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Focus on Dine Equity (DIN): High Debt Binging During The Credit Bubble Causes Indigestion For This Food Chain!
This is a fairly detailed review of Dine Equity (DIN), pre-refinancing.
Background
Early in 2010 we performed a comprehensive scan of retail companies,
believing that much of the market actually bought into the hype that was
labeled “recovery”. If we were right, than profitable short plays were
available. As it turned out, we were right on point, and profitably so.
I broke the retail scans into two posts with the first one detailing
methodology and reasoning and the second one containing the actual
initial scans:
- What We’re Looking For To Go Splat! Part 1 Friday, April 23rd, 2010
- What We’re Looking For To Go Splat! Part 2 Monday, April 26th, 2010
We created a list of 141 retail companies whose market cap is greater
than$500 million and share price is over $10 that we used to create a
universe of potential retail shorts. From that list we:
- Eliminated 65 companies with Negative Net Debt and Positive Sales Growth (Quarterly) – 74 left.
- Applied various conditions for key parameters to shortlist companies
(proprietary), created a rated list out of the aforementioned 74 - Selected companies primarily based on:
- Declining margins
- Declining sales
- High debt
- Reduced the list to 4 companies and scoured the footnotes, addenda and fine print to see what we could dig up.
One of the companies from the shortlist, Dine Equity, garnered further
attention. I took two views of the company with two different analysts,
each with a unique perspective. I will share the first view publicly,
and the second will be offered for download to all subscribers at the
end of this post.
Dine Equity Forensic Overview
This opinion was derived in September, BEFORE Dine Equity successfully refinanced its debt.
Company Description
DIN owns, operates and franchises two restaurant concepts in the
casual dining and family dining categories: Applebee’s Neighborhood
Grill and Bar® and IHOP (International House of Pancakes). With over
3,400 franchised or company−operated restaurants combined, DIN is the
largest full−service restaurant company in the world. In November 2007,
the company completed the acquisition of Applebee’s International, Inc.
(“Applebee’s”). The company reports its operations under four segments
including: franchise operations, company restaurant operations, rental
operations and financing operations. Within each segment, as applicable,
the company operates under two distinct restaurant concepts: Applebee’s
and IHOP.
As of December 2009, the company had 1,609 restaurants operated by
Applebee’s franchisees in the United States, one U.S. territory and 15
countries outside of the United States. While under the restaurant
operations segment, Applebee had 398 company−operated restaurants in the
United States and one company−operated restaurant in China.
Under its IHOP segment the company had 1,443 restaurants operated by
IHOP franchisees and area licensees in the United States, two U.S.
territories and two countries outside of the U.S, and 12
company−operated restaurants in the United States and one restaurant
reacquired from a franchisee that was operated by IHOP on a temporary
basis until refranchised on January 4, 2010.
Key Concerns:
· High Debt is the key concern for the company:
The Company has a high net-debt to equity ratio 14.3x and Debt-to-ttm
FCF of 12.2x at the end of 2Q10. Moreover, based on the company’s debt
maturity schedule at the end of December 2009, we have estimated that
98.4% of total debt which is nearly $1.6 billion is due for repayment
over the next two years (i.e 2011 and 2012), this excludes the current
portion of $25.2 million which is due for payment in the 2H10.
|
Debt Repayment schedule- At the end of December 2009 |
|
|
|
|
|
|
(in $ mn) |
1 Year |
2-3 Years |
4-5 years |
More than 5 years |
Total |
|
|
2010 |
2011-12 |
2013-14 |
2015 and after |
|
|
Debt to be paid (in $ mn) |
25.2 |
1637.2 |
0 |
0 |
1662.4 |
|
Debt prepaid |
76 |
|
|
|
|
|
Remaining at the end of 1H10 – Estimated |
|
|
|
|
|
|
Current maturities |
25.2 |
1561.2 |
|||
|
As a multiple of annualized FCF |
0.6 |
3.0 |
|||
|
As a % of Total debt |
1.6% |
98.4% |
|
|
|
At the end of 2Q10 the company had an interest coverage ratio of 1.6x
which has remained stable over the last five quarters and is higher
compared to 2008. However, it could become a concern for the company if
it is unable to maintain its current level of sales and margins in the
coming quarters.
