Special Situation Investing

Tuesday, October 17, 2006

Wendy's (WEN) Large-Scale Share Repurchase Program

Hamburger retailer Wendy's (WED) caught my eye today when they announced that they will attempt to repurchase ~ 19% of outstanding shares in a modified Dutch auction tender. Wendy's closed trading at $34.57, whereas the Dutch auction will occur in the $33-$36 range. I do have to wonder what kind of message their management is trying to send by setting the repurchase range largely below the current price. Perhaps there are some large institutional holders looking to bail? However, ultimately I like the Dutch auction program as it tends to be an equitable and relatively efficient (e.g. cheap) way for the company to distribute it's capital to investors. In this case, assuming the price hasn't been tampered with pre-announcement, it would seem that holders as opposed to tenderers are getting the better deal. In short, if Wendy's was correctly priced based on it's fundamentals then this deal only strengthen's non-tenderers position.

This is not the first major strategic move by Wendy's either. They have recently spun-off their Tim Horton's chain and sold Baja Fresh Mexican Grill. (As a side note, to give you an idea of the popularity of Tim Horton's, there are rumors going around that the company puts cocaine into it's coffee to enhance it's addictiveness.) In addition, the company has announced plans to spend $525 million renovating and repurchasing franchised restaraunts. The company is playing perfectly to shareholder-friendly, refocus -on-the-core principals and investors are rewarding it for it's efforts.

OK, but is it a buy now? Well for that we will need to look at some numbers. The company has revenue of $3.8 billion and 117 million shares outstanding. After the dutch auction, assuming all 19% are repurchased, the company will have ~95 million shares outstanding. This gives a figure of $40 revenue per share. Of course revenue is a meaningless figure in itself, how much profit can they draw from it? Historically not much. Last fiscal year, excluding non-recurring costs, operating income was around 10% of revenue, net income was around 6%. I am not sure if it is a fair comparison but McDonals had operating income of 20% of revenue last year. In fact, McDonald's net income relative to rev. was even higher at 13% than Wendy's operating percentage. Of course, we are not here to talk about Mickey D's, I am just trying to establish that Wendy's certainly has some room to run as far as operational improvements go. This in turn would lead to higher earnings. Another point to note is that even if the share repurchases are financed completed by debt (they won't be, WEN has $1.2 billion in cash compared to $800 million in expected share repurchases) Wendy's will still have less debt relative to revenue than McDonald's. If Wendy's was even able to earn 8% net of revenue, you would be looking at $3.1/share in earnings and a very reasonable share price.

Given their shareholder friendly management, strong financial position (I didn't really cover this in enough detail but take my word for it or look at their latest 10-Q), and potential for operational improvements the company does seem like a good deal. You are not going to get rich off of it, but given the valuations I am seeing on other companies right now it appears an attractive place to park some money.


I intend to buy shares in Wendy's.


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