Can Greed Save Denny's Restaurants from Itself?
With a story line that seems plucked from the Go-Go 1980s, slumbering casual restaurant chain Denny’s is locked in a bitter battle with a couple of swashbuckling private equity firms that are taking on management and the board of directors.
The battle will culminate in a May 19 shareholders meeting that in many ways could resemble corporate raider Gordon Gekko’s infamous confrontation with management at Teldar Paper in the fabled 1987 movie Wall Street.
If you remember anything about the movie, it’s likely Gekko’s signature line: "Greed is good. Greed works."
While that sentiment, in part, is certainly driving the Denny’s takeover battle, the confrontation between management and dissident stockholders is far more complicated. Sure, some of this stems from a strong desire to wake up the chain’s sleep-walking management. At the same time, it signals several emerging trends that all franchise organizations – or any corporation for that matter – should heed as the economy recovers.
Foremost, what do you do when corporate raiders come a knockin’?
The battle also has particular relevance to franchise companies and franchisees. That’s because a key element in Denny’s strategy to re-energize the company is to adopt a franchise business model and sell off its restaurants to independent owners. The franchisees, in turn, have become pivotal players in the battle.
Through what the company calls its Franchise Growth Initiative (FGI), it has sold 290 company-owned units to 56 separate franchisees. The move has increased the percentage of franchised-owned units from 67 percent in early 2007 to 85 percent today. Ultimately management wants the chain to be 90 percent franchisee-owned.
From a broader perspective, 1980s-style corporate raids are likely to increase in number as the economy gains steam. Private equity whiz kids, backed, in some cases, by deep-pocketed hedge funds, are prowling for companies battered by the deep recession. They are particularly looking for good brands to turned around and maximize shareholder value.
As the old saying goes, any fool can make money in a good economy. But nothing raises a red flag on bad management like an economic downturn. And, the whiz kids at investment firms Oak Street Management LLC and Dash Acquisition LLC, believe that Denny’s is a case in point. They own 6.3 percent of its stock and want new management – namely themselves – on the board.
The restaurant chain occupies what’s known as the Quick Service Restaurant or QSR segment of the hospitality industry. It was founded in 1953, and by 2000 it had grown into the largest full-service family restaurant chain in the nation, with 1,822 restaurants and total sales of $2.23 billion.
The company’s peak year also happens to roughly coincide with the appointment of Nelson Marchioli as its chief executive in 2001. Since then, the ride for Denny’s has been mostly downhill, according to the dissident investment group, which calls itself The Committee to Enhance Denny’s.
"This stands in stark contrast to the company's closest competitor, IHOP [International House of Pancakes]," the group asserted in a shareholder letter that scorched current management. "Since Marchioli’s appointment, IHOP has increased system-wide restaurants from 922 units to 1,456 units as of December 31, 2009." In that same letter, the committee noted that Denny’s total units fell by 15 percent to 1,551 units.
What’s more, since 2000, IHOP has more than doubled system-wide sales from $1.2 billion to more than $2.5 billion for 2009, based on public filings, while Denny's system-wide sales have stagnated.
Going back to Gekko, in his storied confrontation with Teldar Paper, he went right for the jugular. He lashed out at high overhead costs and fat-cat management with no ownership stake in the company, charging that it was enriching itself at the expense of shareholders. On that score, the whiz kids at Oak Street Management and Dash Acquisition appear to have ripped a page right out of Gekko’s playbook.
They note that Denny’s general and administrative expenses rose at a time when it was closing and selling off stores. The group takes even more direct aim at what it characterizes as Denny’s "generous payments" to its board and management while the company is racked by poor performance.
In particular, they noted that management handed Marchioli a back-door $496,000 bonus in 2006 that was neither mentioned in Denny's compensation committee report, nor counted in the company's summary compensation chart, according to the New York Times. It did it by granting him 333,000 "in-the-money" stock options priced at $2.42 when Denny's shares were selling for $3.91; a 38 percent discount.
Meanwhile, Denny's share price has declined by 76.9 percent since the company emerged from bankruptcy in January 1998. "Over the past five completed fiscal years alone, Denny's share price has plummeted by 51.3 percent, an unacceptable outcome," the committee charges.
Dissident shareholders also point to other management foibles. The company, for example, bought a Super Bowl ad last year, but never prepared its restaurants for the influx of customers generated by the promotion. Franchisees were swamped by long lines that caused core customers to leave in frustration. These shareholders charged in its letter "that management irresponsibly tripled down on an ineffective promotion" when it bought three Super Bowl ads this year.
The company also bungled a bid to capitalize on social media. Last October, it invited customers with a menu promotion to follow the company on Twitter. But it provided the Twitter address of a guy named Denny in Taiwan, instead of its own corporate address. To date, the menus are still in circulation.
The company also launched an all you-can-eat french fries and pancakes promotion that drew customer complaints and protests from Irish Americans. They claimed it made light of the 19th century Irish potato famine that killed millions of people.
The company had the misfortune of making national headlines for all three promotion snafus. "We believe these incidents speak volumes about management's lack of judgment and oversight in deploying its marketing strategy," the dissidents charge.
Needless to say, management isn’t taking the assault lying down. It fired off its response to the dissident letter this week.
It pointed to the success of its franchise sales, noting that it had unloaded 86 percent of its lower-performing stores "at franchise multiples that exceed the industry norm." General and administrative expenses were cut by 15 percent last year and "Denny's …in fact, outperforms the average of comparably-franchised companies."
It said its new $2, $4 $6, $8 Value Menu promotion offering 16 items at various prices has been endorsed by 95 percent of its franchisees. It’s the first national value menu with prices more associated with the quick-service segment than a full-service family-dining chain, according to Nation’s Restaurant News.
And management says the company is growing again, adding 40 new restaurants in 2009, resulting in a net increase of 10 units, after subtracting restaurant closures. Franchisees are committed to open at least 185 new units, of which 58 have already opened. "We fully expect that our annual new unit growth run rate will exceed our 2009 performance of 40 new units," it states.
As for its franchisees, both sides claim to have their support, but the Denny’s Franchise Association has yet to endorse either competing board slate.
If anything, the shareholder revolt seems to have lit a fire under current management and the company’s stock, which is up more than 70 percent since the proxy battle was launched. But more than that, the fight reflects the brave new corporate world of post-recovery America.
As Gekko said: "The new law of evolution in corporate America seems to be survival of the unfittest. Well, in my book you either do it right or you get eliminated.
"The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit.
And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
Welcome back to the 1980s.
