Dine Equity: Indigestion After High Debt Bingeing During Credit Bubble

Jan.10.11 | About: DineEquity, Inc. (DIN)

This is a fairly detailed review of Dine Equity (NYSE:DIN) that I have decided to release, in part, to the public. Subscribers who wish to view and download the full analysis can scroll down to the bottom to access the appropriate links.

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:

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:

  1. Eliminated 65 companies with Negative Net Debt and Positive Sales Growth (Quarterly) – 74 left.
  2. Applied various conditions for key parameters to shortlist companies (proprietary). Created a rated list out of the aforementioned 74
  3. Selected companies primarily based on:
    1. Declining margins
    2. Declining sales
    3. High debt
  4. Reduced the list to 4 companies and scoured the footnotes, addenda and fine print to see what we could dig up.
Subscribers are urged to peruse our shortlist and delve into our stated reasons for shortlisting each – File Icon Retail Short Analysis. Professional and Institutional Subscribers have access to the very wide swath of fundamental data on the entire universe of retail stocks considered, as well as 48 quarters of personal consumption data across many categories – File Icon Retail Sector Shortlisting_042110 – Pro Addendum.
Click to enlarge

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.

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%

Click to enlarge

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 the company’s margin has 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: the company has already started looking at 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 December 2037, at a fixed rate of 7.1767% (inclusive of an insurance premium of 0.75%)

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

Click to enlarge

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)

  • 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).
  • 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)
  • 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) 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
Commencing in:

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

Click to enlarge

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 (NYSE:BCS) and Goldman Sachs (NYSE:GS) 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 7year at 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:

  1. A Quick, Yet Informative Note From a BoomBustBlog Reader on Consumer Stocks Monday, July 19th, 2010
  2. The American Recovery and the North American Economic Outlook Tuesday, May 4th, 2010
  3. 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
  4. What We’re Looking For To Go Splat! Part 1 Friday, April 23rd, 2010
  5. What We’re Looking For To Go Splat! Part 2 Monday, April 26th, 2010
  6. China’s Most Expensive Export: Price Inflation Friday, January 15th, 2010



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.