DIN – Reality vs. perception

On Friday DIN rose 30% on the back of a 13D filing by the company’s largest shareholder, Southeastern Asset Management, and a strong market. Southeastern says that it is converting its ownership filing to 13D from 13G “in order to be more active in corporate governance and management matters, and to have the ability to enter into discussions with third parties concerning proposed corporate transactions of a significant nature. In this situation, Southeastern has talked to the Issuer's management, and will have additional conversations with management and/or third parties, regarding opportunities to maximize the value of the company for all shareholders.”

The filing goes on to say “Southeastern is engaged in the business of investment management of its clients' assets and pursues an investment philosophy of identifying undervalued situations and acquiring positions in undervalued companies on behalf of its clients. In pursuing this investment philosophy, Southeastern analyzes the operations, capital structure and markets of companies in which its clients invest and continuously monitors the business operations of such companies through analysis of financial statements and other public documents, through discussions with knowledgeable industry observers, and with management of such companies, often at management's invitation.”

The part that say’s “often at management invitation” is interesting given the current situation at DIN. Given the current economic crisis facing every casual dining operator DIN is in crisis mode, or should be. The company is leveraged at 7x EV/EBITDA and has been operating with an interim CEO since the end of September. The company desperately needs to sell assets to relieve the burden of excess leverage to give the company breathing room. In addition, management is cutting costs thru layoff’s, significantly reduced bonuses and reduced vacations, which is not an environment that will foster significant goodwill with the company’s employee base. Lastly, the Applebee and IHOP franchisees are faced with P&L inflation, lower traffic and increased discounting resulting in lower store level cash flow.

So what can DIN do to create long term value for shareholders? Let’s remember this is a restaurant company so the options are limited. To start, the stock is not undervalued relative to its peers. Using a NTM EBITDA range of $330-$350 million, DIN is trading at around 7.5x EBITDA versus its peers at 5x. The most effective way to build value for shareholders is to get more customers in the door paying full price, but that’s not likely anytime soon. The only real option the company has is to sell assets beyond what has already been announced. Given current sales trends and limited access to capital assets sales in this environment is nearly impossible. Additionally, no person in his right mind would pay more than 3-4X EBITDA for Applebee’s assets. Needless to say, with the stock selling at 7.5x EV/EBITDA selling assets at those prices would be dilutive to DIN and would not create shareholder value.

My guess is that Southeastern could act as a buffer between an angry franchise community and company management. Southeastern’s track record is impressive and they own stocks for years, but the change in to a 13D from a 13G is a defensive move not offensive. DIN is going to need miracle to save this ship.

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