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Applebee’s: Credit crunch forced OK of IHOP buyout

Applebee’s: Credit crunch forced OK of IHOP buyout

OVERLAND PARK KAN. Applebee’s International Inc.’s board of directors chose the lesser of two evils in July when they agreed to allow IHOP Corp. to acquire the 1,950-unit casual-dining chain for $2.3 billion just as turbulent credit markets scotched a management-led plan to fund a recapitalization of the company, proxy materials recently filed with securities regulators indicated. —

The detailed proxy, filed with the Securities and Exchange Commission Sept. 6, also revealed that five of Applebee’s 14 directors had opposed the IHOP deal and have indicated that they will vote their combined 5-percent equity stake against the pending transaction because they view the $25.50-per-share offer as too low. —

No date has yet been set for a shareholder ratification. IHOP officials would not comment on the proxy materials because of sensitivities surrounding Applebee’s upcoming shareholder vote. —

According to the proxy materials, the tightening credit markets forced Applebee’s board majority to approve the “more certain” result of an IHOP buyout rather than stand behind Applebee’s management, which had proposed a “stand-alone” plan for a $1.6 billion recapitalization and bridge financing to fund a special shareholder dividend. —

“The board had conducted a publicly announced, comprehensive sale process of [Applebee’s], and…only one definitive offer was received as a result of that process,” the proxy stated. “Moreover, the board believed that…revised views and the tightening of credit markets cast considerable doubt on [Applebee’s] ability to execute the more definitive, near-term component of [management’s] stand-alone plan.” —

Applebee’s initially solicited 35 potential buyers and received “indications of interest” from four that offered nonbinding per-share buyout prices ranging from $26.50 to $30.50, the proxy showed. Glendale, Calif.-based IHOP, which is parent to the mostly franchised, 1,319-unit IHOP brand, initially indicated it could pay between $28 and $29 per share. —

But after further due diligence was completed, and as Applebee’s continued to report declining same-store sales, one bidder dropped out of the process, leaving in contention IHOP, a consortium of unidentified financial sponsors and a large Applebee’s franchisee that also was not identified. —

Eventually, IHOP remained as the only credible bidder. Despite a per-share offer from IHOP that fell from $27.50 to a final offer of $25.50, Applebee’s directors approved the proposal in a 9 to 5 vote, the proxy said. The companies now are moving forward on the deal, which is expected to close in the fourth quarter. —

The tightened credit markets also could delay, or at least make more expensive, the asset-backed securitization of both Applebee’s and IHOP and the bridge financing that IHOP planned to use to fund the majority of its purchase, one analyst noted. —

“There continues to be some uncertainty with the terms and necessity for the arranged bridge financing as well as the timing and ultimate terms of the whole company securitization given current credit market conditions,” securities analyst Steven Rees at J.P. Morgan said in a research note Sept. 10. “However, [IHOP chief financial officer] Tom Conforti expressed optimism of market receptivity for the wrapped, fully insured securitization of the IHOP and Applebee’s franchise royalties.” —

Applebee’s and IHOP are not alone in their dealings with the uncertain credit markets, which tightened quickly starting in June as a result of the sub-prime lending bust. Nick Cole, managing director of Wells Fargo Commercial Capital, says he has seen some restaurant deals get completely pulled because of the lack of liquidity. —

“At least for a period of time we’re going to be…in a situation when even if deals can get done, it will be more expensive,” he said. “You’ll definitely see more expensive borrowing affecting all corporate decisions.” —

Illustrating that point, the proxy documents show that Applebee’s financial advisor, Lehman Brothers, continued to revise downward starting in July the expectations that financing would be equally available for both an IHOP buyout and for Applebee’s proposed stand-alone plan. —

Lehman concluded, according to the proxy statement, that the ratings agencies and bond insurers would be more receptive to financing in connection with an IHOP-led buyout than with Applebee’s stand-alone plan mainly because of “heightened sensitivity” surrounding enterprise value, which was projected to be lower in the stand-alone plan “in light of…deteriorating market dynamics” as well as “significant recent volatility in the interest rate and credit market.” —

Despite such warnings, five Applebee’s directors, including current chief executive David Goebel, current chairman and former CEO Lloyd Hill and former corporate executive and franchisee Burton “Skip” Sack, indicated that they believed the challenges presented with the stand-alone plan could be overcome and that Applebee’s should have a chance to facilitate its own turnaround so that its own shareholders could benefit, according to proxy information. Applebee’s chief financial officer Steve Lumpkin and director Erline Belton were also among the dissenters on the board. —

Both Goebel and Lumpkin said they believed IHOP’s final purchase offer “was not fair to stockholders, in comparison to the higher value they believed would be produced by the stand-alone plan,” the proxy stated. —

In addition to the recapitalization and special dividend, which was pegged between $15 per share and $16 per share, the stand-alone strategy also included plans to refranchise the majority of Applebee’s 508 corporate restaurants, reduce corporate costs by about $52 million and continue to own the company’s real estate but “retain the flexibility” to sell the land at attractive prices. —

The management directors also asserted that Lehman’s negativity toward the financing available to fund the stand-alone plan was “suspect,” the proxy revealed, because Lehman would receive a large fee for its work on the IHOP-Applebee’s bundled securitization. —

Still, the majority of Applebee’s board voted for the IHOP offer as it presented “a more certain value [and] a better alternative for our stockholders,” the company’s filings said. The documents showed that using estimated Applebee’s earnings before interest, tax, depreciation and amortization for 2007, the stand-alone plan would equate to between $19.08 per share and $23.87 per share, well below IHOP’s offer of $25.50 per share. —

Wall Street analysts and institution investors had yet to offer opinions on whether the revelation that five inside Applebee’s directors oppose the deal could inspire other groups of shareholders to grow skittish, or whether financiers who would be expected to fund the buyout might be influenced negatively by the board minority’s dissent. —

Prior to the revelation, activist investor Sardar Biglari, who also is chairman of family-dining chain Western Sizzlin,’ said he planned to vote his 1 million Applebee’s shares, or about a 1-percent stake, against the deal because the valuation was too low. —

If the deal does not close, Applebee’s could be required to pay a $60 million “breakup” fee to IHOP. —

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