Applebee’s International (NDAQ:APPB) may find itself under fire after Breeden Capital Management LLC announced that they would be nominating four of their own candidates to the company's board of directors. The hedge fund insists that this action is necessary due to the board's disregard of shareholder interests and company's long term underperformance. It is important to note that Breeden is run by Richard Breeden, who is a former chairman of the U.S. Securities and Exchange Commission. His fund is very well regarded and experienced in these kinds of situations.

Why are they targeting Applebee's? According to a letter attached to the fund's 13D/A filing with the SEC:

"During the three years ended December 1, 2006, the price of Applebee's shares fell from $26.13 per share to $22.34, a decline of 14.5%, while total shareholder return fell 13.4%.(1) Applebee's performance in total return to shareholders during this period ranked 13th worst out of 14 comparable public companies. (2) During this period other metrics of operating performance, growth and efficiency have declined as well.

In contrast, during this same three-year period shares of Darden Restaurants ("Darden"), operator of Red Lobster and Olive Garden restaurants, rose from $20.47 to $40.06 (up 99% in total return), California Pizza Kitchen rose from $18.40 to $31.48 (up 71.1% in total return), and Brinker International, operator of Chili's, rose from $22.24 to $30.36 (up 38.3% in total return). If Applebee's shares had matched Darden's share price performance record during this time, shares of Applebee's would be trading at more than $50 per share, and the company would have created substantial new shareholder wealth. Instead, the aggregate value of Applebee's shares has fallen by hundreds of millions of dollars.

We have communicated proven ideas for maximizing Applebee's return on invested capital and shareholder value to your management team. When we did so, it was our hope that the new management would welcome ideas on how to correct the slide in shareholder value as well as key operating metrics that has been going on during the last three years. We were politely received, and we were assured that many changes were being studied. We were advised to wait to see the company take action. Like other shareholders, we have been waiting to see that action, but the company has not disclosed anything of significance.(3) As demonstrated by the extremely poor third quarter results, the company continues to perform poorly. Evidently the board has not yet decided that action is required to stop Applebee's further deterioration. In this environment, we do not believe that hope is an adequate strategic plan from the board." (Read More)

The fund was also angered by a last second change in bylaws that made it more difficult to nominate candidates to the board. They elaborated in their letter:

"Last August, shortly after Breeden Capital Management informed management that our funds were significant shareholders, the board saw fit to amend the company's bylaws to institute a requirement that the company be notified nearly six months in advance of the company's annual meeting of any candidate wishing to stand for election to Applebee's board. As you know, this is a fairly unusual length of time, and it appears unrelated to any legitimate need of the company beyond entrenching board members even further than what the company's staggered board already does.

Absent this change in your bylaws, Breeden Capital Management would have had more time to watch the company's performance before making a decision whether or not to put forward board candidates. However, by your choice we must submit nominations now, or be foreclosed through the annual meeting in 2008 from having a chance for the company's shareholders to elect new members of the board. While we would have preferred to be able to continue observing the company's performance before deciding whether to submit our own candidates, the board's bylaw amendment forces us to make that decision now. As a result, we are today nominating four candidates for election to the company's board at the 2007 annual meeting." (Read More)

Finally, Breeden also revealed five changes that he would implement if elected to the board of directors:

1. Significantly reduce the number of company-owned restaurants by re-franchising a substantial number of restaurants in a multi-year program.
2. Cease all further capital expenditures to open new company-owned restaurants, and minimize capital expenditures to renovate company-owned restaurants pending their sale.
3. Reduce overall expense levels, especially in corporate level overhead, and dispose of non-core assets.
4. Use excess cash generated from these steps and improved performance to increase the return of free cash flow to shareholders.
5. Improve various governance practices, including reducing the number of insiders on the company's board, precluding former CEOs from continued board service, strengthening independence requirements, eliminating the personal use of corporate aircraft and abolishing your staggered board.

In the end, to paraphrase the fund's letter, all shareholders would benefit from a stronger, independent board that is able to evaluate and act upon opportunities for creating value. If the proposed nominees are elected to the company's board of directors, it could mean significant share appreciation over the long-term for the company's shareholders. This makes APPB a stock to keep a close eye on into their 2007 elections.

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