Bearish Investors Hope IHOP Stock Goes Flat : Franchises: The Glendale-based pancake restaurant chain is growing at a brisk pace. But its shares continue to attract short-sellers.
IHOP Corp. wishes some of the most loyal fans of its International House of Pancakes restaurants would go away.
They are short-sellers, bearish investors who profit when a stock goes down in price. And they have been betting against IHOP ever since the Glendale-based franchiser went public two years ago at $10 a share.
Today, IHOP’s stock fetches more than twice that. It closed Monday at $26.13 a share in the national over-the-counter market.
About 9% of IHOP’s 9 million shares are currently held by short-sellers, a figure that has remained “remarkably consistent” since the company’s July, 1991, initial public offering, said Frederick G. Silny, IHOP’s chief financial officer. Part of the shorts’ reasoning seems to be that so much of the company’s revenue comes from franchising fees that it will eventually slow. Last year, one-time start-up franchise costs plus ongoing fees, such as rent and royalties, paid by franchisees accounted for 65% of IHOP’s $114 million of revenue.
Most analysts don’t consider short interest alone a reliable measure of investor sentiment. But it is curious that IHOP continues to be a favorite with the shorts, even as the company’s sales and earnings keep stacking up new records.
IHOP’s chief executive Richard (Kim) Herzer, a 63-year-old finance man who has been with the company 25 years, said he refuses to let the persistent short interest in the stock get him down. “Sure it bothers me that anybody would bet against us, but I’ve gotten used to it. We’ve come so far so fast that some people just don’t believe we’re for real yet.”
Herzer contends that some shorts don’t understand the company’s unusual franchising approach, while others misguidedly question its reliance on franchise start-up fees.
IHOP currently has 550 restaurants in the United States, Canada and Japan, nearly 90% of them operated by its franchisees. The company’s first-quarter profits jumped 48%, to $1.4 million on a 24% increase in revenue to $30.2 million. Analysts expect IHOP’s full-year profits for 1993 to climb 53%, to a record $12 million on a 22% gain in revenue to a record $138 million.
In 1992, IHOP’s revenues and profits also set records, as earnings climbed 70%, to $7.9 million. The recession hasn’t hurt pancake sales: In IHOP restaurants that have been open for at least one year, revenue increased 4% in the first quarter, and rose nearly 8% in 1992. The yearly figure was better than twice the restaurant industry’s average.
IHOP plans to open another 57 restaurants this year and is moving to replace its old familiar “A” frames with larger, more attractive dining rooms aimed at boosting its lunch and dinner trade.
To be sure, there are some worries. About 70% of IHOP’s food sales still come from breakfast items, although that includes pancakes, waffles and omelets served all day. The company also has $35 million of long-term debt, of which $32 million was refinanced last year.
Short-sellers work by borrowing shares of a stock, which they sell immediately, while agreeing to return those borrowed shares later in the hope they can repurchase them at a lower price. If the stock declines, short-sellers buy the shares back--known as “covering” a short position--return them to the lender and pocket the difference.
(Shorts don’t have to cover their positions within any certain time period. Shares that have been sold short, but not yet repurchased, constitute what is known as a stock’s short interest.)
With the buoyant stock market looking more and more vulnerable to a setback, short-sellers in general have lately come out in force. May was the second straight record-setting month for short interest among all over-the-counter stocks when it rose 3% to 525.1 million shares.
IHOP’s short interest in the four weeks ending May 15 was 783,128 shares, out of the company’s 9 million shares of common stock that were outstanding at the end of the first quarter.
Although a substantial short position in a stock reflects heavy speculation that its price will tumble, some investors consider an increase in short interest bullish. The reason: Sooner or later, the borrowed shares must be bought back.
The original IHOP opened its first restaurant in Toluca Lake in 1958. The company was barely breathing when a management group led by Herzer, and the New York investment firm Kelso & Co., took the company private in a 1987 leveraged buyout. But when the same group took IHOP public again in 1991, short-sellers closed in when Kelso sold its entire 54% IHOP stake.
Last year Herzer sold 12,000 IHOP shares to buy a house. As of March, he still owned 638,774 shares.
Herzer believes that some of the investors who shorted IHOP at the offering two years ago haven’t covered their original positions, even though they are now out more than a dollar for every dollar they invested--at least on paper--if they shorted IHOP close to the $10-a-share offering price. Since IHOP doesn’t pay any dividends--which short-sellers normally must give up--”it isn’t costing them anything to carry their positions,” he said.
Unlike some other national restaurant chains, IHOP develops each new pancake restaurant itself, in many cases owning the site, and picking everything from the location to the color of the place mats. IHOP then opens a new restaurant’s doors to test it out for a few months. Then it franchises the restaurant as a going business. The franchisee then pays the company rent and royalties, as well as buying pancake mix and other supplies from the company.
A franchise buyer’s one-time start-up fees can range anywhere from $50,000 to $600,000, depending on the restaurant’s projected sales, Herzer said.
Some analysts have criticized how IHOP treats this income on its books. Even though the company often finances as much as 80% of a franchise buyer’s start-up fee for five years, it counts the entire amount as income as soon as it sells the franchise.
“Does this mean we’re capable of beefing up our income by scheduling new restaurant openings? Sure, but we also charge all of our direct costs like construction, development and overhead against those fees” at the same time IHOP receives its start-up franchise fee, Herzer said.
The accounting practice is standard, said Becky Barfield, an analyst who follows IHOP for the brokerage firm First Boston. “The company certainly doesn’t try to hide anything,” she said.
IHOP’s Stock Climb
The pancake-restaurant franchiser and operator’s stock has more than doubled since the company went public at $10 a share. Monthly high and low closing bid prices per share. The closing price on June 14 was $26.13.
