When IHOP (NYSE: IHP) agreed acquire Applebee's nine months ago, Applebee's shareholders were none too pleased. Highly respected investor Sardar Biglari vocally opposed the deal, Applebee's director Burton Sack made plans to sue, and shares of IHOP rose more than Applebee's on the announcement -- a very rare occurrence.

But now things have changed as the restaurant industry has continued to weaken and shares of IHOP have lost a good chunk of their value. Applebee's competitors like Ruby Tuesday's (NYSE: RT) have plunged, and the deal is looking less well timed.

The company released its first quarter results this week and the Applebee's turnaround appears to be doing as well as could be expected given the environment -- the company saw the first quarter of positive same-store sales growth in two years. However, plans to sell and lease back some of the real estate that came with the deal has been "challenged by weakening credit market conditions." The plan to franchise more of the company-owned stores has made some progress.

It's a bad sign for restaurants: they're handing out coupons in an effort to lure reticent diners, who are nervous about gas prices, the economy and, of course, housing.

According to the USA Today, Ruby Tuesday is offering $5 off two dinner entrees, IHOP (NYSE: IHP) franchisees are handing out two-for-one coupons, Darden's (NYSE: DRI) Smoky Bones is giving diners $5 off $15 orders, and
T.G.I. Friday's is giving $5 "Bonus Bites" to those who purchase $25 gift cards.

So what's an investor to do? High gas prices and housing woes are most likely to weigh on the minds of middle-class consumers -- a wealthier diner probably isn't going to let his restaurant plans be interrupted by transportation costs.

Cheescake Factory (NASDAQ: CAKE) has seen its share prices slide as traffic growth has slowed. The company has scaled back its expansion plans and is using the extra cash to repurchase stock. Higher dairy prices have affected gross margins but, long-term, there's a lot to like here. The company has a strong brand, lots of room for expansion, and a much higher average check than a lot of the fast casual chains that are struggling.

A mall operator's efforts to prevent the chain from opening in a competitor's location underscores the company's strength: Cheesecake Factory is a destination in a way that lesser chains like Applebee's and Friday's aren't.

Applebee's International, Inc. (NASDAQ: APPB) director Burton Sack, who is the company's largest individual shareholder with 3.2% of the stock, is planning to ask a Delaware court to award him more money for his shares of the company that has agreed to be acquired by IHOP Corp. (NYSE: IHP).

Sack says he will seek to assert his appraisal rights, which allow him to have a court evaluate whether the deal provides full value to shareholders. If the court agrees with Sack, he could be awarded more money.

The Applebee's deal has been controversial from the beginning. Back in July, I wondered whether the deal was fair, asking If IHOP wants it, should Applebee's sell it? Then respected investor Sardar Biglari announced his opposition to the deal, pointing out that shares of IHOP rose more than shares of Applebee's when the deal was announced. It is extremely unusual for an acquirer to rise more than the target. Then it emerged that five Applebee's directors, including the chairman, CEO, and CFO had all opposed the deal. Then a pension fund sued Applebee's, alleging that the merger agreement was unfair to shareholders. That suit was settled.

Given all this controversy, and the strong opposition of influential investors, it's amazing that the deal is still going through. In what could be an indication that Applebee's has stronger growth potential than the buyout price reflects, the company will be opening its first Chinese location this week.

Sadly, there don't appear to be any indications that the dissident directors will make a late push to block the deal, probably because such an effort would likely be futile.

I used to eat pretty regularly at a Waffle House in Atlanta. I'd usually show up with some friends in the wee hours, looking for a snack before getting some shut-eye. It would usually be pretty slow in the restaurant, so we'd spend some time joking with the regular late-night cook, named Thomas. We'd always say that we would love to eat some pancakes -- and as any Waffle House devotee knows, you can't get pancakes at the big yellow house. Only waffles.