· Declining Sales owing to poor sector outlook:
Company’s sales declined 12.4% in 2009, and based on Bloomberg’s
consensus estimates this decline is expected to continue in 2010 and
2011 at 4.5% and 9.0%, as the casual dining industry in the US (which is
the major area of operation for DIN) is not expected to witness a
significant recovery at-least in the near-term. Though, company’s margin
have improved to 19.6% in 2009, it is still below the pre-crisis and pre-acquisition level of 20.0% in 2007, 24.4% in 2006 and 24.3% in 2005.
· Based on relative valuation the company is marginally overvalued:
As of September 30, 2010 the company was trading at an EV/EBITDA of
7.7X its 2011 estimates, while its competitors BOBE (Bob Evans Farms,
Inc.), DENN (Denny’s Corporation) and CBRL (Cracker Barrel Old Country
Store, Inc) were trading at an EV-to-EBITDA of 4.8x, 6.3x and 7.7x,
respectively.
However, there is a safeguard to the company’s weak financial
position, i.e the company has already started looking for refinancing
its debt, and if the company is successful in doing the same at some
favorable terms (which looks extremely difficult), it may be able to
temporarily postpone its problem for the time being.
Moreover, if the company is unable to refinance its debt, it
has the option of extending its maturity by 6 months for December 2007
debt and 2 years for March 2007 debt, although at a higher interest
rates, which will adversely impact the already low interest coverage
ratio of the company.
As per the company’s 2009 10K, “As described in Note 8 of the Notes
to the Consolidated Financial Statements, the Fixed Rate Notes (the
“Notes”) issued as part of the Applebee’s and IHOP November 2007
securitization transactions have a legal maturity of December 2037;
however, the indentures under which the Notes were issued includes
provisions which may require the early repayment, in whole or in part,
of the Notes which, if not met, would require the Company to use all or
part of the excess cash flow that would otherwise be available for
general business purposes to fund a reserve account for the Notes or to
begin to pay down the Notes. As of December 31, 2009, the conditions
that would require an early repayment date for the Notes had not
occurred.
Irrespective of covenant compliance, the accelerated payment date for
the Applebee’s and IHOP November 2007 securitization debt is December
2012, subject to extensions as discussed below.
In the event that we are unable to refinance the Applebee’s and IHOP
November 2007 securitization debt by December 2012, we will have the
ability to extend the scheduled payment date for six months if we are in
compliance with applicable covenant ratios at that time. The interest
rate on this debt will increase by 0.50%, and any unpaid amount will
accrue interest at such increased rate.
Similarly, if we are unable to refinance the IHOP March 2007
securitization debt by March 2012, we will have the ability to extend
the scheduled repayment date for up to two years with a 0.25% annual
increase in the interest rate each year. However, if the IHOP November
2007 securitization debt goes into rapid amortization, the IHOP March
2007 securitization debt will go into rapid amortization as well.
We intend to refinance all of the Applebee’s and IHOP indebtedness
prior to the expiration of such extension periods that are available.”
Though, the company has started looking for refinancing options it
looks as if it will be difficult for the company to refinance its debt.
Therefore, the company is trying various ways to raise cash to meet its
requirement for the already announced debt under offer discussed below:
· On September 10, 2010, the company announced a cash tender
offer for any and all of the outstanding principal amount of the
following notes :
|
|
O/S Amount (in $ million) |
Amount of valid tender received prior to deadline (as of Sept 24, 2010) |
Percent of O/S amount tendered |
Tender offer consideration |
Early tender Premium |
Total Consideration |
|
Series 2007−1 Class A−2−II−A Fixed Rate Term Senior Notes due |
599 |
534 |
89.10% |
985 |
30 |
1015 |
|
Series 2007−1 Class A−2−II−X Fixed Rate Term Senior Notes due December 2037, at a fixed rate of 7.0588% |
366 |
366 |
100% |
985 |
30 |
1015 |
|
Series 2007−1 Fixed Rate Notes due March 2037, at a fixed rate of 5.744% (inclusive of an insurance premium of 0.60%) |
175 |
171 |
97.60% |
1020 |
30 |
1050 |
|
Series 2007−3 Fixed Rate Term Notes due December 2037, at a fixed rate of 7.0588% |
245 |
187 |
76.30% |
1045 |
30 |
1075 |
|
Total |
1385.1 |
1257.4 |
|
|
|
|
The Tender Offers and the Consent Solicitation are scheduled to
expire at 5:00 p.m., Eastern Daylight Time, on October 8, 2010, unless
extended or earlier terminated by DineEquity. (Source: http://www.marketwatch.com/story/dineequity-inc-announces-preliminary-results-of-tender-offers-and-consent-solicitation-2010-09-24?reflink=MW_news_stmp)
· Moreover, to finance these notes the company has already
announced that it plans to offer, up to $825 million aggregate principal
amount of its senior unsecured notes due 2018. No other material detail
has been provided by the company on its progress after that. (Source: http://www.marketwire.com/press-release/DineEquity-Inc-Announces-Proposed-Private-Offering-of-Senior-Notes-NYSE-DIN-1316843.htm).
