“Change will come. It’s only a matter of who brings it.”—Richard C. Breeden, hedge fund manager, Applebee’s stake-holder, former SEC chairman
For more than two years, the restaurant industry has witnessed and been affected by the heightened activity of a new breed of “activist investors.”
Those activists—often the heads of private-equity firms or hedge funds—are confident, vocal and sometimes larger than the companies they target. They also have successfully forced change at some of the biggest restaurant companies, including McDonald’s, Wendy’s, Applebee’s and OSI Restaurant Partners, parent of the Outback Steakhouse brand.
The activists’ “strategic suggestions” also have forced other restaurant companies—even those not targeted by buyout bids or demands for assets spinoffs or seats on boards of directors—to proactively undertake moves that are “shareholder-friendly.” Those might including share repurchases, slowed unit development, reduced corporate spending and the shedding of noncore chain assets.
As Doug Brooks, chief executive at Chili’s Grill & Bar parent Brinker International Inc., said at a recent investor conference, “there is no shortage of interest in our industry these days, and much of the recent news has centered on the participation of activist shareholders…but it is my job as CEO to act as our own internal activist.”
As Brinker and many other restaurant companies have demonstrated, corporate entities repeatedly are being placed on the defensive by activist investors. Their newer tactics, including websites that project the investor’s point of view about corporate governance or business strategy, predictably can appear one-sided. But the activists’ uses of mass media to disseminate their slates of strategic alternatives, which typically were discussed previously behind closed doors, appear to have led to faster action by targeted companies.
THE GOVERNMENT MAN RICHARD C. BREEDEN Chairman and chief executive, Breeden Capital Management LLC CLAIM TO FAME: former chairman, U.S. Securities & Exchange Commission; former corporate monitor of WorldCom Inc. during the company’s restructuring AGE: 57 FUND ASSETS: more than $1 billion HOME BASE: Greenwich, Conn. TARGET:Applebee’s International Inc. STAKE: 5.42 percent DEMANDS: four Breeden-nominated board members; reduced corporate spending; increased refranchising; additional capital to shareholders D-DAY: May 25, Applebee’s shareholder meeting, Overland Park, Kan.
For example, about a week after activist investor William A. Ackman showcased a 40-minute audio-visual diatribe against McDonald’s corporate structure in late 2005, the company announced it would sell 1,500 of its restaurants, repurchase $1 billion of its stock within about three months and provide more details about restaurant-level performance—all moves that Ackman had called for.
Ackman at that time held a 4.5-percent stake in McDonald’s, but he leveraged more clout by using the powers of the media to get his point across to the close-knit investment community that was represented at the time at the inaugural Value Investing Congress in New York.
The accomplishments of early activist investors have spurred others to be even more aggressive.
“Success spawns imitation,” says Mark Schwarz, founder of Newcastle Partners LP, a Dallas-based hedge fund that works both passively and actively within its investments. Newcastle holds a majority stake in Pizza Inn Inc., a company which Schwarz chairs, and it owns the Fox & Hound Restaurant Group.
“There is a long, storied tradition of relational investors,” he says. “The term ‘activist investor’ is the flavor of the day, but if you look back, you’ll see that Warren Buffet was a shareholder activist. Today there is an aggressive and negative connotation that is clearly there.”
Regardless of the terminology, observers and pundits conclude that companies must take proxy threats, public letters to board members and calls for changes to corporate strategy very seriously, regardless of the size of the investment, the size of the hedge fund or even the lack of restaurant industry experience.
The most recent corporate battles surround two very different investors focused on two very different companies. Both situations, however, are set to erupt next month at the shareholder meetings of Applebee’s International Inc. and Friendly Ice Cream Corp.
Richard C. Breeden is a former U.S. Securities and Exchange Commission chairman who in 2005 founded the Breeden Partners LP hedge fund, which is managed by Breeden Capital Management LLC. Based in the hedge-fund haven of Greenwich, Conn., Breeden Partners has grown quickly to the $1 billion-plus asset level and counts the deep-pocketed California Public Employees’ Retirement System as an early investor. CalPERS committed a reported $400 million to the Breeden fund in early 2006.
For the year ended in December, Breeden Capital counted among its investments the tax services provider H&R Block Inc. and STERIS Corp., a provider of health science technologies, products and services. Breeden’s largest and most public holding, however, is in Applebee’s, operator or franchisor of about 1,942 namesake restaurants. Currently, Breeden and its related funds own a little more than 4 million common shares of the industry’s largest casual-dining chain, or about 5.4 percent of Applebee’s total shares outstanding.