One night, though, Thomas said he had a surprise for us. A few minutes later, a stack of hot, golden pancakes sat before us on the counter. Thomas said that from now on, he would cook us anything we could think of, as long as he had the ingredients, starting with these pancakes, which most certainly were not on the regular menu. Thus began a month-long culinary odyssey through the freezer of our local Waffle House. We started with pancakes and worked our way up to potato hash, sloppy joes, and, finally, butterflied pork chops. It was quite an experience, and ended, sadly, when Thomas was fired. I've never known for sure, but I think it had something to do with our off-menu explorations.

The Christian Science Monitor recently ran an article about the "secret menus" at various fast food restaurants. Apparently, I'm not the only one who has gone off-menu in search of something beyond the usual fare. The article claims that at In-N-Out Burger, the justifiably famous burger chain in southern California, you can order a hamburger "protein style" -- meaning without the bun. Apparently, you can get a McBruschetta at McDonald's (NYSE: MCD), which has toasted tomatoes, onions, and a bun; a Naked Chicken at Popeye's, which has no breading (!); and a Short Cappuccino at Starbucks (NYSE: SBUX), which is served in a kiddie cup.

MOST NOTEWORTHY: The mortgage finance sector, Applebee's, Fuel-Tech, BHP Billiton, Anglo American and Rio Tinto were today's noteworthy downgrades:

• Lehman downgraded the mortgage finance sector to Negative from Neutral citing the potential of over $100B in losses for the group in the coming years. Washington Mutual (NYSE: WM) was downgraded to Equal Weight from Overweight; IndyMac Bancorp (NYSE: IMB) and Countrywide Financial Corporation (NYSE: CFC) were downgraded to Underweight from Equal Weight.
  
• Applebee's International (NASDAQ: APPB) was downgraded to Underperform from Market Perform at Wachovia, as the firm sees potential downside risk if the company's acquisition of IHOP Corp (NYSE: IHP) does not go through, following mixed reviews from Proxy firms.
  
• Merriman downgraded shares of Fuel-Tech (NASDAQ: FTEK) to Sell from Neutral after channel checks indicated the competitive landscape is much more challenging than commonly perceived for the FUEL CHEM product line. Merriman sees significant risk to shares at current levels.
  
• Citigroup downgraded shares of BHP Billiton (NYSE: BHP), Anglo American (NASDAQ: AAUK) and Rio Tinto (NYSE: RTP) to Hold from Buy on valuation following the recent rally.

OTHER DOWNGRADES:

• Lehman downgraded the specialty finance sector to Neutral from Positive; the firm downgraded American Express Company (NYSE: AXP), Capital One Financial Corporation (NYSE: COF) and Discover Financial Services (NYSE: DFS) to Equal Weight from Overweight.
  
• Lululemon Athletica (NASDAQ: LULU) was downgraded to Neutral from Buy at Goldman Sachs.
  
• JP Morgan downgraded Dollar Tree Stores (NASDAQ: DLTR) to Underweight from Neutral.
  
• Angiotech Pharmaceuticals (NASDAQ: ANPI) was downgraded to Sector Performer from Sector Outperformer at CIBC and to Sector Perform from Outperform at RBC Capital.

The ranks of discontented Applebee's International Inc. (NYSE: APPB) shareholders have been on the rise since the company announced that it would be acquired by IHOP (NYSE: IHP) in July. My first reaction was, If IHOP wants it, should Applebee's sell it? The deal gave Applebee's shareholders a paltry premium and shares of IHOP soared on news of the deal -- further confirmation that this was better news for IHOP shareholders than for Applebee's. In acquisitions, generally it's the opposite.

Then shareholder Sardar Biglari announced his opposition to the deal and Applebee's disclosed that five of its directors including its Chairman, CEO, and CFO opposed the deal.

Now Applebee's has settled a shareholder class-action lawsuit filed by the New Jersey Building Laborers Pension and Annuity Funds alleging that the merger agreement deprived Applebee's shareholders of the benefits they might have gotten if the casual restaurant chain had stayed independent or sold off its company-owned locations to franchisees, the Associated Press said. No money will exchange hands in the settlement. Applebee's has simply agreed to provide shareholders with greater disclosure about IHOP's post-deal plans for Applebee's.

