Casual dining restaurants around the world are struggling, and the coronavirus pandemic is to blame. Most publicly traded restaurants, like IHOP and Applebee's parent Dine Brands Global (NYSE:DIN), are surviving. These companies benefit from easy access to liquidity, a luxury many smaller restaurants don't have.
Since the pandemic began, spending at restaurants has fallen more than consumer spending in general, according to data from the Census Bureau. Moreover, spending at casual dining restaurants has been hit harder than spending at fast-food chains. It's a troubling trend. According to the Independent Restaurant Coalition, a whopping 85% of independent restaurants could close permanently in 2020 without further financial assistance.
Dine Brands' CEO Steve Joyce sees this situation as an opportunity. According to Nation's Restaurant News, Joyce has wanted to add a third restaurant brand to the company's portfolio for some time now. And given the current restaurant environment, it's possible the company can finally acquire a new brand at a bargain price.
Acquiring a third restaurant chain is Dine Brands' plan. But might a different acquisition be a better use of capital right now?
Does it have enough firepower?
Dine Brands just reported ugly results for the second quarter of 2020. Revenue fell 52% year over year, due to restaurants operating in a limited capacity. This resulted in a whopping $135 million net loss. Granted, $107 million was noncash impairment charges, but that leaves $28 million in real losses.
The company withdrew $220 million from its revolving line of credit, anticipating losses. Including this already tapped credit, Dine Brands has $279 million in unrestricted cash. That's plenty of liquidity for now, but its losses are ongoing.
In Q2, comparable-restaurant sales fell 49% year over year for Applebee's and 59% for IHOP. Many locations operated as to-go only out of necessity. That's particularly challenging for IHOP. After all, who wants to-go pancakes?
Dine Brands has now reopened 95% of its restaurants. Nevertheless, its third-quarter-to-date results showed Applebee's comps were still down 18% and IHOP's comps were still down 38%. In other words, consumer discretionary spending isn't just snapping back to normal for casual dining restaurants.
Joyce is reportedly looking for a regional restaurant chain operating between 40 and 80 locations with under $100 million in revenue. But these poor quarterly results continue eating into Dine Brands' acquisition firepower.
Consider that Darden Restaurants acquired Cheddar's Scratch Kitchen at a valuation of approximately 1.1 times sales in 2017. At the time, Cheddar's had 165 locations. While it was considerably bigger than Dine Brands' target, I'd expect any acquisition to have a similar valuation, likely costing somewhere in the $75 million neighborhood. That's a lot of cost for this company right now.
Dine's struggling franchisees
While Dine Brands has plenty of liquidity for ongoing operations, the same can't be said for all of its franchisees. CFRA Holdings owned 49 IHOP locations in the Southeast, but it was forced to file for Chapter 11 bankruptcy protection in May because of the coronavirus. Of CFRA's 49 locations, 41 have already been acquired by another franchisee, who is apparently doing fine. But many other franchisees, especially those in California, are still losing money. It's a stressful situation.
It isn't unique to Dine Brands. Yum! Brands owns Pizza Hut. In July, NPC International, the largest Pizza Hut franchisee, also filed for Chapter 11 bankruptcy protection. It operates over 1,200 Pizza Hut locations, and over 1,600 total restaurants, showing even large companies aren't immune to the coronavirus.
Therefore, it's logical to assume at least some of Dine Brands' franchisees are struggling. The company actually has very few franchise partners (there were only 32 for Applebee's as of the end of 2019), meaning each operates many locations. Rather than look for a third brand, Dine Brands should look to acquire a struggling franchisee.
Dine Brands doesn't want to be a restaurant operator. It says it brings "franchising expertise, capital, and franchisees" to the table. But by offering franchise opportunities in the first place, it implies that the company believes its Applebee's and IHOP brands are profitable ventures.
Acquisitions can be tricky. Integrating new operations doesn't always go smoothly, and now is a time with elevated challenges. If it acquires a third brand, it will seek to immediately sell franchise agreements. But it's doubtful existing franchisees will rush to purchase new franchise agreements for more struggling casual-dining restaurant locations.
By contrast, no one knows Applebee's and IHOP like Dine Brands. It could smoothly begin operating an acquired franchisee, immediately boosting corporate revenue. If the company truly believes in these brands' potential, it seems it would make this deal rather than searching for a third (potentially distracting) concept.
Investors will have to wait to assess a third-brand acquisition on its individual merits. But on the surface, it doesn't seem like a great plan.