THE MAVERICK NELSON PELTZ Chairman and chief executive, Triarc Cos. Inc. Chief executive and founding partner, Trian Fund Management CLAIM TO FAME: college dropout with net worth in the $1 billion-plus range; early leveraged buyouts were partly funded through Michael Milken’s junk bonds; purchased Snapple Beverage Corp. for $300 million and sold it three years later for $1.5 billion AGE: 64 FUND ASSETS: Undisclosed, although more than $2 billion in publicly disclosed investments HOME BASE: New York TARGET:Wendy’s International Inc. STAKE: 4.4 percent DEMANDS: spinoff of Wendy’s-owned Tim Hortons; reduced corporate spending; and three Trian-nominated board members—all met. Speculation exists that Peltz will put Wendy’s in play. D-DAY: the standstill agreement between Wendy’s and Peltz expires in June.
Breeden has filed proxy materials for the nomination of four people he is sponsoring for membership on Applebee’s board, pitting them against four incumbent directors, including chairman and former chief executive Lloyd Hill.
“The last person on earth who should sit on a board is the former CEO,” Breeden says. Using a football analogy, he adds, “If a new CEO says he is going to pass [the ball], and the last CEO says, or even wonders, if he would have run [with it], the board could be reluctant to move forward because of embarrassment, and that is not what they should be worried about.”
Breeden has called for Applebee’s to sell about 300 of its own restaurants to franchisees and to reduce corporate spending, including the payouts of bonuses and incentives, during a period of corporate “stagnation.”
Through public filings, published reports and in conversation, Breeden makes it clear he does not think very highly of those leading the Applebee’s brand.
The company, like many of its casual-dining peers, has suffered from a sales slump for almost three years. Its profits have declined, its same-store sales have trended negative and the chain has yet to gain any traction from turnaround strategies it has implemented, such as an increased focus on higher-end menu offerings from celebrity chef Tyler Florence and new advertising campaigns.
With pressure mounting from Breeden Partners, which first took a position in the company in late 2006, Applebee’s said in February it would begin exploring strategic alternatives, including a possible sale of the company or a large recapitalization. It recently agreed to close 24 underperforming units and said it was looking to replace its former advertising agency.
“I’d like to see [Applebee’s] transform from a sluggish, badly run company to a good strong competitor that maximizes its potential,” Breeden says.
At Applebee’s, the frustration with the investor’s statements is palpable.
“The real issue here is improving our business in the midst of a very tough competitive environment,” Applebee’s chief executive Dave Goebel declared late last month in a prepared statement. “We are aggressively working to build sales and traffic, which will improve our return on investment and, ultimately, deliver more value to shareholders.”
Applebee’s also said it had offered two board seats to Breeden and a confidentiality agreement so that he could monitor the status of the company’s strategic review. Breeden rejected those offers, a move Applebee’s said “was difficult to understand” from someone “who says he wanted to be a constructive force.”
“Curiously [Applebee’s] said we could have two reps on the board, but that they wanted to pick who,” Breeden says, explaining why he rejected the company’s overtures for a settlement. “I’m the CEO of the fund; I would make the judgment as to who sits on the board. It was an offer [Applebee’s] knew would be rejected. It was a [public relations] play.”
Breeden scoffs at the question of whether foodservice industry experience should be a prerequisite for sitting on a restaurant company’s board.
“Goebel should know about running restaurants,” he says, “and it’s his job to deal with same-store sales. The board’s job is to set performance targets that are meaningful, hold management accountable, to worry about the long term, and the allocation of capital.”
Applebee’s shareholder meeting is scheduled for May 25. In the run-up to that potential showdown with the Breeden forces, there has been speculation that the company is working hard to line up a buyout deal before the meeting. Applebee’s said in March that it had begun contacting potential buyers, and most analysts hypothesize that private-equity buyers could purchase Applebee’s for a per-share price in the high-$20-to-low-$30 range, placing its total value in excess of $2 billion.
Breeden says he has “no objection” to a sale of Applebee’s “if they can get a good price.” But if Applebee’s “tries to sell at anything” below that good price, then the fund would reject the proposal, he adds.
