Applebees, Inc. (NDAQ:APPB) shares moved down $0.08, or 0.32%, to $24.74 today after Breeden Partners criticized the company's performance and governance and made several recommendations to the company's board of directors in a Schedule 13D/A filing with the SEC. This is not the first time that Breeden has become involved with Applebees either; back in December, the 5% holder pointed out similar problems with the company and threatened to nominate its own candidates to the company's board of directors.

The hedge fund began its letter by pointing out APPB's chronic under-performance compared to other company's in its peer group. They noted Applebee’s performance was 113.3% worse than Darden, 51.7% worse than the S&P 500, and 47.4% worse than the 75th percentile of the casual dining peer group. Next, Breeden pointed out the company's deteriorating fundamentals by showing declining same-store sales (5.2% to -1.0%), declining operating margins (16% to 12.4%), and declining return on capital invested (16% to 10%). The hedge fund noted that many of these problems stemmed from:

1. A fundamentally flawed growth strategy
2. Ineffective leadership during several years prior to Dave Goebel becoming CEO
3. Serious ongoing internal weaknesses in marketing and finance
4. Poor capital allocation policies
5. Excessive overhead costs
6. An ineffective board
7. Poor governance practices of various types
   
8. Inability to make timely decisions of consequence

The letter then moved into an area that is generating an increasing amount of press coverage - executive compensation. Breeden noted that even while the company has lost million in value over the past few years, executives were still granted over $30 million in bonuses! They also uncovered some other highly questionable executive perks, including personal use of corporate aircraft and even the use of shareholder funds to pay executives' personal income taxes. Perhaps the hedge fund said it best:

"We do not believe that shareholder interests are served by turning corporate aircraft into flying limousines for senior executives’ personal vacations. Just as importantly, this practice is inconsistent with the wholesome “neighborhood values” that Applebee’s claims to embody as a company. I am quite certain that most Applebee’s customers would be shocked to find out that a portion of the cost of their meal goes to fly the former CEO back and forth to his beach house aboard a corporate plane ... In addition to not requiring executives to pay any of the costs for their personal travel, the Committee has taken the extraordinary step of requiring shareholders to pay the income taxes owed by the CEO and other senior executives for their aerial vacation tours."

Clearly, there is a disconnect here between management and shareholders that the board is failing to correct. To address these issues, Breeden made several recommendations to the company's board of directors:

1. There should be a moratorium on any incentive compensation for any tier one executives so long as TSR remains negative. Similarly, incentive compensation should be zero if the company remains in the fourth quartile of relative performance in generating TSR.
2. A large proportion of incentive compensation (such as 50-75%) should be based on relative measures of performance compared to the company’s publicly traded casual dining competitors shown on page two of this letter.
3. Growth in average per restaurant royalty fees from franchise operations should be included as an incentive target for relevant executives (including the CEO and CFO), since franchisees represent 73% of the company’s system.
4. The level of free cash flow would be a healthy measure for some portion of incentive opportunities, especially for the CEO and CFO.
5. Minimum relative performance in generating TSR or EVA (such as being in the top 20%) should be a significant part of every executive’s target incentive eligibility. All executives should have a vital stake in the company outperforming its peers.
6. Personal use of corporate aircraft should be banned. Tax gross-up payments made during the last three years should be repaid to the company.
   

In a past filing, the hedge fund also made several recommendations on how to improve the company's performance:

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

Combined, hopefully these changes will be implemented by the company's board of directors and management in order to protect the company's integrity and restore shareholder confidence in the company. The changes could also help the Applebees boost their performance and better motivate management to deliver shareholder value. This makes APPB a stock worth watching closely over the next few months.

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Nasdaq Stock Market Inc. (NDAQ:NDAQ) shares moved down $0.13, or 0.38%, to $33.94 today after the company said that they have not been contacted by the London Stock Exchange and do not have enough time to revise its $5.3 billion offer, which is due to expire on Saturday. Even after the Nasdaq threatened to sell off its nearly 30% stake in the exchange, the LSE still maintained that it was worth more than $5.3 billion even on a standalone basis. Meanwhile, LSE shareholders remain unconcerned as the stock trades at roughly even, retaining the buyout premium.

While the exchange has the ability to extend the offer until February 11th, it is more likely that they will simply attempt to gain control of the LSE by continuing to purchase shares. The Nasdaq currently owns approximately 30% of the company, while several hedge funds have also upped their stake. These hedge funds are hoping to accumulate a stake that they could later sell to the Nasdaq at a premium to help them quickly obtain a controlling stake. Among them is U.S. corporate raider Samuel Heyman who recently announced a 10.44% stake in the LSE.

If the Nasdaq is able to successfully acquire the LSE, it would create a trans-Atlantic exchange comprising over 6,400 companies with a total market capitalization of $11.8 trillion. Meanwhile, NYSE Group, Inc. (NYSE:NYX) has already agreed to a merger with Euronext and said it was working towards and agreement with the Tokyo Stock Exchange. Given the NYSE's successful transition abroad, it is becoming increasingly critical for the Nasdaq to establish itself. This situation is definitely one worth watching...

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Cost-U-Less Inc. (NDAQ:CULS) shares continued their rise today after Delafield Hambrecht demanded that the company immediately put itself up for sale in a letter attached to their Schedule 13D filing with the SEC. These demands come after Monarch Activist Partners - a 5.4% holder in the company - made similar demands for the company to put itself up for sale in order to deliver value back to shareholders.  They both argue that the company would be better off being private as it is incurring heavy costs associated with being a public company while failing to realize the benefits with an illiquid, under-performing stock.

Just how much is Cost-U-Less actually worth in their eyes? Well, Delafield Hambretch reasons that given the company's current enterprise value of $30 million, and using EBITDA estimates of $7 million for 2006 and $7.5 million for 2007, pro-forma EBITDA for a prospective buyer should be $8.5 million (after adding back public company expenses). If this assumption is correct, then the company currently trades at only 3.5x EBITDA. What does all of this mean? Well, Monarch Activist Partners noted that Pricesmart (the company's self-acknowledged closest competitor) trades at a multiple of almost 16x. This means that even after taking an extremely conservative approach and valuing the company with a 40% discount from the industry mean, CULS is worth in excess of $12 per share. This translates into a 40% or greater premium to today's stock price!

Delafield Hambrecht also indicated that while a strategic buyer would likely pay more for the company, financial buyers would still pay a significant premium to the current market rates. On that note, the hedge fund said that it would likely participate as such a bidder if the company were put up for sale. Many investors also insist that there could be other strategic buyers, given the company's low market cap and deep discount to its peers.

But will any of this materialize? Well, given the nearly 15% combined stake in company by these two hedge funds, management may decide to respond to shareholders rather than risk a confrontation with the two hedge funds. Indeed, both hedge funds said that if they did not hear back from management, they may seek to replace members of the board in a proxy contest, which should set off some alarms at company headquarters. Unfortunately, the company's Investor Relations personnel were unavailable for comment today when we called; however, we will follow-up and post any developments here at SECInvestor.com. Meanwhile, this is definitely a stock to keep a close eye on as this situation unfolds, especially given the deep discount in the company's share price.

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