The part of my job that I love most is being able to listen to CEOs talk through their strategy. Business is fascinating – a complex and many faceted endeavour where the only constant is change. While one must always set a course, it’s a never-ending journey where external factors continuously alter the destination. A good friend was involved in the Taste Holdings story from the early days, so I’ve been a keen observer of its rapid development. And took time off this morning to spend a couple of hours in a small Press Conference where CEO Carlo Gonzaga shared the experiences of the past financial year (to end February). He came into the Biznews.com studio afterwards for a focused chat on the key issue – Taste’s transformative deal with the world’s number one pizza company, US-listed Domino’s – and the legal challenge to it which has created uncertainty. Frank as ever, Gonzaga also cleared up misconceptions around Burger King – admitting it was another big fish that got away. Then again, without going through that experience, Taste might never have ended up with Domino’s, a franchise that has the potential to replicate the astonishing success of local market jewel KFC. – AH
ALEC HOGG:  With me in the BizNews studio is Carlo Gonzaga with the financial results from Taste Holdings for the year-to-end February. Carlo, I’ve been following your company for a while. You guys have certainly been giving great returns to shareholders, but going through the financial results today, what jumped out at me is that this past year you made investments in NWJ, which is a great business, and we’ll talk about that in a while, but the future seems to be very tied up with Domino’s.
CARLO GONZAGA:  Yes. Certainly, in our business and food…there’s quite a big focus on that. It seems like a big deal, but we’re quite well balanced in terms of what we’re doing in the supply chain, our low LSM’s and certainly, in jewellery. It certainly is a big focus for quite a big portion of our business at the moment.
ALEC HOGG:  Let’s leave the NWJ and the lower income, because they’re also exciting in their own respect, but Domino’s Pizza were in South Africa in the past. Did you ever eat any of their pizzas here?
CARLO GONZAGA:  I may well have because I do remember going to a store on Coronet Drive in the late nineties (about 1999). It really came here in the post-1994 euphoria, that a couple of American businessmen thought they could leverage, and it was an abject failure from the beginning, to be honest. However, it was an execution failure, not a brand failure.
ALEC HOGG:  And it is the biggest pizza brand in the world. I wonder why no one has pulled it back.
CARLO GONZAGA:  That’s a good question. In 2004 – and until now, this was not commonly known – we tried to convert Scooters to Domino’s, so I have a pre-existing relationship with the guys. I’ve always had a view around licensing brands and big brands that benefit SA.
ALEC HOGG:  You say ‘with the guys’…the Domino’s owners?
CARLO GONZAGA:  Yes. In fact, the current global CEO was the Head of International in 2004 and believe it or not, the actual middle management that were dealing on this business then are the guys that I spoke to this time around as well. We’ve thought about it before. It’s not new. At the time, we’d really been happy in South Africa. We have a culture of creating new brands and new businesses and I don’t think anybody’s really thought about the benefits big brands bring. Certainly, in the last two months, I can tell you that my view has changed substantially around the benefits that big brands bring.  I’ve learned stuff about pizza that I really didn’t know anything about in the last 19 years.
ALEC HOGG: In the last two months…so you spent time in the U.S.
CARLO GONZAGA: Yes, we spent time in the U.S. I spent time in Mexico, with what is one of the largest QSR operators in the world, with 2500 outlets, of which he owns 2000. Domino’s is one of his brands.
ALEC HOGG:Â QSR?
CARLO GONZAGA: Quick service restaurant. He has 2500 quick service restaurants. We spent time in the U.S. We’re back in the U.S. next week for a week with 15 people for the Franchisee Conference – a small little event – 5000 people. I’m certainly really becoming a big believer that these big brands are going to elevate the level of customer service and consumer expectations in a positive way.
ALEC HOGG: And you’re converting St. Elmo’s, which is a pizza brand and Scooters, which you spoke about a bit earlier, into Domino’s stores. How do the guys who currently own those brands feel?
CARLO GONZAGA: That’s really been the biggest unknown for us until about a month ago in that we had all these great ideas. We thought it was the right thing, but really, we said ‘what are our franchisees going to think’. Given our listed status, we couldn’t go talk to franchisees before. Since signing this, we’ve been through all our franchisees and I can tell you I’ve been surprised on the upside, as to how franchisees have embraced this. We think it’s a great commercial opportunity for them.
ALEC HOGG: How are they going to change, or who’s going to pay for the changing in the décor?
CARLO GONZAGA: There are a couple of levels of investment. The first one though, is that we’re assisting franchisees to raise the capital to convert their stores. We’re also investing in a production facility from the Taste side, which is really part of our supply chain stuff, and we’re going to pre-invest in the marketing fund as well.
