Flagstar Companies, Inc.

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Flagstar Companies, Inc.

203 East Main Street
Spartanburg, South Carolina 29319
(803) 597-8000
Fax: (803) 597-7538

Public Company
Incorporated: 1979 as Transworld Corporation
Employees: 105,000
Sales: $2.60 billion
Stock Exchanges: NASDAQ
SICs: 5812 Eating Places; 6794 Patent Owners and Lessors; 6719 Holding Companies

Flagstar Companies, Inc. is one of the United States largest restaurant companies, operating four popular restaurant chains, including Dennys and Hardees. Originally part of a much larger and more diverse conglomerate, Flagstar was formed through a series of corporate mergers and divestitures, which ultimately produced a company focused on restaurants. The companys legacy of corporate restructuring, however, left it with large debts, which were not offset by its strong financial performance.

Flagstar emerged in the early 1990s from the Trans World Corporation, which was created in 1979 as a holding company for Trans World Airlines (TWA), Hilton International hotels, and the Canteen Corporation, a contract food-services company. Later that year, TransWorld acquired Century 21 Real Estate and Spartan Food Systems, which owned the restaurant chain Quincys Family Steakhouse and is the largest franchisee of Hardees restaurants. In the mid-1980s, TransWorld moved to streamline its diverse operations, spinning off TWA to its shareholders and selling Century 21 to the Metropolitan Life insurance company.

In 1986, Trans Worlds profits declined sharply after its purchase of American Medical Services, a nursing home operator in poor financial shape. As a result of this acquisition, the companys stock price dropped dramatically, attracting the attention of corporate raiders, who sought to buy up the inexpensive shares of Trans World stock, take over the company, and sell off its other valuable constituent parts for a profit. In order to ward off such hostile takeover attempts, Trans World was forced to restructure. The companys stock was liquidated on December 31, 1986, and new stock, for a company called TW Services, Inc., was issued. This new entity included the assets of Canteen, Spartan, and American Medical Systems, along with other businesses.

The following year, TW Services moved to consolidate its operations further, and it sold its hotel operations, Hilton International, to Allegis, Inc. At the same time, TW Services expanded and strengthened its restaurant operations, purchasing Dennys, a restaurant chain with 1,200 outlets, and El Polio Loco, another chain of 70 eateries specializing in chicken. After this process of corporate restructurings, TW Services emerged as an operator of chain restaurants and other food services. The companys five principal food-oriented businesses included Dennys, Hardees, Quincys Family Steakhouse, El Polio Loco, and the Canteen Corporation.

The oldest of TW Services units was Canteen, founded in July 1929 by Nathaniel Leverone and two other partners. Just before the onset of the Great Depression, Leverone acquired the Chicago Automatic Canteen Corporation, the vending operations of an American Legion chapter in Chicago. The company oversaw the operations of 100 five-cent candy bar machines stationed throughout the Chicago area. In 1930, Leverone changed the name of his company to the Automatic Canteen Company of America, and he began to seek out franchise operators, who would be given an exclusive contract to operate Canteen machines in different areas of the country. By 1931, 15 different franchises had been established.

Wartime shortages in the early 1940s challenged the abilities of Canteens franchise operators. However, at the end of the war, a sharp increase in the manufacture of consumer goods proved a boon to Canteen operators, since many of their machines were located in factory lunchrooms. The company thrived throughout the 1950s, and, in 1960, its operations were expanded with the purchase of Nationwide Food Service, which also provided food services for people in their workplace. In the mid-1960s, American Canteen shortened its name to the Canteen Corporation. Three years later, the company was purchased by International Telephone and Telegraph (ITT).

Under ITT, Canteens operations continued to expand, as it moved into the fields of hospital and college campus food services. In 1973, Canteen was sold to the Trans World Corporation, and, over the next several years, Canteen became involved in running food services for the National Aeronautics and Space Administration (NASA), as well as concession stands in national parks and at convention centers, sports arenas, and massive entertainment complexes.

The second oldest of the TW Services restaurant units was Dennys, founded as a doughnut stand in Lakewood, California, in 1953. Originally called Dannys Donuts, the shop was opened by Harold Butler, who planned to offer coffee and doughnuts 24 hours a day. By the end of its first year in operation, Butlers doughnut stand had garnered profits of $120,000. In 1954 Dannys Donuts became Dannys Coffee Shops, and Butler began expanding his operations, opening additional stores. Five years later the chain of coffee shops became Dennys restaurants, and doughnuts were phased out of the menu.

