concern: Although Subway reported 10 consecutive quarters of positive sales growth in April, its franchisees still lag behind competitors. Jersey Mike’s average store volume reached $1.2 million in 2022, well above Subway’s $492,536 average during the same time, according to FranData, a franchise data analysis company.

Subway has made some significant changes over the last few years. Under new Chief Executive Officer John Chidsey, who took over in late 2019, the company has revamped its menu, remodeled stores, expanded its rewards program and dropped its $5 “footlong” deal, which drew traffic but ate into profits. The company is improving its reputation by slicing its deli meats fresh in some restaurants, and plans to expand its North America store fleet by 35 percent this year while growing its international footprint, which Chidsey says could reach 40,000 to 60,000 new restaurants.

That last part sounds a lot like more of the same business model that largely got Subway into the jam it’s in now. There’s still time for Subway to take a lesson from former Popeye’s Louisiana Kitchen Chief Executive Officer Cheryl Bachelder’s turnaround playbook. Bachelder’s strategy centered around a “ servant leadership” ethos focused on mending fractured relationships with franchisees. The strategy worked. Popeye’s quadrupled its share price and increased average restaurant sales by 45 percent. The company eventually sold to Restaurants Brand International in 2017 for $1.8 billion, about 21 times its cash flow.

Leticia Miranda is a Bloomberg Opinion columnist covering consumer goods and the retail industry. Views are personal and do not represent the stand of this publication. 

Credit: Bloomberg