The Culpability Question in RMH Franchise Bankruptcy
Soon after one of the most positive quarters in Applebee’s recent history came a speed bump. The brand’s second-largest franchisee filed for bankruptcy protection, sending the stock right back down and dragging a ‘zor-‘zee spat out into the open.
Applebee’s parent Dine Brands Global reported its first-quarter results and had some positive momentum with 3.3 percent same-store sales growth at Applebee’s compared to the industry average of 1.9 percent growth as seen by Knapp Track, a research group that tracks restaurant results. The first-quarter results also showed expected cash flow and net income declines given the roughly 100 restaurants that closed last year. The stock popped on the results.
But a few days later, RMH Franchising, a portfolio company of private equity firm ACON Investments, filed for Chapter 11 bankruptcy protection. In its filing, the 159-location, 15-state operator called out the franchisor, saying, “specific managerial decisions made on behalf of it by its franchisor … have negatively impacted the debtors’ business operations and left them facing near-term liquidity issues,” according to the Delaware bankruptcy court filing. It also called out the move to wood-fire grills and a new ad campaign, along with existential restaurant issues like food costs, wages and increasing rents, as factors in the liquidity issues.
The stock sank. Investors were clearly worried that if the 8 percent of the system RMH represents was falling apart, the stock and the generous dividends could follow.
The filing also revealed an ongoing dispute between RMH and the franchisor that had been going on for some time. According to the filing, RMH had been making efforts to slim operating expenses by “renegotiating lease terms with landlords, divesting themselves of certain underperforming locations, and initiating various efforts to reduce corporate and back-office overhead expenses.”
The filing states that RMH and the franchisor had been working through the issues and negotiating millions in back royalties and other fees, but on the eve of what would become the company’s filing date, the franchisor “indicated that it intended to issue a notice of termination of the Debtors’ franchise rights relating to locations in Arizona and Texas.” According to the RMH filing, that would have forced 37 locations out of RMH and under Dine Brands Global's corporate umbrella.
The news of that termination is what allegedly prompted RMH to finally file for bankruptcy protection, according to the filing. Also on May 8, Applebee’s sued RMH to recover royalties and turn over operations to the parent company. But because of the bankruptcy filing, that suit was moot.
Gregg Flynn, Chairman and CEO of the Flynn group, the largest Applebee's franchisee issued a statement on the topic saying that despite this dispute, the brand is doing well.
“It’s unfortunate that this particular franchisee has an issue, but at the same time, I’m very happy that Applebee’s is experiencing some of the best sales and traffic in a decade. A strong driver of our success has been our incredible collaboration and partnership among franchisees and Applebee’s leadership. I believe the future is very bright for Applebee’s,” said Flynn.
Who’s to blame?
Now it’ll be a court battle with a whole lot of restaurants caught in the middle. But the core issue isn’t exclusively Applebee’s performance.
While Applebee’s has floundered to turn itself around in recent years, RMH has risky business in its DNA. It went aggressively from nothing to 163 stores in three years, borrowing incredible amounts of money and selling real estate as it did to fuel more acquisitions, including buying blocks of restaurants that had already gone through bankruptcy.
According to filings, the company owes more than $68 million to senior creditors and more than $51 million to the top 30 unsecured creditors (of the more than 5,000 creditors). The largest unsecured creditor provided a sponsor loan of $30 million for acquisition. Applebee’s International is owed more than $14 million.
The wood-fire grill didn’t put the company this deep in debt, risky practices did. Now with sales sagging from $431 million in the 12 months preceding March 31, 2016, to $379.9 million in the 12 months preceding March 31, 2018, the company is stuck trying to work out a deal with creditors.
One could argue that Applebee’s should be investing in the brand instead of in its stock, but ultra-aggressive growth and deep debt is really to blame here. As John Hamburger writes this month in our sister publication Restaurant Finance Monitor, few franchisees thrive on deep debt.
“Franchisees get rich when they own real estate, keep their leverage ratios below 3 to 4 times EBITDA and maintain their stores in tip-top shape,” wrote Hamburger. “There are ups and downs in any franchise system, products that work and don’t. Highly leveraged franchisees have no margin for error and only serve to enrich their franchisor, the same ones that allow them to grow beyond their capacity to run great stores.”