In choosing locations for his restaurants, Butler concentrated on major highway and freeway exits, where travelers would be plentiful at all hours of the day and night. The expansion of a national network of interstate highways during this time prompted increasing numbers of Americans to travel by car, and Dennys restaurants became a rapid success.

In 1967 Dennys opened its first foreign restaurant, located in Acapulco, Mexico, and eventually established additional outlets in Mexico as well as Hong Kong. In 1969, in an effort to streamline and centralize its food production, Dennys bought Dellys Food, changing the name of that concern to Proficient Food Company. This subsidiary was responsible for running warehouse and distribution operations to keep the companys restaurants supplied. Four years later, Dennys opened its own food processing facility, called Portion-Trol Foods, in Mansfield, Texas. In the mid-1980s, Dennys was purchased for $800 million by a group of investors in a leveraged buyout. Two years later, these investors sold the company to TW Services for $843 million.

TW Services also owned and operated the largest franchisee of Hardees, one of the units of Spartan Food Systems. The first Hardees franchise was opened in October of 1961 in Spartanburg, South Carolina. A second Hardees franchise outlet was soon opened in another area of Spartanburg. This restaurant, which was a walk-up operation rather than a drive-in, was owned and run by Jerry Richardson and four other investors, who contributed a total of $20,000 and called their enterprise Spartan Investment Company.

Offering hamburgers, french fries, and beverages priced between ten and 15 cents, the franchised Hardees was a success, and the Spartan investors soon opened other outlets. Within five years, they were running 15 different Hardees restaurants. In 1969, the partnership changed its name to Spartan Food Systems and began to offer stock to the public. In 1976, Spartan was listed on the New York Stock Exchange for the first time.

The following year, with the money raised from this stock offering, Spartan purchased the Quincys Family Steakhouse chain, founded in 1973 as the Western Family Steak House, a single restaurant located in Greenville, South Carolina. By 1976, nine Western Family Steak Houses were in operation, and the companys name was changed to Quincys, in honor of co-founder Bill Brittains grandfather. By 1978, the number of Quincys restaurants had almost tripled, and this rate of rapid growth continued after Spartan was purchased by Trans World in 1979. Over the next five years, an additional 189 Quincys steakhouse restaurants were opened throughout the Southeast.

TW Services also acquired El Polio Loco, Spanish for The Crazy Chicken, a company that got its start in Mexico in 1975. Francisco Ochoa opened a modest restaurant by the side of a road in the small town of Gusave, serving flame-broiled chicken that had been marinaded with his familys recipe of fruit juices, herbs, and spices. Ochoas operation expanded rapidly in Mexico, as 90 outlets in 20 cities were opened during the 1970s.

At the end of 1980, the company opened its first restaurant in the United States, on Alvarado Street in Los Angeles, and, within three years, 16 more American restaurants were established. In 1983, the Ochoa family sold its American restaurants to Dennys, retaining the El Polio Loco Mexican operations. Under its new owner, the American El Polio Locos were expanded to include several new outlets in California and Nevada, before being purchased by TW Services in 1987.

With a stable group of food service properties in place, TW Services announced in 1987 that it planned to invest $700 million in expanding and improving its operations in an effort to strengthen its presence in the food services industry. Toward this end, the company cut back the administrative staff at Dennys headquarters and simplified the chains menus, improving the companys profitability.

Before other efforts had begun to take effect, however, TW Services found itself in the midst of another corporate takeover battle in the fall of 1988. Coniston Partners, an investor group known for breaking up and selling off parts of other big corporations, sought to buy TW Services for $1.14 billion. In response, the company put in place a poison pill defense intended to make it extremely expensive for any outsider to buy more than 20 percent of its stock. Coniston challenged this move in court, while continuing to purchase increments of TW Services stock. By mid-December 1988, 85 percent of TW Services stock had been purchased by Coniston, and by the middle of the following year, the deal had been completed. Coniston bought TW Services for $1.7 billion. The companys new owners planned to keep its food services units and sell off its less profitable nursing home unit.

In 1990, American Medical Services was divested, along with two other smaller units, The Rowe Corporation and the Milnot Corporation. In addition, the company consolidated the administration of all of its restaurant chains, moving the headquarters of TW Services from Paramus, New Jersey, to Spartanburg, South Carolina, where its Hardees franchises were based. In the months following, the headquarters of Canteen was moved from Chicago to Spartanburg as was Dennys administrative staff, which transferred from Irvine, California. Only El Polio Loco, whose restaurants were located exclusively in the western states, retained its headquarters outside the new central company facilities.

