The WEN/TRY Deal...

Overview of the Transaction

Upon completion of the transaction, the new company is a combination of two national brands with over 10,000 restaurants in the U.S. and approximately $12.5 billion in system-wide sales. The Arby's and Wendy's chains are roughly 70% franchised. The Arby's system is roughly 3,700 units across the U.S. and Canada, and generates system-wide sales of approximately $3.5 billion. Currently Arby's has plans to open 50 company operated units and 100 franchised units in 2008. The Arby's system had commitments from franchisees to open almost 400 new units over time. Wendy's is the third largest quick service hamburger chain in the world with more than 6,600 restaurants and system-wide sales of approximately $9 billion.

The deal terms include Wendy's shareholders receiving 4.25 shares of Triarc Class A Common Stock for each Wendy's share they own. According to the Merger Agreement, the Board will have 12 members, including two directors nominated by Wendy's. Arby's and Wendy's will operate as autonomous business units headquartered in Atlanta, Georgia, and Dublin, Ohio, each led by brand CEOs. A support center headquartered in Atlanta will be created to manage all public company responsibilities and other shared services. Roland Smith will serve as the CEO of the parent company, as well as of the Wendy's brand. Tom Garrett will become the CEO of the Arby's brand and Steve Hare will be CFO of the parent company.
  • Re-energizing the brands - Revitalize the advertising message by focusing on the quality heritage created by Dave Thomas. Also, improve the new product innovation pipeline and expand dayparts like breakfast and snacks.
  • Improving operations and margins - Improve Wendy's store operations and margins by developing an ownership mentality at company-owned stores. Currently, Wendy's store level margins are more than 400 basis points below where they were six years ago. This could take as long as three years to achieve.
  • Shrinking the corporate structure - Management has identified $60 million in synergy savings. We can only imagine the bloodletting that is going to happen in Dublin. According to management, these savings will take approximately two to three years to fully realize.
  • In the world of M&A changes never come easy.....
  • Issue #1 - the restaurant industry rarely sees a successful M&A transaction. The turmoil that is created through combining the employees and the franchise system is draining and very unproductive. The risk of increased turmoil within the Wendy's system is even greater with Roland Smith, a Wendy's outsider, as CEO of the Wendy's brand. I do not believe that anyone outside the Wendy's system has ever managed the brand. It will take a special person to win the hearts and minds of the Wendy's system.
  • Issue #2 - Arby's has strong penetration in the Midwest, like Ohio, where the chain has over 300 restaurants. Wendy's, headquartered in Ohio, is also very strong in the Midwest. We believe that the restaurant industry is a zero sum game; it's likely that competitive issues will crop up among the Wendy's and Arby's franchise systems.
  • Issue #3 - It's very difficult to fix restaurant level margins in an environment where customers are strapped and food inflation is rampant. In addition, Wendy's biggest rival, McDonald's, is very well positioned and has lots of relative momentum.
  • Issue #4 - Both chains lost market share in 1Q08.
  • Currently pro-forma EBITDA for the New New WEN is around $350-$400 million in EBITDA.
Transaction Rational and Valuation Matrix

On Target

Ok, here's an odd one... WWD reported that Target and Barney's are teaming up on a brand/marketing initiative. Yes, that's the same Target that sells everything from kids' underwear, to Weber grills, to eggs, and the same Barney's that sells Prada. Now there's an eye-grabber.

Even more interesting is that Target is the one originating the content. Target is trading up in prestige, and Barney's is trading down big time. This is a limited run, limited distribution campaign on Target's exclusive Rogan Gregory line. It's not a big revenue event by any means. But it shows a couple of interesting longer-term trends.

1) The 'content vs distribution' play in this space is dying a slow death. No longer can Wall Street box these companies into 'retailers vs brands.' The premium brands are earning the right to become retailers, and as we see with Target, the more successful retailers are earning the right to be viewed as brands in their own right.

2) Owning the consumer relationship matters now more than ever. Both our opinion and fact-based analysis on the secular landscape for apparel is not for the faint of heart. As the global supply chain is squeezed and stress-tested to a degree greater than at any time in history, it is the brands and retailers that are pushing the envelope with innovation -- both in product and marketing -- that will come out ahead.

3) Those that are not investing today in order to stay above water tomorrow will sink at a rate faster than they can lower their own expectations (never mind the Street's).