Shares of Applebee's aren't acting as if traders expect the deal to be blocked or the price raised, but if either of those two things happens, shareholders should do quite well. Buying a few shares here looks like an interesting gamble, with a chance for profit if the anti-IHOP deal movement gains steam.

Normally when a company announces a definitive agreement to be acquired, you can tell when it happened just from looking at the stock's chart. That's because takeovers usually happen at substantial premiums to the stock's most recent trading price. In the case of Applebee's International (NASDAQ: APPB), the premium when IHOP Corp. (NYSE: IHP) agreed to acquire the company was so small that it's not noticeable on the stock's chart.

I couldn't believe the Applebee's board would agree to such a deal, and it's refreshing to see that at least a few directors are none too pleased. According to DealBook, "Applebee's disclosed Thursday that five board members, including its chairman, its chief executive, and its chief financial officer, are opposed to the $1.9 billion sale. That wasn't enough to stop the board from approving the deal in July -- nine directors voted in favor -- but it represents an unusual level of internal opposition to a supposedly friendly deal."

I've been skeptical of the deal since it was announced. In July, I wrote that if IHOP's plan to revive the company would work, Applebee's shareholders would miss out on the upside by selling out now. Then investor Sardar Biglari acquired a small stake in the company and expressed his displeasure: "... we believe that if Applebee's undertook the same initiatives as IHOP has in mind, the appreciation IHOP recently gained would, at the very minimum, shift to Applebee's."

Perhaps this disclosure of dissenting directors (including the CEO, chairman, and CFO!) will spark a grass-roots campaign to block the deal, but the stock isn't trading like such a campaign would have much success.

On July 17th, I had this to say about IHOP's (NYSE: IHP) deal to acquire to buy Applebee's (NASDAQ: APPB): "iHop shares soared on the news -- it's one of the only times I can think of that shares of an acquiring company have risen 3 times as much as those of the company being acquired. The premium was tiny -- the stock traded higher a month ago -- and represented a paltry return for the company's shareholders... I'm surprised none of the big institutional shareholders haven't spoken up yet."

Well none of the big institutional shareholders has spoken up, but a small yet feisty one has. Sardar Biglari, the Chairman and CEO of The Lion Fund and Western Sizzlin (OTC BB: WSZL), issued a press release blasting the deal:

I wasn't too impressed with IHOP's (NYSE: IHP) decision to buy Applebee's (NASDAQ: APPB). But at the same time, I think Applebee's shareholders should be pretty upset. iHop shares soared on the news -- it's one of the only times I can think of that shares of an acquiring company have risen 3 times as much as those of the company being acquired. The premium was tiny -- the stock traded higher a month ago -- and represented a paltry return for the company's shareholders.

Today's Wall Street Journal asked the question Can iHOP Chief Restore Polish to Applebee's? According to the Journal:

IHOP Corp. Chief Executive Julia Stewart said she plans to revive Applebee's International Inc. by better distinguishing the chain from competitors, remodeling its restaurants and selling hundreds of company-owned locations to franchisees.

OK -- distinguishing the chain, remodeling, and emphasizing franchising. As Kevin Kelly wrote yesterday, it seems like a good idea, but the question is Why did Applebee's need to be sold to do that?

If Stewart's plan will work -- I doubt that it will because Applebee's will likely continue its decline as a brand -- Applebee's shareholders are getting the shaft.

I'm surprised none of the big institutional shareholders haven't spoken up yet.

Before the bell, IHOP (NYSE: IHP) announced that it is purchasing Applebee's (NASDAQ: APPB) for about $1.9 billion - a 4.6% premium to Applebee's market value at the close on Friday. IHOP said it plans to franchise most of Applebee's company-owned restaurants. The deal is being paid for with credit that is being backed by Applebee's assets. Additional capital is from IHOP's securitization structure, according to the press release.

