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In researching his thoughts about the potential merits of the Applebee’s deal, Goldman Sachs restaurant analyst Steven Kron looked at the chain’s recent results in a way most analysts don’t. He didn’t spend much time on its financials; Applebee’s is a well-run chain with a decent balance sheet and solid cash flow. As a public company, subject to audits that adhere to Sarbanes-Oxley standards, those numbers are out there where everyone can see.

Instead, Kron took a butts-in-seats approach, looking back into recent history to see how Applebee’s has performed over time.

What he found wasn’t good. Examining August 2007 figures for the chain’s guest traffic, he noticed a reported decline of between 6 and 6.5 percent from August 2006. But that August 2006 number had been 2.5 to 3 percent lower than that of August 2005, which itself had been off 4-4.5 percent from August 2004. That latter number had been off 1.5 percent from August 2003.

All through this period, tightened operation controls and modest menu price increases had kept Applebee’s numbers in the black. Nevertheless, Kron points out, Applebee’s August customer traffic has collectively declined between 14-15.5 percent over the past four years. Not a good number there. Neither is another one Kron found: Applebee’s has reported falling guests counts for 34 of the past 37 months.

It doesn’t sound like this is a company anyone would want to own, but customers counts have little to do with the argument about the Applebee’s/IHOP deal. Both sides see the chain as a cash cow in the making.

In a nutshell, IHOP is offering $1.9 billion in cash and would assume $155 million in debt to take control of Applebee’s. IHOP doesn’t actually have the cash, but would get it by selling off most of Applebee’s company-owned stores to franchisees and also selling the real estate on which those company-owned stores sit.

The dispute has arisen because only some of the current shareholders want to take the cash. The rest wonder why Applebee’s doesn’t just sell the company-owned stores and the real estate itself, aka the stand-alone plan. “We should do this ourselves,” they argue. “Who needs IHOP?”

That’s what Proxy Governance is thinking. “We acknowledge that there are financing and execution risks association with the stand-alone plan. However, we are not convinced that the certainty that comes with accepting the all-cash merger consideration outweighs the opportunity to share in the potential upside from executing the stand-alone plan.” Which is to say, getting cash in hand from IHOP now is less attractive than what might result if shareholders keep control and handle the sell-off and its proceeds themselves. A bold assumption, given the customer count trend.

Glass Lewis sees it the other way. “We do not believe that the board of directors has taken the decision to sell the company lightly. Nonetheless, a majority of the board’s directors did not have an adequate level of confidence in the executive team or the risk-adjusted value of the recapitalization plan in order to support the stand-alone plan.” The board vote to sell to IHOP was nine to five.

It sounds like those nine board members might have been a little alarmed by the declining customer counts, and wanted to get out while the getting was good. If so, they’ve got company, because parts of the full-service restaurant market appear headed for heavy weather. Check out what the prognosticators at Technomic had to say in the October 2007 edition of the American Express Market Brief. While second-quarter same-store sales were pretty good for limited-service restaurants, “the modest LSR success rate was not equaled in the full-service realm, where 25 of 49 chains reported same-store sales below those of the same quarter in 2006 (emphasis added).

Who’s feeling the most pain? Casual dining restaurants like Applebee’s, where the price points are most reasonable.

“Patrons of lower-end casual diners and the bar and grill segment will continue to be the most impacted by macroeconomic headwinds in our view,” says Kron.” We expect those concepts to experience the most same-store sales weakness.”

To be specific, those headwinds include credit market and housing market woes that make potential customers feel, or actually be, poorer. It seems like this situation could get grim, but the competing forces battling over control of Applebee’s must see it in a different light.

We don’t know which view of the casual dining segment will prevail, but Applebee’s is not alone in the shrinking-customer-count dilemma. J.P. Morgan Securities has calculated that Chili’s Bar & Grill traffic was down 12.2 percent from August 2004 through August 2006, while another Brinker concept, Romano’s Macaroni Grill, posted a cumulative customer count decline of 18.4 percent from July 2003 to July 2007. Brinker has put Macaroni Grill up for sale.

So what happened to all the customers? A recent survey conducted by WD Partners, a Columbus, OH-based consulting company, identified several factor impacting them, including higher gasoline prices, rising levels of household debt and people who said they were “tired of the same old chains.”

“Have chains been too slow, or too conservative, in evolving their concepts?” WD’s Dennis Lombardi asks. “Maybe the megabrands need to focus on innovation to catch up with consumers.”

Until they do, that leaves plenty of opportunity for the more nimble players in casual dining. If you’re one of those restaurant operators who bemoan the fact that big chains have all the advantages, your time has come, because they sure don’t now.

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