IHOP Digs into Applebee's

The pancake house thinks its recent revival might rub off on the languishing dinner chain. But will shareholders agree to the deal?

IHOP (IHP), a recent and rare success story among national restaurant chains, believes it can use similar strategies to revive the flagging Applebee's (APPB) restaurant chain. IHOP offered $25.50 per share to buy out Applebee's in a $2.1 billion deal on July 16.

In making the deal, IHOP chairman and chief executive Julia Stewart is biting into a company almost twice IHOP's size. The new outfit will run 3,250 restaurants and generate more than $6.8 billion in sales each year.

Stewart said the first item on her agenda will be selling off company-owned restaurants to franchisees. Almost all IHOP restaurants are owned by franchisees, but about a quarter of Applebee's restaurants are owned by the company.

"We will fundamentally change the company's business model," Stewart told analysts Monday. The sale of restaurants can help pay down debt from the acquisition, but it will also allow IHOP to exploit its skill in franchising, the firm says.

J.P. Morgan analyst Steven Rees wrote recently IHOP has "a strong track record of franchising." He added: "Stewart is an excellent leader, in our view, and has earned substantial respect from IHP's franchise community."

IHOP's business model "generates stable cash flows" while avoiding risks of inflation in labor or commodity costs, Rees wrote.

IHOP may have a tough challenge in reviving Applebee's brand.

The number of customers visiting casual dining restaurants has been falling since the middle of 2006. It's a trend many blame on higher gas prices and lower home values. Applebee's sales were down 3.7% in the first four months 2007, a sign perhaps of declining customer interest in its menu offerings.

Standard & Poor's analyst Mark Basham expects the fundamentals for restaurants to recover in the long term as more Americans eat out more often. However, rapid expansion by Applebee's and others has led to an oversupply of restaurant outlets, he says. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

Stewart says a main goal will be "reenergizing Applebee's brand." She points to success attracting customers to IHOP, a 50-year old brand. "We are highly confident we can repeat this success with Applebee's," she said.

CIBC analyst John Glass notes that IHOP has been successful "turning a once-sleepy company into a stock up 30% in the past year."

However, Glass wrote in a July 16 research note, he wonders if Applebee shareholders will agree to the proposed acquisition. The price is a 4.6% premium over Friday's close, but it hit higher prices in late June. Also, the all-cash deal doesn't give Applebee's shareholders any chance to participate in a revival of the company. "We think that some within [Applebee's] shareholder base may take exception," Glass wrote.

Before it's here, it's on the Bloomberg Terminal.