· Based on another press release as of September 20, 2010,
the company is planning to raise debt through speculative-grade debt as
Junk Bond Investor Inflows Surge in the market. Source: http://www.bloomberg.com/news/2010-09-20/dineequity-plans-debt-as-junk-bond-investor-inflows-surge-new-issue-alert.html)
· Recently, on September 29, 2010, the company announced it
has reached three preliminary deals to refranchise a combined 86
company-owned Applebee’s restaurants, continuing its effort to move to a
franchisee operating model. And we believe that the proceeds from this
deal if completed will be used to repay debt. Another pending deal to
sell 63 in Minnesota and Wisconsin and is slated to close in the fourth
quarter of 2010. But as per the company if the deal is terminated by
mid-November, the company won’t be able to carry out plans to redeem $28
million of preferred stock.
Overall, though the company has announced the cash tender offer (for
repayment of debt), it still remains unclear how the company will
finance the payments for its tender offer, which is a key concern in our
view, as refinancing still remains difficult in the current market
conditions. Further, we expect to get more clarity on companies’
operating performance and refinancing plans once the company releases
its 3Q10 results in the last week of October 2010.
Certain key facts related to Dine Equity’s (DIN US) debt refinancing efforts.
- Though, DIN’s debt is due for payment in 2012, the company is making
serious efforts to get the debt refinance as early as possible. This
is mainly because of the company’s debt covenants that till now the
company has met, but if the future industry trends fails to support the
company’s operating performance, it could become a concern.
Most analysts believe that company is being proactive and does not
want to reach a condition where it ends up breaching any of its
covenants.
The most significant covenants related to the company’s securitized
debt require the maintenance of a consolidated leverage ratio and
certain debt service coverage ratios:
o The consolidated leverage ratio which is defined as (a) the sum
of (i) all securitized debt (assuming all variable funding facilities
are fully drawn); (ii) all other debt of the Company; and (iii) current
monthly operating lease expense multiplied by 96; divided by (b) the
sum of (i) the Company’s EBITDA (as defined) for the preceding 12
months; and (ii) annualized operating lease expense, has the maximum
limit of 7.25x (for the Applebee’s Notes) and 7.0x (for the IHOP
Notes). As of June 2010, the company had a consolidated leverage ratio
was 5.96x.
o Debt service coverage ratios (DSCR), which is the ratio of
restaurant net cash flow divided by total debt service payments, which
include, interest payments, insurance premiums and administrative
expenses. As per the covenants the company has to maintain a minimum
DSCR of 1.85x, failing which the company can face a Cash Trapping Event,
a Rapid Amortization Event, or a Default Event. At June 30, 2010, the
Applebee’s three−month DSCR was 3.70x and the IHOP three−month DSCR was
3.48x.
o Another DSCR covenant that became effective under the Applebee’s
Notes starting fiscal quarter January 2010, and will continue till
fiscal quarter of October 2012, sets the minimum limit for twelve-month
DSCR described in the table below:
|
Fiscal Quarter |
Minimum Twelve Month DSCR |
|
Apr-10 |
2.25x |
|
Jul-10 |
2.30x |
|
Oct-10 |
2.35x |
|
Jan-11 |
2.40x |
|
Apr-11 |
2.45x |
|
Jul-11 |
2.50x |
|
Oct-11 |
2.55x |
|
Jan-12 |
2.60x |
|
Apr-12 |
2.65x |
|
Jul-12 |
2.70x |
|
Oct-12 |
2.75x |
As of June 2010, Applebee’s 12−month DSCR as of June 30, 2010 was
3.33x. If the restaurant cash flow components of the calculation had
been $82.5 million, or 32.3%, lower, the Company would have fallen below
the current 2.25x minimum threshold.
