Operators stung by rising interest rates

Nation's Restaurant News, April 17, 1989 by Rajan Chaudhry

Operators stung by rising interest rates

Operators nationwide are feeling the sting of rising interest rates and searching for salves to soothe the pain.

While the higher cost of money has already scotched some plans -- like that of Furr's-Bishops Cafeterias L.P. to recapitalize -- and is forcing others, including highly leveraged Shoney's Inc. and Foodmaker Inc., to scramble to lighten debt loads and lock in rates, the worst may be ahead, according to economists and industry analysts.

"When interest rates rise," said Bob Goldin, a senior principal with the Chicago-based research firm Technomic Inc., "it tends to have a negative impact on new-unit construction because of higher financing costs. And, more important, the amount of money available to be spent at restaurant decreases. We've found that disposable personal income is the key variable in terms of restaurant industry spending."

"When you have rising interest rates, it has a whole domino effect," agreed Anthony Baiamonte, proprietor of Baiamonte's Italian Restaurant in Toms River, N.J., and president of the Garden State Restaurant Association, which represents more than 400 independent family restaurant operators.

"For example, down here--especially in the Shore area--rising interest rates affect the home-building trades. When the rates go up, building slows down. The carpenters don't work; the masons don't work; the electricians don't work; the carpet people don't work.

"Everything slows down. And people cut down on the times per month or the times per week that they go out and enjoy our restaurants."

Since December the prime rate -- the interest rate charged by banks to their most creditworthy customers -- has climbed 1 percentage point, to 11.5 percent, and many economists expect further increases.

Sally Yanchus, a senior analyst for the Philadelphia-based Wefa Group, an economic forecasting firm, said she expects the prime rate to hit 12.5 percent by November and dip no lower than 11 percent by the third quarter of 1990.

If Wefa's predictions are on target, the franchise industry is in for problems, said Kenneth Franklin, president of Franchise Developments Inc., a Pittsburgh-based franchise consulting firm.

"The impact of the higher interest rates will be less store openings and probably more concentration by the franchisors on enhancing the volume of business coming out of the present operations," said Franklin, a former sebior vice president of franchising for Arby's. "The same thing goes for the franchisees."

Already, the rise in interest rates is affecting the way operators do business.

In Lubbock, Texas, Furr's-Bishops, which announced in November that it would recapitalize and change the structure of the company to a corporate form from a master limited partnership, shelved its plans "primarily" because of "the limited access to the public subordinated debt markets at an acceptable interest rate," said C. Wayne Smith, executive vice president and chief financial officer.

The company is taking a charge of $1.75 million against first-quarter income for costs related to the aborted recap and conversion, Smith said.

Companies like Shoney's, which recapitalized last year, and Foodmaker, which went private in a leveraged buyout in 1988, are doubly vulnerable to rising rates. Not only do both have high levels of floating-rate debt, but with cash-flow earmarked for servicing of that debt, both have turned to franchising for system growth.

San Diego, Calif.-based Foodmaker, for example, has about 960 Jack in the Box restaurants, 35 percent of which are franchised. and the company's goal is to increase the ratio of franchised to company-owned units to 50-50, Long said.

In addition to building new franchised units, Long noted, Foodmaker is raising money by selling company-owned stores to franchisees.

Shoney's, based in Nashville, Tenn., is likewise accelerating franchise growth.

Both Shoney's and Foodmaker are redoubling efforts to pay down their debt and fix interest rates on the remainder.

Shoney's, whose debt from the recapitalization totals about $500 million, has proposed an innovative offering of zero-coupon bonds that will allow the company to fix a portion of its debt and give the company almost $50 million for prepayments of bank debt. Shoney's is already $62.2 million ahead of schedule in paying off its debt, and the proposed offering would reduce the interest rate on the remaining debt 0.25 percent.

"The reason that this is such a terrific financing technique for Shoney's and why my hat goes off to it," said analyst Leslie Steppel, who tracks Shoney's for Prudential-Bache Securities Inc., "is that it's in effect converting some floating-rate debt into fixed-rate debt, and it's deriving a tax deduction in the process. It will have a very positive impact on Shoney's cash flow immediately."

Foodmaker is also moving to restructure its debt. The company said that it has filed a $150 million senior note offering with the Securities and Exchange Commission and that it would use the proceeds to reduce its bank debt.