Like Breeden, activist investor Sardar Biglari borrows his investment style from legendary investor Warren Buffett. It was the book “The Warren Buffett Way” that inspired Biglari to create his own investment fund with proceeds from the sale of an Internet services provider he founded with a friend while at college in 1996.
Biglari’s San Antonio-based Lion Fund LP and its related entities hold a nearly 15-percent stake in Friendly Ice Cream Corp. Much like the situation at Applebee’s, Biglari and Friendly Ice Cream have battled for months over board seats, corporate strategy and the disputed use of the corporate jet by executives. Friendly is the operator or franchisor of more than 500 Friendly’s restaurants.
Biglari was born in Iran, and with his family he gained asylum in the United States at the age of seven after his father had been detained by forces in Iran led by Ayatollah Khomeini. Biglari’s father had worked for Iran’s former leader, Shah Mohammed Reza Pahlavi.
THE WHIZ KID SARDAR BIGLARI Chairman, Western Sizzlin’ Corp. Chairman and chief executive, Biglari Capital Corp. General partner, The Lion Fund LP CLAIM TO FAME: founded Internet services provider INTX Networking LLC, which he sold for a hefty profit in 1999; launched The Lion Fund in 2000 with his college professor AGE: 29 FUND ASSETS: undisclosed HOME BASE: San Antonio TARGET: Friendly Ice Cream Corp. STAKE: 14.92 percent DEMANDS: Two Biglari-nominated board members; corporate governance improvements; reduced debt; increased franchising D-DAY: May 9, Friendly Ice Cream shareholder meeting, Wilbraham, Mass.
After Biglari sold his Internet services company, he formed the Lion Fund with his former college professor at Trinity University, Philip Cooley, who is now a fund director and vice chairman to Biglari’s chairmanship at Western Sizzlin Corp. Biglari gained a spot on Western Sizzlin’s board in December 2005 after purchasing a 35-percent stake in the company, which operates or franchises about 129 grill-buffets.
Since then, Biglari has garnered almost total power at the company. According to Western Sizzlin’s annual 10-K filing with federal regulators, the company’s investment decisions and “all major capital allocation decisions” are made solely by Biglari. He invested “a material percentage” of the company’s assets into Friendly Ice Cream, the filing also said.
Critics say Biglari is interested in making the same moves at Friendly that he made at Western Sizzlin. But he explained in an e-mail interview that his investments in both companies are long-term plays in “good-quality businesses whose future I can evaluate and can purchase at a great price relative to its intrinsic business value.”
Biglari has taken his battle with Friendly public and has purchased billboards around Friendly’s corporate headquarters in Wilbraham, Mass. The billboards highlight Biglari’s website,
“A proxy battle is by virtue of its occurrence very public,” Biglari says. “One is forced to share views and communicate through a public forum to reach shareholders. Phil Cooley and I don’t allow conventional thinking to drive our decision making, including how one should communicate with shareholders.”
Biglari wants Friendly to focus its efforts on franchising, reduce its corporate debt and improve its cash flow by operating more successful restaurants.
THE MEDIA MAESTRO WILLIAM A. ACKMAN Founder and managing member, Pershing Square Capital Management LP CLAIM TO FAME: Harvard grad who struck it rich in New York real estate through his Gotham Partners, a fund that eventually folded under regulatory pressure; pushed Wendy’s to spin off Tim Hortons before Peltz even invested in the burger brand; made McDonald’s corporate strategy front-page news AGE: 40 FUND ASSETS: more than $3.5 billion HOME BASE: New York STAKE: 1.6 percent DEMANDS: former proposals include the spinoff of corporate restaurants and a public sale; increased refranchising; and a move to a 100-percent franchised structure D-DAY: pending
“Simply stated, the company should be in the real estate, franchise and foodservice business for the very good reason that it would achieve high profit margins, take less risk, and require very little in capital expenditures,” he says.
Friendly has said that it is not convinced Biglari’s agenda is that simple.
“We believe that Mr. Biglari wants to gain control of the board in order to redirect corporate assets for purposes other than the continued growth of Friendly’s,” chairman Don Smith said in a letter to shareholders. “The Friendly’s board will take all actions necessary to prevent this from happening. Friendly’s is a restaurant company, not a hedge fund or investment company.”
Friendly’s shareholder meeting is scheduled for May 9.
It was perhaps the work of well-known activist investors Nelson Peltz and Ackman in 2005 and 2006 that may have emboldened a new crop of investors to target restaurant companies and look for added value.