ALEC HOGG: Let’s just go back to our own Scooters store. I’m now going to have to rebrand it to Domino’s. I’m doing okay at the moment. You have 150 of these stores around the country so clearly, they’re still making profits. What is the incentive for them to presumably, reinvest or invest more in making the transformation?
CARLO GONZAGA: There are a couple of soft issues, but let me talk to some of the hard ones. Certainly, we see when we look at Domino’s stores around the world; they’re trading at higher margins than we’re trading at currently at store level.
ALEC HOGG:Â Do they call them processes?
CARLO GONZAGA: It’s a bit of a combination of everything: processes and labour. You walk into a Domino’s store anywhere in the world and you will see a screen that will tell you your labour efficiency in half-hour increments – live. If you’re a multiple store owner, you can walk into any one of your multiple stores and it will give you your metrics – live – of all your stores’ performance as they are happening. Because they’re born out of markets with very high labour costs, competition is tough. We think it’s tough here. Try doing this in the U.S., Australia, or the U.K. They’re born in markets where it’s tough. They become very keen and very performance driven. Franchisees will see that immediately. Certainly, they trade at higher turnovers than we do here. Their levels of market penetration through the combination of a bunch of things are far higher than we certainly, currently experience in our business. In addition, you can’t deny (or I don’t think you can) that there’s some extra value to be associated with a global brand. The real swinger here is if you talk to franchisees, they’re saying ‘even if I don’t see some benefits tomorrow, five years from now do I want to be part of the world’s biggest pizza delivery brand or do I want to be part of a local brand’.
ALEC HOGG:  It’s a bit like KFC. When I talk to people in your industry, they say ‘if you want a license to print money, buy a KFC shop’. Could it be something similar here with Domino’s, or is it something similar around the world?
CARLO GONZAGA:  I certainly think that when you’re looking at the future… If I’m a franchisee investing (let’s call it fresh capital for now) in a new store, am I going to buy a Domino’s outlet or another one? I think you’re probably going to say to yourself ‘even if they produce the same returns on paper, which one do I think is going to be here for the long run’. The answer is probably going to be – if you look at their track record of how long they’ve participated in the markets – it’s probably going to be with a global brand.
ALEC HOGG:  With you guys supporting it, rather than last time with a couple of fellows coming out to South Africa and not really knowing the market, it makes a big difference. I’m really looking at it from the entrepreneur’s perspective. If KFC were coming into the country for the first time tomorrow, there would be some smart entrepreneurs picking up franchises. Is this a similar opportunity with Domino’s?
CARLO GONZAGA: I have to tell you we’ve had probably more franchise enquiries in the last three months, than we had all of last year. What’s interesting is its very different types of enquiries. The level of franchisee is quite different in the sense that the guys who are enquiring are saying ‘I have R5m and I want to invest in three or four stores’.
ALEC HOGG:Â Can you get that many stores with R5m?
CARLO GONZAGA: Yes. We think a store will probably go for about R1.5m (is what our initial estimates are telling us now). It’s a work in progress, but that’s where we think we’re at.
ALEC HOGG: So you’re going to take your 150, convert those, and then open how many new stores?
CARLO GONZAGA: We’re aiming to open 100 in the next five years – new stores. We think we can get to that. So far, the early interest we’ve had would lend credibility to that number. To answer your question around the entrepreneurs: we’ve seen a very different level of entrepreneurs. You’ll have some guys who say ‘if I’m going to invest in this, I’m excited. I’ve seen the KFC success. I’ve certainly seen the Burger King top line success. I’m sure the guys will sort out their margin stuff in time to come. This is a timing issue’. They’ve seen the interest that there is, so I think we’re going to undergo a transformation in the food segment in South Africa that is going to be massive – far bigger than people anticipate – in the next three years, as all these brands come into our market.
ALEC HOGG: Â So Famous Brands might have some challenges.
CARLO GONZAGA:  They’re a good business. They’re a well-managed business. I have great respect for what they do, and they have other levers that they can grow in.
ALEC HOGG:  From your perspective, you said ‘hang on. Let me rather be part of this globalisation of the South African fast food market’.
CARLO GONZAGA:  We can talk at corporate level, but I don’t want to be the franchisee that’s next door to a Burger King, no matter what brand you’re in.
ALEC HOGG:  Tell us about Burger King. The talk is that you had the first bite of the cherry and Hassan Adams ended up with it. What went on there?
CARLO GONZAGA:  Two-and-a-half years ago probably, we went quite a long way down the line with Burger King and in the end, we pulled out of it operationally. We just felt that it didn’t make sense for us to be there. That was our first foray into thinking about licensing brands, aside from me trying to do it in 2004. I do look back now and I think ‘maybe I should have been a bit bolder in my thinking’, so what happened, is perhaps unfortunate. However, we actually pulled out of it at the time and then GPI went in and got it. We weren’t competing at the same time, as far as I understand.
