Corporate Focus: Analysts Expect Changes in IHOP Franchisee Financing

Corporate Focus: Analysts Expect Changes in IHOP Franchisee Financing By CARLOS MARTINEZ Staff Reporter Glendale-based IHOP Inc. has yet to decide whether it will scrap its program aimed at financing its franchisees, but analysts are already saying the company will likely get out of the loan business and bolster its bottom line by selling the loans $287 million worth for cash. “They have very significant receivables in their books and, frankly, they can turn around and sell them to buy their way into another growth vehicle,” said Greg Schroeder, managing director of Fulcrum Global Partners in New York. The restaurant chain, which operates more than 1,000 International House of Pancakes restaurants nationwide, has been under pressure from its biggest stockholder, Southeastern Asset Management, to dump nearly $300 million in loans it holds from its franchisees. In a filing with the Securities and Exchange Commission last May, Southeastern said the company must sell the loans and improve its stock value by using the sale proceeds for stock repurchase or dividends. In response to Southeastern, the company has hired Solomon Smith Barney Inc. to give it some advice on whether to scrap its loan program. Regardless of what advice it gets, Schroeder said, the company will likely end its longstanding loan program and join its competitors, none of which finance their franchisees. Schroeder said, “They’re locking up their cash in high-risk loans to independent business people.” Traditionally, IHOP borrows money at wholesale interest rates of 8 to 9 percent while charging franchisees between 11 and 12 percent, Schroeder said, making a tidy profit on the interest. The company, no matter what, is on solid financial ground. Last year, IHOP reported net income of $35.3 million on total sales of $303.2 million, compared to $32.1 million in net income on sales of $273.2 million in 1999. IHOP’s stock price has hovered around the $30 range for the past month, with a 52-week high of $31.03 and a 52-week low of $18.90. It closed Friday at $30.06. Robert Killen, CEO of investment banking firm The Killen Group, said IHOP has been successful by following a solid business strategy all its own by building new restaurants then leasing the buildings back to the franchisees, it collects a steady revenue. But even Killen agrees the company’s days in the financing business are numbered. “There’s pressure to maximize stock value to the shareholders and they’re sensitive to that, so I see them selling off those loans,” said Killen, whose company owns about 122,000 IHOP shares. It was unclear what IHOP would do about its loans. Company CEO Robert Herzer was unavailable for comment. But a decision on the potential restructuring or sale of the loans could come sometime in the next three months, Killen said. Dennis Joe, an investment analyst with Sidoty & Co., said the company would do well by either restructuring its loan program or dumping it altogether. “It’s a pretty quiet company for the most part. Its stock doesn’t move that much, so it could help itself by selling off its loans and putting the cash to use,” he said. But Joe, like other analysts contacted by the Business Journal, said he was neutral on the stock, with a price target for this year of $32 and projected earnings of $2.18 per share. After last month’s hiring of Applebee’s International Inc.’s marketing whiz Julia A. Stewart as its president and COO, IHOP figures to make a major push to win over the lunch and dinner crowds that have so far escaped it, said Randall Hiat, an analyst with Fessell International. “Julia’s got a lot of experience in marketing and she’ll be able to recognize the opportunities to market the brand,” he said, noting her success at Applebee’s in a marketing campaign that highlighted her changes in the menu to attract more diners. Stewart had been president of Applebee’s Domestic Division. So far, more than half of IHOP’s sales come from its breakfast business and efforts to increase dinner and lunch traffic have been unsuccessful, Hiat said. Stewart’s arrival will likely change that, Hiat added. “Once she takes over for Herzer (who is expected to retire later this year), you’ll see some changes. But it’s not like a turnaround situation. It’s a ‘go forward’ strategy to move the company forward.”