Posted by: Aaron Pressman on March 28, 2006
All the talk about Wendy’s International (WEN) and its semi-hot spin-out IPO of Canadian donut chain Tim Hortons (THI) had me thinking back to an earlier age. The current theory making the rounds is that the market is wildly overvaluing TH so it’s not a buy but since Wendy’s still owns 85% of the chain, Wendy’s shares are a bargain. I’m skeptical, based on a deeper look at the numbers and a little history. Pass the ketchup, hold the mayo, Wendy’s share price looks just okay-o.
First the history – who remembers the March 2000 IPO of Palm? At the time, the maker of popular handheld "digital assistants" was owned by 3Com. Palm had one of those insane, bubble-era IPOs that left the company with a market cap of over $50 billion on revenue of just over $500 million. 3Com itself, which still owned 95% of Palm, had a market cap of under $30 billion. So what was the market saying that time? I’m sure you can predict how the story turned out. Both stocks were huge losers falling over 50% within months. Sometimes the fact that a parent owns shares in an overvalued spin-off isn’t a value play but a warning signal.
The current analysis indicates that Wendy’s remaining stake in TH is worth $4.25 billion thus the rest of the hamburger company is being valued by the market at about $3 billion, or so the logic goes. Said another way, the TH stake is about 60% of Wendy’s total cap.
But in this case, TH is also a big part of Wendy’s profits and revenue. For 2005, TH’s $1.2 billion of revenue accounted for 31% of the company total. It's been growing faster as well -- up from 26%
just 19% of total revenue in 2003. More importantly from an equity perspective, TH’s $279 million of operating income represented 74% of the entire company’s operating income. Even excluding a charge for goodwill impairment, TH had 68% of the company’s operating income. Arguably, TH should account for an even bigger chunk of Wendy’s market cap so Wendy’s is the more overvalued.
It’s also worth noting that same store sales at Wendy’s were down 3% and down 4% at its other chain, Baja Fresh. Same store sales at TH were up 5% in Canada and 7% in the U.S.