These moves were intended to help TW Services run more efficiently, to offset its high debt, and stem its losses, which reached $67.8 million in 1990. The transfer of operations was completed in 1991, but the company still finished 1991 with losses of $67.6 million. Help for the beleaguered company came in 1992, when TW Services cut a deal with the venture capital firm Kohlberg Kravis Roberts & Company, which contributed $300 million in capital to TW Services, in return for a 47 percent stake in the company.

Hope for financial improvements was offset, however, by disturbing news on another front; African-American customers at Dennys restaurants in California began to complain that they had been discriminated against and denied service. Specifically, the customers alleged that some Dennys restaurants either refused adequate service or forced them to pay in advance for their meals, while white customers in the restaurants were not asked to do the same.

As the U.S. Justice Department began an investigation into Dennys, TW Services began an effort to control the public relations damage to its reputation. The company apologized to customers, made contact with civil rights groups, fired or transferred problematic employees, and implemented a cultural relations team designed to educate employees on issues of race. Negotiations with the Justice Department continued throughout 1992. In March 1993, TW Services signed a consent decree with the Justice Department that called for an end to prejudicial practices. The company agreed to initiate improved training guidelines for employees and to allow for the spot testing of Dennys restaurants for compliance with its nondiscriminatory policy.

Nevertheless, the companys legal troubles continued, as aggrieved customers pressed lawsuits. Moreover, in May 1993, six African-American Secret Service agents sued Dennys, claiming that they had been denied service at a restaurant in Annapolis, Maryland. The charges received extensive media exposure, as critics charged that Dennys employees exhibited such consistent racist behavior that it constituted a part of the companys culture.

In the midst of these image problems, TW Services changed its name in June 1993. Shedding all vestiges of its past association with Trans World, the company took Flagstar as its new moniker. Flagstar also hired its first African-American executive, a human relations administrator who vowed to tackle the problems at Dennys.

One month later, Flagstar announced an ambitious minority advancement program developed in conjunction with the NAACP. To demonstrate its good faith in its effort to stamp out racism, Flagstar announced that it would double the number of Dennys franchises owned by minorities to 107, hire 325 African-American managers, and pledge $1 billion to be earmarked for goods purchased from minority-owned contractors over a seven-year period. Moreover, the company promised to maintain a policy of designating 12 percent of its purchasing budget, ten percent of its marketing and advertising budget, and 15 percent of its legal, accounting, and consulting budget, exclusively for minority-owned firms.

Flagstar continued to suffer financial difficulties. Surveys showed the customer traffic in its Dennys chain, which contributed the bulk of its revenues, was down by seven percent. In an effort to draw more people into its restaurants, Dennys inaugurated an all-you-can-eat promotion, which had to be cancelled in the summer of 1993 when it became too expensive. By the end of the year, the companys losses had reached $1.7 billion, which included a $1.5 billion write-off of goodwill and other intangible assets. In addition in January 1994, Flagstar announced that it would take a $192 million restructuring charge in order to close or franchise 14 percent of its restaurants, primarily Dennys outlets. The company also announced that it would embark upon a modernization program for its 1,000 company restaurants, installing new facades and menus, additional lights, and contemporary logos in facilities that, in many cases, had not been updated in 20 years.

In May 1994, Flagstar agreed to pay $54 million to plaintiffs in three class action lawsuits against Dennys. This sum represented the largest and broadest settlement ever made in such a suit. With this move, the company hoped to settle 4,300 claims against it, contained in legal proceedings taking place in Maryland, Virginia, and California. At the same time, the company renewed its commitment to improving race relations at Dennys, setting up discrimination testing programs and monitoring employee behavior.

The following month Flagstar announced that it had completed the sale of the Canteen food and vending operations to London-based Compass Group PLC for $450 million. At the same time Flagstar began searching for buyers for its Volume Services and TW Recreational Services divisions. These efforts reflected the companys decision to focus on its restaurants, Flagstars core business. With these steps in place, Flagstar hoped to move forward to more equitable and profitable operations in the years to come.

Further Reading:

Deveny, Kathleen, Do These Raiders Really Want to Start Flipping Burgers? Business Week, October 10, 1988.

Frank, Robert, Flagstar Loss Is $1.65 Billion on Big Charge, Wall Street Journal, January 25, 1994.

Holden, Benjamin A., Parent of Dennys Restaurants, NAACP Agree on Plan to Boost Minorities Role, Wall Street Journal, July 1,1993.

Labaton, Stephen, Dennys Restaurants to Pay $54 Million in Race Bias Suits, New York Times, May 25, 1994.

Ringer, Richard, Dennys Parent Has Loss After a Large Write-Off,New York Times, January 25, 1994.

Serwer, Andrew E., What to Do When Race Charges Fly, Fortune, July 12, 1993.

Elizabeth Rourke