Applebee's reverses course with buyback plans

Nation's Restaurant News, Dec 16, 1991 by Peter O. Keegan

KANSAS CITY, Mo. -- In a major about-face, Applebee's Neighborhood Grill & Bar is looking to buy back units from its franchisees.

Traditionally, the dinner-house operator has grown by shotgunning company units into a new market, nurturing the places until they turn a profit and then selling them to franchisees. The arrangement has enabled Applebee's to expand at a rapid clip while keeping its balance sheet free of debt.

However, "we rewrote our five-year plan to put more emphasis on company stores," observed Abe Gustin, president and chief executive of the 190-unit dinner-house chain. "Phase II of our growth plan is to look at the acquisition of profitable franchisees -- to increase the bottom line and earnings per share."

"If it's a $2 million franchised store, we get only $80,000 in revenue fees. If it's a company-owned store, we get $300,000 in revenues," Gustin pointed out.

Gustin said the strategic reversal would also enable Applebee's to keep growing at a rapid clip. A franchisee that sells its units and relieves itself of debt will be more likely to secure financing for the opening of stores in new markets, he explained. Lenders will also be more eager to deal with operators who have proven that they know how to build a successful franchise.

"Financing is our biggest stumbling block right now," Gustin explained. "We would like to build at twice our rate."

One of Applebee's largest franchisees, 40-unit Apple South, recently issued stock because it could not raise money to fund future growth. The stock is trading for 12.50 per share.

Gustin expressed hopes that it could exceed that number next year.

Gustin also noted that the chain added 40 franchised stores last year. "We hope to bust this year's number if financing eases up," he said.

Management has already looked at seven or eight acquisition candidates, according to Gustin. "They said, 'Buy these and give us the development rights for somewhere else,'" he said.

Currently, 80 percent of Applebee's restaurants are franchised, and 20 percent are company owned. The new plan calls for doubling the precentage of company-owned stores, in part by buying 100 franchised units during the next five years.

"Most [companies] are going in the opposite direction," commented Mike Mueller, a restaurant analyst who follows Applebee's for San Francisco-based Montgomery Securities. He noted that chains like McDonald's are currently selling company stores back to franchisees because they run them better.

Gustin noted that many frnchisees were interested in exchanging units for stock instead of cash.

"The fact that they want a stock swap is a good indication that they have confidence in the company," Mueller pointed out.

The push to acquire franchisees marks a reversal of position for Applebee's. Earlier this year, at an investment conference in New York, Gustin told investors, "We don't intend to have more than 65 to 70 company-owned restaurants, which will be used for training and personnel-development purchases."

In a recent interview, Gustin explained that franchising has enabled Applebee's to expand quickly without generating a lot of debt. Furthermore, it allowed the chain to capture a market before a competitor could.

But the company is now at a point where it can greatly increase its profitability by adding more company-managed stores, he said.

Mueller observed that the company is now in a better position to grow through company development because it recently upgraded its management. For instance, industry veteran Ken Hill recently joined the company as executive vice president and chief operating officer.

"Now that they have more people in the company, they can control things better than they ever had," Mueller explained. "Ken Hill has helped them to focus more on store operations.

"When you are company owned, you control your own destiny much better. While earnings are more stable when there are more franchised units, predictability of expansion is greater when there are more company-owned stores."

For the third quarter ended Sept. 29, sales at restaurants open for the prior 12 months grew by 4.7 percent, while the average intake of franchised units fell 2.4 percent. Mueller said those results were partly due to the week economic environment of some franchised stores and partly attributable to tightened operations at company stores.

On the other hand, Gustin said the company is realizing higher sales with a new 180-seat "Pop Out" prototype, with two restaurants bringing in more than $2.5 million in sales in their first year. Average unit volume at Applebee's is $1.76 million.

Applebee's did not open any company-owned units last year but is working on eight to 10 sites for next year. Gustin said the company does not pay more than $425,000 for a site, yet some franchises pay up to $650,000.

To help increase profits next year, Applebee's is in the process of searching for a new ad agency and the company is also stepping up its video training programs.