ALEC HOGG:  With hindsight, if you could have it again…
CARLO GONZAGA: Â With hindsight, I think I probably would be a bit bolder about it.
ALEC HOGG:  But you have Domino’s. Maybe the decision for Domino’s was influenced by not taking Burger King first. It’s like that, isn’t it? One reflects.
CARLO GONZAGA:  Yes, you do and you also get to compare, of course. I now know what the Domino’s margins are and I have a point of comparison. We spent some time, as I said, in Mexico and that licensee owns both Domino’s, and Burger King Stores. We’ve seen his PNL’s between the stores and I do think that we probably ended up with one of the better brands in the world – certainly, in his opinion – as far as being a licensee is concerned.
ALEC HOGG:  What’s this going to do to your working capital in the year ahead – the conversion of existing stores – although they are franchised stores – to the whole Taste Holdings structure, which shareholders can invest in?
CARLO GONZAGA: A couple of things the shareholders will see… The first one is that we’ll incur some pre-expenses in this and these international brands are quite demanding about the standards they put on. We’re quite excited that we do have to upgrade parts of our facility to meet international ISO standards. We’re excited because we think it will increase the bar generally in the local market. We have some CapEx to put into our local manufacturing facilities. We’re going to have some pre-expenses – this team of people going to the U.S. next week – so we’ll be normalising those for shareholders. They’ll see what those numbers are and they can decide whether it’s a good investment or not. Whatever we spend in this still targets our general view around how we allocate capital in Taste and so far, I think we have a reasonably good record of consistently allocating capital.
ALEC HOGG: You said you look for IRR of 25 percent. Is it similar with Domino’s?
CARLO GONZAGA: Yes. Internally, that’s what we do and we do it simply. It’s not a very difficult equation from our perspective. We do it because we think that if shareholders invest in Taste, they need to be getting a premium of what they could get at the Alsi, and that’s what we seek to do in our own capital allocation decisions.
ALEC HOGG: This is taking you very much into the big league, but it hasn’t been plain sailing. Somebody says that there’s a legal challenge. What’s the history there?
CARLO GONZAGA: It’s quite a difficult one for me to answer. I’m trying to not sound too evasive, but I can only answer on what I know. The claim has been lodged fundamentally, if I look at what’s in the papers and what’s made its way into the press.
ALEC HOGG:Â Are they court papers?
CARLO GONZAGA: It’s not a summons. It’s an application. It’s been in the press today, and all those allegations levelled against Domino’s…so for me to speculate what the answer is (and I haven’t seen the answer)…
ALEC HOGG: So it’s not against you…it’s against Domino’s.
CARLO GONZAGA: It’s against Domino’s. These guys apparently dealt with Domino’s previously and there is a whole bunch of allegations in there. There is no signed agreement. Domino’s confirmed that telephonically with me, that there’s no signed agreement with them. We have a signed agreement. I can’t really answer because I haven’t seen Domino’s’ reply. They’ve put forward their version of the case.
ALEC HOGG: You have a signed agreement. As far as you know, you’re off to the U.S. next week. You’re going to be converting your stores. It’s not really that related to you, unless these local fellows manage to win some kind of action against Domino’s. Is that right?
CARLO GONZAGA: Yes, I think that probably sounds right. Domino’s are certainly fully committed to this. Their global CEO announced this three times, publicly. We’ve had 15 operational people over here in the last little while, across various functional heads: Head of IT etcetera.
ALEC HOGG:  Carlo, the problem is you had a similar legal issue with Fish & Chips. Now, from an outsider’s point of view you seem… Is this just a reflection of the industry, that it is rather litigious?
CARLO GONZAGA:  I think there’s an element of that. Unfortunately, there’s an element that when you’re listed it does attract this because there’s some pressure around when you’re listed, to not want to have bad news around you. Our view – the same as Fish & Chips – is that we communicated this… We got this late Monday afternoon. We took a view that we would rather communicate it sooner with less clarity, than try to sit on it until we had full clarity, and I think it turned out that it was the right decision. I don’t think it’s the industry, necessarily. There are just some elements in it that want to pursue it this way. We’ve never heard from these guys. The reason is that they don’t have a beef with us. That’s how it would appear at the outset.
ALEC HOGG:  Well, I’m sure it’s all going to settle down. We look forward to talking to you about the growth of Domino’s into the future. Is there another Burger King potential…Wendy’s Hamburgers not in South Africa…would you look at something like that?
CARLO GONZAGA:  Our stated intention is that we really do want to look at other licensed brands and we think there are enough categories and examples. Firstly, we’d like something in burgers. That’s clear. I don’t know how many options we have. That’s part of our restructuring and our business has given certainly, to a few other guys and I, the capacity to go and do this. Domino’s is the first one to bear fruit.
ALEC HOGG: Â Carlo Gonzago is with Taste Holdings.
