COMMENT
The Battle Of The Pizzas

By David Kuo (TMFDragon)
February 22, 2006

Our love for pizzas has turned pioneers of the cheese-topped flat bread into mozzarella millionaires. Early exploiters in this country included Peterborough Football Club chairman Peter Boizot, who opened the first PizzaExpress restaurant in London, and serial entrepreneur Luke Johnson, who helped to float the company onto the stock market.

From a standstill start in 1965, when most Brits weren't even sure how to eat pizzas properly, the UK pizza market is now worth a lot of dough -- almost £2bn a year. Pizza Hut, which is owned by Whitbread (LSE: WTB) is the market leader, and is reckoned to be double the size of Domino's Pizza UK (LSE: DOM) and PizzaExpress combined. PizzaExpress is now owned by Gondola Holdings (LSE: GND), which also owns the ASK and Zizzi chains.

In my view, being prominent second liners in a large and growing market can have their advantages. There are good opportunities to capture market share, and to develop new customers through market penetration. But with good growth on the cards for both Domino's and Gondola, which of the two is the better bet?

Perhaps the biggest difference between Domino's and Gondola lies in the way the two businesses are run. Gondola owns and operates its restaurants while Domino's franchises its business. Interestingly, in its early days, PizzaExpress also expanded through franchises but these were bought back in the mid 1990s to give the company greater control over its brand. By comparison, Domino's growth has been fuelled through franchising, and it is reckoned that there may be as many as 2,000 hungry franchisees currently awaiting approval.

Despite losing some control over the business, franchising can be a cheap way to grow. That's because much of the up-front costs are paid for by the franchisor. Additionally, a large slice of ongoing franchise fees, royalties and other revenues drop straight down to bolster bottom-line profits. In the case of Domino's they helped to boost pre-tax profits 35% last year to £8.8m.

That probably helps to explain why Gondola is growing at a more sedate pace than Domino's. Currently, Gondola has around 500 restaurants and plans to roll out 25 new eateries this year. On the other hand, Domino's has around 380 home-delivery outlets, and plans to open 50 more this year. In fact, Domino's believes there is room for over 1,000 units in Britain. It seems that each Domino's outlet can service around 20,000 households, and given that there are around 25 million British households, growth at the present rate may continue for some time to go.

But with easyPizza's arrival into the market, there may be threats on the horizon for incumbent pizza operator. Stelios, the entrepreneur behind easyJet (LSE: EZJ), easyHotel and easyCar, plans to re-engineer the pizza delivery business to produce a no-frills, low-cost, delivery operation. He believes he may engage as many as 9,000 independent operators.

Mind you, it is still very early days for easyPizza, which only signed up its first franchisee in Portsmouth this month. Nevertheless, it highlights the danger for a fast-growing, highly-rated company such as Domino's. Currently, it is valued at 23 times earnings, which reflects the rate that it is supposed to grow. In contrast, Gondola, which is only valued at 12 times earnings and yields 3%, looks a safer bet.

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