Richard “Mick” McGuire, hedge fund manager of Marcato Capital Management suggested to the management of DineEquity Inc (NYSE:DIN), owner of famous restaurants Applebee’s and IHOP, to maximize its equity value and to distribute $6 annual dividend to shareholders. McGuire was previously a senior analyst at Bill Ackman’s Pershing Square.
In his letter to Julia Stewart, chairman and CEO of DineEquity Inc (NYSE:DIN), McGuire, expressed that his recommendations can be readily executed without disrupting the performance of the franchise system of the company.
McGuire noted that the re-franchising campaign and the debt reduction effort of the company related to its acquisition of Applebee’s in 2007 have been completed. He also emphasized that the business model of DineEquity Inc (NYSE:DIN) is attractive.
McGuire wrote. “The Company has successfully transitioned its business model to that of a pure royalty collector that creates value for its network of franchisees by providing brand and menu management expertise. In our view, this business model is very attractive. It produces a stream of cash flow that is extremely stable and grows without capital as franchisees add new units and work to increase same-store-sales.”
According to him, the important issues that needs to be addressed by the company right now is maximize its equity value and to use its “generous and growing free cash flow” appropriately.
In order to address these issues, McGuire provided several recommendations to the board and management team of the company. He believes the largest shareholders of DineEquity support his views. He encouraged the management team of the company to understand and incorporate his recommendations in their plan for 2013. His recommendations include:
• Maintaining a target leverage ratio of 5.0X Net Debt/EBITDA- According to him, based on their analysis of the current borrowings of the company, the coverage ratio are healthy at its current level. He believed that further payments to reduce borrowings would represent a very low return on investment on free cash flow of the company
• Return Free Cash Flow to Shareholders- He believes that the company is generating significant free cash flows in relation to its market value and it is appropriate to return the profits to owners by distributing an annual dividend of $6 per share. According to him, there is a possibility for the dividend to grow via new franchise unit growth, improved revenue performance across the franchise system, and reduced interest expense from the refinancing of high-coupon bonds that were convertible in late 2014. McGuire said, “We expect that a stable and growing dividend will attract many new investors and reward the company with a much higher valuation, more consistent with that afforded similar high-margin royalty businesses.”
• Amend of Refinance Existing Borrowings to Provide Maximum Flexibility- According to him, it is important for the company to refinance its bonds with 9.5 percent coupon and currently trading at yield of 4.3 percent that are convertible by October 2014. He added that the bank facility should be the immediate priority of the company. McGuire emphasized, “The company should immediately embark on a parallel process to refinance the bank facility with a new lender on market terms or reach an agreement with existing lenders to eliminate mandatory cash flow sweep.