We have not had the privilege to talk to Bill Ackman about his thoughts on WEN, but here is my take on the Wendy's situation. Upon completion of the WEN deal, Pershing square will own TRY, which is trading at the low end of the valuation matrix we created. On a pro-forma basis, TRY is being valued in line with other domestic QSR companies that are experiencing declining traffic and margins. See the valuation matrix chart.
To summarize, I think the Ackman model for creating value at Wendy's requires the company to sell off assets and focus on the core business of being a franchisor. For Wendy's, this means selling the company's real estate portfolio and/or re-franchising the company store base. At this point, the market will value the company at a higher multiple due to the stability of the high margin, high return royalty stream.
- Research Edge thoughts:In isolation, sale leaseback transactions do not create significant value. At the completion of a given transaction the company swaps valuable real estate for increased leverage. If the proceeds are used to re-purchase shares, the incremental interest expense offsets the benefits of the lower share count.
- Both the Arby's and Wendy's chain are roughly 70% franchised. For competitive reasons, it's important for a QSR franchisor to own 10-15 of the store base. It was not long ago that Arby's was nearly 99% franchised, so we don't think management is headed down that road again. So there are not that many stores to sell to create significant value. In addition, selling company-owned stores is dilutive to EPS and reduces EBITDA.
- In the end there is some financial engineering to do, but it's not a game changer for TRY. It all boils down to operations and can management get WEN margins back to historical levels. While operationally there may be some low hanging fruit that can improve margins, most of the margin issues rest outside of management's control.