For those who haven't followed the IHOP story over the last couple of years, the company has essentially shifted strategies from the company-owned restaurant business to the franchising business. While I'm usually very skeptical of strategy shifts, this one actually makes tremendous sense because the franchising business is very lucrative and much less capital-intensive than the ownership business. In recent years, the company has trimmed its exposure to company-owned restaurants down to less than 1% of IHOPs. IHOP has been doing well implementing this plan and I believe it will be able to shift the Applebee's strategy successfully.

According to an AP article on the story, same-store sales are down more significantly at company-owned Applebee's than they are for franchisee-owned stores. This indicates that IHOP is correct in planning on franchising company owned stores because franchisers are more successfully running the restaurants than the company was able to.

MAJOR PAPERS:

• IHOP (NYSE: IHP), of pancake house fame, is buying Applebee's International Inc (NASDAQ: APPB), the huge casual dining restaurant chain, for $2.2 billion in a deal concluded last night, reported the Wall Street Journal (subscription required).
• Vodafone Group (NYSE: VOD) is looking at a possible $160 billion bid for Verizon Communications Inc (NYSE: VZ), reported the Financial Times (subscription required).

OTHER PAPERS:

• The U.K. Times reported that Ford Motor Company (NYSE: F) is preparing to sell Volvo, the Swedish car group it bought eight years ago, in a move that could raise $8 billion.
• The Observer reported that BHP Billiton (NYSE: BHP) is lining up a £20 billion bid for Alcoa Inc (NYSE: AA), after its bid for rival Alcan Inc (NYSE: AL) was trumped by Rio Tinto (NYSE: RTP).
• Large American Internet companies, possibly including Google Inc (NASDAQ: GOOG) and Yahoo Inc (NASDAQ: YHOO), are considering snapping up Rediff.com India (NASDAQ: REDF), which runs one of India's most popular consumer Internet portals, reported the Hindustan Times.

I'm not sure why IHOP want its, but it got it. IHOP (NYSE: IHP) has agreed to buy Applebee's (NASDAQ: APPB) for $25.50 a share, or $2.2 billion. The deal comes at a premium of just 4.6% to Friday's closing price, and stock traded above $26 as recently as last month. The deal probably won't be too pleasing to the company's major shareholders like Richard Breeden, who is credited with forcing the sale of the company.

But I'm not surprised by the low price the company fetched, and I've thought since the beginning that Breeden was barking up the wrong tree. On June 29th, I wrote about the epic tale of the Decline and Fall of Applebee's. Even company founder T.J. Palmer has blasted that company, saying that "It doesn't have anything that would make me want to come back."

Maybe IHOP can work some magic and turn the chain around, but it might be difficult. The company is financing the entire acquisition with debt, and may not be so quick to provide the face lift the restaurants so badly need.

But then again, IHOP's revenue in 2006 was lower than it was in 2002. So maybe this is a case of two drunken sailors trying to hold each other up. There's nothing much to get excited about for shareholders of either company.

Stock futures indicate a lower start on Wall Street this morning after Friday's record close and last week's rally. As investors prepare for a bombardment of earnings this week, they also eye rising oil prices and the upcoming Fed chairman Bernanke's testimony this week.

Last week, U.S. stocks posted strong gains as they reached another record level when the Dow Jones Industrial Average came close to the 14,000 level (less than a hundred points to go). General Electric Co.'s (NYSE: GE) earnings and the rise in consumer-confidence helped boost sentiment.

Today, already Mattel (NYSE: MAT) reported earnings this morning that beat estimated profits by a cent.
This week, investors will get a chance to hear reports from many large caps on Wall Street, many of them tech and financials including Microsoft, Intel, Citigroup, Merrill Lynch, Google and Yahoo!. Eleven of the 30 stocks that make up the Dow industrials will report this week.

Also this week, Federal Reserve Chairman Ben Bernanke will give two days of semiannual testimony on U.S. monetary policy before Congress. No doubt, the housing market and inflation will be in focus, as well as the overall economy.

The key economic release today will be the July NY Empire State Index, a survey of manufacturing in the area, which is expected to have fallen. The release will be at 8:30 a.m.