Macro Matters!

'Yeah, macro might matter, but this industry has a mind of its own.'
That's the most common feedback we get as to why macro calls don't work in apparel/footwear.

As much conviction as we have in the disastrous secular outlook for softlines (see 5/5: This Ride Is Far From Over), we're getting even more concerned about where we are in the cycle. What? Getting MORE concerned after earnings tank and the stocks get clobbered?

Yes. And it's all about Asia. It's macro.

Since we've gone live with our portal, I've been having fun searching out relevant charts and pictures that help tell an investment-significant story. This time, I'm going to blatantly plagiarize from my colleague Keith, with whom I share real estate on this site. Check out the excerpt below from his morning comment posted early today (be sure to click on the image to enlarge it).

Here's a few other recent events worth considering...
* India inflation report came in at a 3 year high. Singh is prepping for '09 re-election with containing inflation as a key point on the agenda.
* BoJ reverted to a neutral stance in light of rising cost pressures.
* Pakistan/Philippines food crisis.
* Singapore Central bank guided down last week in terms of growth. Growth was 7.7% last year. Now guiding to 4.6%. Best case, by 2009 growth is cut in half.

So Asia, which has been the source of stimulus for increased per capita consumption in the US due to lower costs, is going to continue to take it on the chin. We've seen some of the cost inflation already, and we think that there's much more to come. But the double whammy comes when growth in Asia slows as well, and an important growth market for US brands eases.

Growth slowing AND margins contracting?


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%


During the late 1990's, as CBRL endeavored to maintain its strong, historical rate of growth, a number of issues lead, to a deterioration in the company's financial performance. Increased capital spending strained the CBRL system! More importantly, aggressive menu pricing and tight management of restaurant expenses threw the consumer value out of balance. The decline in operational performance, coupled with declining customer counts caused a significant decline in profitability.

As seen in the chart below the same management team is aggressively raising prices again! At a time when the typical CBRL customer can't afford to fill his tank with gas!

2Q08 EPS quality looked suspect.....
CBRL posted sluggish revenue growth of 3.6% in 2Q08. As expected higher operating costs caused restaurant operating income to decline 1.6%, but a 12.9% decline G&A versus last year enabled operating income to increase 7.5%. The balance of the EPS growth in the quarter was driven by a $0.05 per share gain on sale of real estate and a 34% decrease in outstanding shares outstanding.

Given the current traffic trends there is a high probability that 3Q08 EPS will look ugly too.....

Oh Canada... Doh!

Sticking with our theme of the GIL CEO's superior 'capital avoidance loss radar' we'd note the following...
  • 1) The percentage of shares held by Canadian institutions accelerated in the back half of 2007, coinciding nicely with the 3.6m shares sold by (Canadian) CEO Chamandy.
  • 2) By the end of December (when stock sales were complete), all analysts still covering the stock today had a Buy rating, and price targets peaked at $48.

Danger Zone

With earnings season about halfway done (brands reported, but retailers have not) we've got a pretty good sense as to where the industry stands. It's not pretty. Sales are off, inventories and high, and margins are down. (Thanks McGough, tell me something I don't know). We know this is painfully obvious to just about everyone that watches the tape, but what might not be as obvious is how bad the industry is on top of increasingly easy compares.

The chart below show shows the spread between sales growth and inventory growth on the vertical axis, and the yy change in Gross Margin on the horizontal axis. The sample includes every publicly-traded company that makes, designs or sells apparel. The place to be is in the upper right-hand quadrant, where sales are growing faster than inventories, and margins are up. On the flip side, retailers never want to be in the lower left quadrant -- inventories growing too fast relative to sales and Gross Margins down.

Unfortunately, we're in that lower left quadrant today. Even more unfortunate is that 1Q is the first quarter of easy compares vs last year in the current cycle. Bulls might argue (correctly) that any move out of the lower left quadrant is a positive stock move. We'd note that K Mart was there in almost every quarter for the 5 years before it went under. Sears and Foot Locker are there perennially.

Importantly, over the past 5 years, the apparel industry was to the right of the vertical line (margins up) almost 90% of the time. This was the tail end of the multi-year margin tailwind we think is going away. We have no reason to think that the current quarter is an aberration in any way vis/vis what is yet to come in this industry.

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