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Cream kills: The Friendly's spiral

September 30, 2011: 3:55 PM ET

Friendly's has a lot of problems. But the biggest one is at the heart of its business.

Family restaurant chain Friendly's is expected to file for Chapter 11 bankruptcy protection next week, just three years after being acquired by private equity firm Sun Capital Partners for $216 million (including assumed debt).

There is a lot of blame to go around, including the sluggish economy, rise of fast-casual alternatives and the chain's inability to overcome its reputation for poor service and grubby interiors. But here's one more factor: The cost of cream.

Rising commodities prices have hit all restaurants hard, but Friendly's is particularly dependent on the price of Class II butterfat -- which is the primary ingredient in ice cream. Take a look at the following chart:

Source: University of Wisconsin Dairy Marketing and Risk Management Program

Those green bars are the prices being paid in 2011. Look at they compare to the red bars, which were the prices just two years ago!

"The amount of butterfat on the world market has been lower than usual, so the U.S. has been exporting more of it which has been propping up the price," explains Joe Gaynor, who works on dairy issues at the USDA.

It also doesn't help that sugar prices have doubled since 2008.

Friendly's has been able to manage the price increases for their branded grocery products, because all of the surrounding ice cream products are beset by the same commodities pressure. In the restaurant world, however, it's been a different story. A large portion of people who eat inside Friendly's -- of which about 50% are franchised -- purchase package meals that include ice cream.

Moreover, Friendly's ice cream is often advertised as a free addition, like: "Buy a burger and fries, get a free banana split." So when the burger and fries suddenly costs more than at a competing chain -- even though it comes with "free" ice cream -- a cost-conscious family is likely to avoid Friendly's.

All of that said, it appears that Sun Capital Partners still believes in Friendly's as a viable business (even though it can't control commodities prices). Word is that the firm is considering a stalking horse bid following the bankruptcy filing, which would include a forgiveness of certain Friendly's debt that Sun assumed in the original buyout.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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