“Restaurants used to be seen as low-margin businesses, sensitive to commodities and consumer sentiment, and part of the business is still like that,” says Ackman, founder of Pershing Square Capital Management LP. “But if you look at each company, and ask ‘How much is franchising? How much is real estate?’ …We have been successful in changing the way the industry is perceived and valued.”
Ackman was the first to pressure Wendy’s to spin off its lucrative Tim Hortons bakery-cafe brand so that shareholders could reap the benefits of a concept that had been undervalued by stock markets.
Peltz also bought into Wendy’s and pressured the company for the same moves. He also convinced Wendy’s to add three Peltz-backed executives to its board of directors and called for the sale of the Baja Fresh Mexican Grill chain. Wendy’s also lost then-chief executive Jack Schuessler, who resigned amidst the negotiations with the hedge funds.
Eventually, Wendy’s undertook all of the moves presented by Ackman and Peltz, changing the company dramatically, increasing its share price and providing billions of dollars to shareholders.
John Barker, Wendy’s senior vice president of investor relations and corporate affairs, says that throughout the process Wendy’s remained focused on its operations, which he suggests is a mind-set that would benefit other companies under pressure.
“Our shareholders want the same thing we want—to grow sales and profits while providing a good return,” Barker says. “Companies must constantly challenge themselves to make sure they remain relevant to customers, drive profitable transactions and produce profits, while at the same time maximizing value for shareholders.”
By March of this year, Wendy’s had posted 10 consecutive months of positive same-store sales. Still, Peltz remains a stakeholder in Wendy’s, and the standstill agreement that he signed with Wendy’s, to allow it time to improve operations and rebound from its strategic shifts, is set to expire in June.
THE POISON PEN DANIEL S. LOEB Founder and chief executive, Third Point LLC CLAIM TO FAME: aggressive and colorful letters to chief executives that have garnered “the Loeb letter” a cult following; owner of the most expensive apartment ever sold in New York City ($45 million) AGE: 44 FUND ASSETS: more than $4.5 billion HOME BASE: New York TARGETS:IHOP Corp.; Chipotle Mexican Grill Inc.; McDonald’s Corp.; and OSI Restaurant Partners Inc. STAKE: 7 percent; 1.8 percent; less than 1 percent; and less than 1 percent, respectively DEMANDS: no plans or proposals made public…yet. D-DAY: pending
Speculation in the analyst community holds that Peltz will push to put Wendy’s in play if the company’s turnaround efforts don’t succeed.
Wendy’s officials would not comment “on rumors or speculation.” Peltz also would not comment.
At IHOP Corp., corporate strategy has included share repurchases, dividends and beneficial refinancings since early 2003, when the company began changing its business model. Still, when well-known activist investor Daniel Loeb of Third Point LLC disclosed in February its 7-percent equity stake in the company, headlines were made and analysts’ reports called attention to the news, proffering views that any value-seeking initiatives could include the taking on of additional corporate debt.
Stacy Roughan, IHOP’s director of investor relations, says her company “has attracted a diverse shareholder base, including Third Point and a number of other hedge funds, which is not surprising given the company’s strong record for creating value for our shareholders.”
Loeb’s handlers did not return calls seeking comment, and the hedge fund has not made any public proposals for IHOP, or for any of Third Point’s other restaurant industry holdings, which include McDonald’s, Chipotle Mexican Grill and OSI Restaurant Partners. Until now, Loeb’s investments have been passive.
However, a former high-ranking Third Point employee who worked with Loeb for five years says “activism is always a core strategy” at the New York-based fund.
Loeb “usually follows investments in a sector,” says the Third Point veteran, who requested anonymity because he is now at a competing hedge fund. “You get comfortable with assets, and where to create value, if it makes sense in A, then it should make sense in B and C as well.”
Securities analyst Bryan Elliott of Raymond James & Associates says that just the potential of a showdown with an activist investor can change a corporate mind-set.
“They are definitely good creators of clear thinking on the part of management teams,” he says.
Whether activist investors’ tactics indeed are positive for the restaurant industry remains a matter of debate, however.
“In the short term, the presence of activist investors has resulted in increased stock prices, without question,” Elliott says. “However, there is a longer-term scenario that is unknowable. A company that has had some issues could conceivably figure out how to solve them and then get back on a growth track.”
