d it not been for a stay of execution by its financiers. A dubious forecast Through the capital raising, it is seeking a cash injection that is more than five times its current market capitalisation of around $31 million on the Australian Securities Exchange. It really is hard to believe that the directors will be able to find enough investors with the appetite for a proposition that cannot guarantee a return to financial health for the franchisor. In announcing the capital raising plan, the company claims it can generate an underlying profit result of between $42 million and $46 million in earnings before interest, tax, depreciation and amortisation for the current financial year after claiming an underlying $44 million EBITDA result for FY19. The forecast is dubious, given that RFG is continuing to incur costs in restructuring, faces the prospect of significant outlays in defending litigation and potentially compensation and substantial penalties and the closure of more than 100 stores in the next 15 months. Store closures can be a positive for a corporate chain, boosting earnings by reducing operating costs and weeding out underperforming outlets that consume management resources and drag on capital. But for the RFG business model, store closures are a negative, likely to result in reduced income from franchise fees, marketing levies and stock sales. Also, in all probability, there will be higher proportional costs in managing the franchise systems and less buying power for products and services from suppliers. Will franchisees buy in? RFG was heavily dependent on a principle of perpetual growth, acquisitions of new retail brands, and the ongoing recruitment of franchisees for new locations – as well as a churn of franchisees in settled locations – all of which brought in payments, fees and income from product sales. What will exercise the minds of investors now is whether RFG will still be able to recruit new franchisees, given its financial woes, the level of dispute with existing franchisees established in last year’s Senate inquiry, any adverse findings from investigations by regulatory agencies and the drastic downsizing of its store network. From a consumer standpoint, the RFG retail brands have probably not been significantly damaged by the problems that have consumed the company since the first cracks started to appear in the Michel’s Patisserie chain in the spring of 2017. Gloria Jean’s, Brumby’s, Michel’s Patisserie, Donut King, Crust and Pizza Capers are all recognised retail brands with a claimed 70 million transactions annually at an average of $7 per sale, but none of them attracted a buyer prepared to pay RFG what it believed they were worth. In September 2018, the company claimed that 70 per cent of its franchisees backed its new direction, which included changes to franchise charges, but realistically most of them had little choice but to hang in and hope because of their own financial circumstances. According to FY19 results, around 24 per cent of current creditor balances may not be recouped, an indication that many franchisees are continuing to struggle financially. The financiers for RFG decided to do much the same thing – hang in and hope – on the basis that a new board and management team could reduce debt, effect a business turnaround and seek leniency from regulators for the sins of the past under previous management. There were two key factors to the generosity of the financiers. The first was that RFG thought it could pay down debt by divesting assets, including one or more of the retail brands. The second reason was interesting, with concern that taking a hard line while the federal government was undertaking inquiries into banking and financial services and franchising might attract negative publicity. Adding up the numbers In any event, buyers for the retail brands were not forthcoming and negotiations with potential equity investors also drew a blank, including with the Hong Kong firm Soliton Capital which actually got to the due diligence stage. So the last option is a credibility-testing capital raising that RFG hopes will allow it to reduce debt by $118.5 million and generate $37 million working capital to fund likely litigation costs and ongoing restructuring and lease exits while also booking $12 million in transaction costs.The capital raising offers shares at 10¢ – well below their most recent quotation price on the stock exchange of 17¢ – in the hope that investors will overlook the problems. But there is arguably more reason to be confident about a soufflé.