- In order to meet its refinancing requirements, the company is
raising two types of debt 1) Secured term loan of $900 million and 2)
Senior unsecured debt of $825 million.
o According to industry sources, the company started marketing it’s
a $900 million term loan (7 years) through Barclays and Goldman Sachs
in the last week of September 2010. Pricing terms of the loans have
been established at LIBOR plus 475 bps, with an initial discount of 1.5
cents on a dollar, a 1.75% LIBOR floor and a one-year, 101 soft call
protection. In addition to this debt. Commitments are due Oct. 4, 2010.
In addition to the term-loan the company is also raising a revolving
credit facility that could be between $50 million and $75 million. Both
proceeds from the loan and revolving credit facility are expected to
be used for refinancing the debt.
o The company is also raising $825 million in senior unsecured 8-yr
notes, non-callable for 4 years, via Barclays and Goldman Sachs. The
notes are rated B3 by Moody’s and CCC+ by S&P. According to media
sources, proceeds will be used to refinance outstanding securitization
debt of Applebee’s and IHOP, and to redeem a portion of series A stock.
No details on pricing terms have been disclosed yet. However, based on
similar deals in the, market we expect the company will be able to
raise this debt at an interest rate of 9.5% p.a.
Though, it is evident that the company is making serious efforts to
refinance its debt, and there is a possibility that it will be able to
raise new debt but that will be only at higher interest rates and with
more stringent conditions and covenants.
Additionally, as per our analysis if the company is able to refinance
through the above mentioned loans it will be at an higher fixed
interest rate of 7.6% (i.e effective interest rate of 12.4%) compared
to 6.7% (effective tax rate of 10.9%) in 1H10.
- Added points of concern include higher interest rates which will
adversely impact the company’s operating performance mainly a lower
interest coverage ratio and lower EPS, which may change the company’s
valuation. We have tried to gauge the impact of the same by assuming
same operating income and other parameters as 1H10 (Annualized) for
2010 and 2011, while the interest rates have be increased as per
refinanced debt. Findings for the same have been summarized in the
table below:
- Overall, currently the company is trading at an EV-to-2011 EBITDA
multiple of 7.7x, which is higher compared to its competitors, despite
the fact that the company has a higher net debt-to-equity ratio.
DineEquity Conference Call Notes
- AppleBee’s same restaurant sales up QoQ 1st time since 2008 first quarter
- Expects to finish sale of ~119 business owned AppleBee’s by end of year
- Refinanced bond deal, 99% perpetual preferred stock redeemed
- SRS 3.3% YoY AppleBee’s
- Menu price increases offset by traffic decline, traffic spending is up
- Increased full year guidance for SRS to -1% to 1% (AppleBee’s)IHOP
SRS were up slightly (0.1%) w/ lower traffic offset by higher checks
- IHOP 9 new restaurants, on pace for 60/year
- SRS guidance increased to match AppleBee’s
- Push made for more franchising in business model to reduce capex
- 1.8 bil refi three weeks ago, favorable debt market conditions
- Refi on securitized debt structure, “allows for favorable capital structure for growth plans for IHOP and AppleBee’s”
- Goal of avoiding refi risk on maturity in 2012, seek attractive interest rates & extend maturities
- Bank debt: 900 mil 7yr @ LIBOR + 450 bps, LIBOR floor of 150 bps (6% rate as of today)
- Weighted average after tax cash interest rate is 4.6%, $7.3 mil savings annually, .42 per share
- Extends maturities from 2012 to 2017/2018
- Watch the interest coverage/leverage rates
Q&A:
- Higher labor/utility costs, disappointed in operating margin
- 2 for 20 is ~20% of sales and is steady at that level
- Modeling 2011 for inflationary conditions, guidance to have it offset by “co-op” work, avoid adding to menu costs
The post-refinancing Dine Equity opinion is available on BoomBustBlog.
Related posts:
- A Quick, Yet Informative Note From a BoomBustBlog Reader on Consumer Stocks Monday, July 19th, 2010
- The American Recovery and the North American Economic Outlook Tuesday, May 4th, 2010
- Is
the Consumer Really Back? Well, It Depends On If You Believe What the
Government Tells You or Whether You’re An Independent Thinker Monday, May 3rd, 2010 - What We’re Looking For To Go Splat! Part 1 Friday, April 23rd, 2010
- What We’re Looking For To Go Splat! Part 2 Monday, April 26th, 2010
- China’s Most Expensive Export: Price Inflation Friday, January 15th, 2010
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