A changing system
The refranchising strategy is going to define Denny’s performance and shareholder return in the coming months. Impressively, the chain has opened nearly 350 new restaurants since 2014, or 20 percent of its overall system. That includes 60 international locations since 2011 in five new countries.
Denny’s said in November that it wanted to refranchise to the level where it would get to 95 or 97 percent franchised owned from today’s 90 percent. And do so over the next 18 months. That would equate to 90–125 company-operated restaurants sold. As of June 27, there were 190 corporate stores and 1,540 franchised or licensed locations. So shift the scale by eight franchised stores.
Why is Denny’s doing this? There are always arguments to both sides of the chain model. But in this specific case, Denny’s said, “transitioning to a lower risk business model” would have accretive impacts on adjusted earnings per share and adjusted free cash flow, and also allow development-focused franchisees the chance to expand without starting from the ground-up. New operators are also able to come into the fold this way. It’s a growth stimulator, in other terms. CFO Mark Wolfinger said the transition to a more asset-light business model could reduce annual capital cash expenditures associated with maintenance and remodel costs by between $7 million and $10 million. Denny’s could also generate pretax refranchising proceeds (in excess of $100 million in this case) and earn about $30 million from selling between 25 and 30 percent of the 95 properties currently owned. With that, Denny’s could purchase higher-quality properties in the future, it said. Denny’s said it expects to upgrade the quality of its real estate through a series of “like-kind” exchanges. Cash proceeds from the sale or property are not captured in cash capital expenditures while purchases of property are included.
A like-kind exchange, also known as a 1031 exchange, is a transaction or series of transactions that allows for the disposable of an asset and the acquisition of another replacement asset without generating a current tax liability from the sale of the first asset. This can get pretty technical but essentially Denny’s can garner better real estate by selling lower-volume stores and redeploying those proceeds in favor of better spots. It’s an optimization path.