Overseas, Asian shares mostly closed lower on Monday. European stocks rose for a third day in morning trading, but have changed direction in the past hour. The euro continued to gain against the dollar to yet another record high.

Corporate news:

It seems the consortium led by Royal Bank of Scotland will have a fresh bid as it raises the cash component of its €71.1 billion ($98 billion) bid for ABN Amro (NYSE: ABN).

IHOP Corp. (NYSE: IHP) said it would acquire fellow Applebee's International Inc. (NASDAQ: APPB) for about $1.9 billion in cash or $25.50 per share of Applebee's. The two sides pegged the total value of the deal at $2.1 billion.

Vodafone Group Plc (NYSE: VOD) is considering a $160 billion takeover bid for Verizon Communications Inc. (NYSE: VZ) according to the Financial Times. While there is no certainty this will go forward, Verizon shares rose 1.9% in premarket trading.
Update: Vodafone says it has no plans to bid for Verizon.

Ford Motor Co. (NYSE: F) denied reports in The Sunday Times that it is putting its Volvo unit up for sale and said it is not negotiating with anyone to sell the Swedish automaker.

Finally, Christopher Bancroft, part of the Bancroft family that controls Dow Jones (NYSE: DJ), is trying to block a takeover by News Corp. (NYSE: NWS).

I've been waiting for Apple (NASDAQ:AAPL) to do the obvious and buy IHOP (NYSE: IHP), but it seems this is not to be. According to a breaking story on Bloomberg, IHOP (formerly know as the International House of Pancakes), the largest flapjack chain in the country, has made a hefty offer of more than $2 billion for Applebee's (NASDAQ: APPB). While Applebee's market cap of $1.92 billion is more that twice that of IHOP's $970 million, the pancake house is know as the home of the big appetite, and they seem ready to chow down.

While IHOP has made their reputation on bountiful down-home grub, Applebee's features a menu with Weight Watchers International-approved, calorie-controlled menu items. Compare their Big Breakfast Combo, three strips of bacon, three sausage links, three ham strips and four eggs, to Applebee's 480-calorie W.W.-approved Tortilla Chicken Melt.

The beauty of this deal is that it would allow IHOP to retain those customers that, due to years of Grand Slam breakfasts, find it necessary to waddle away toward a lighter menu. And when Applebee's customer get that hankering for some grease and grits, the answer is right there in-house.

My hope is that, whomsoever ends up with Applebee's, they have a grammarian on staff that will fight for a correction to the slogan "Eating good in the neighborhood."

I'm thinking, "Dining good in the neighborhood."

MOST NOTEWORTHY: Today's more noteworthy initiations included International Game Technology (IGT), Big 5 Sporting Goods Corp (BGFV), CVS/Caremark Corp (CVS) and IHOP Corp (IHOP):

• Jefferies assumed coverage of International Game Tech (NYSE: IGT) with a Buy rating and $47 target citing an attractive risk/reward.

• Big 5 Sporting Goods (NASDAQ: BGFV) was started with a Sector Performer rating and $33 target at CIBC, expecting shares to be driven by an operating margin recover and improving cash flows.

• CVS/Caremark Corp (NYSE: CVS) was reinstated with an Overweight rating at Lehman Brothers and resumed with an Overweight rating at Morgan Stanley.

• JP Morgan believes the rough environment, growing competition and valuation warrants IHOP Corp (NYSE: IHP) to start with a Neutral rating.

OTHER INITIATIONS:

• B. Riley initiated shares of United Online, Inc (NASDAQ: UNTD) with a Buy rating and $18 target.

• Bear Stearns started T-3 Energy Services, Inc (NASDAQ: TTES) with an Outperform rating and $32 target.

• Morgan Stanley initiated shares of Vanda Pharmaceuticals Inc (NASDAQ: VNDA) with an Overweight rating and $29 target.

• American Technology initiated shares of Bankrate, Inc (NASDAQ: RATE) with a Buy rating and $48 target.

• Altus Pharmaceuticals Inc (NASDAQ: ALTU) was initiated with an Outperform rating and $20 fair value estimate at Leerink Swann.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).