Thursday, June 21, 2007

Wendy's Post: An Answer

I usually ignore things like this but when they cross the line from a well though out rebuttal (like Andy Kern's Berkshire rebuttal to me that I requested from him and actually posted on my site) to one that takes selective items from a post of mine while ignoring and misstating others to make a point, I need to set the record straight.

In a post, David Cohen states: "Aside from ignoring and/or mis-stating key facts (Bill Ackman is indeed a long term value investor, and Nelson Peltz, who still holds Wendy's shares, also pushed for the THI spin-off), I think the argument is off-base." THI is Tim Horton's International

First things first. I never claimed Ackman was a long or short term investor and as a matter of fact I alluded to him still owning McDonald's (MCD) saying "he recognizes the bright future there". What I said was that he had "a short term interest in the company (Wendy's)". Ackman first disclosed a Wendy's stake in April 2005 and by November 2006 (immediately after the Tim Horton's spin) had liquidated it and yes I consider this short term. Don't believe me? Let Ackman himself tell you, "We buy things when they are discounted, and once they reach the potential of what we think they are worth, we sell. It could take months, or it could take years. That is our business." Bottom line? He is "long term" or "short term" depending on the situation and what he wants out of it. Is this any different that what I said?

Nelson Peltz. In my post I said "agitation from activist investor Nelson Peltz and former shareholder William Ackman that action be taken to boost the company's share price." I am not sure what the point of restating my comment as though I alluded to something else is.

He continues "Sullivan's argument is that Wendy's could be doing much better if it only sold coffee to its customers, as McDonald's seems to be succeeding in doing. My retort: Can't Wendy's (WEN) sell coffee without THI just as it could with THI? What in the world does Tim Horton's have to do with Wendy's selling coffee?"

Again this only touches the and I think intentionally misses the core of my argument. It never implied it was the "only" thing they would have to do, just a glaring opportunity they now do not have. Also, the argument was "premium" coffee, not "brown liquid in a cup". Again to accurately quote my post, "given the overwhelming success McDonald's (MCD) has had with it's premium coffee offering." McDonald's sold coffee before but the introduction of the premium (Newman's Own) stuff has lead to an explosion in coffee sales for the chain. Along with the added customer trips come more ancillary sales of food items. There is a reason in every monthly earnings release "breakfast" (coffee) is at the top of the list of reasons for yet another record month at the Golden Arches.

If anyone has been to where Tim Horton's does business, they are wildly popular, more so than Dunkin Donuts. It is a premium brand in those areas. Are we really going to believe that selling premium coffee at Wendy's drive thru's would not lead to increased business? This is true if for no other reason it would stop people from defecting to McDonald's for a cup and give them a reason to stop at Wendy's. More customer trips always equal more sales in the fast food business. Selling Tim Horton's coffee would have assured additional trips to Wendy's as McDonald's has proven premium coffee drives business.

Again Mr. Cohen: "I would argue that if the spin-off of THI never happened, then Wendy's would still be basking in the glory of its well-run THI operation and not focusing on its mismanaged core business. Now that THI exists (and is thriving) on its own, everyone can see how badly Wendy's is lagging behind McDonald's and Burger King. With this transparency comes shareholder pressure to improve operations. If the THI spin-off never happened, it never would have been so painfully obvious how badly Wendy's is managed. With the transparency of the spin-off comes a recognition of problems. While the solutions may not be easy, recognition is the first step."

Not sure why he "would argue" this after I said "Now holders are stuck with a third rate burger chain that is missing what would have been the fastest growing part of it." I think everyone new the burger chain was mismanaged and if they did not, they just did not look into the company very well before they bought shares. What Horton's did was buffer shareholders while they tried to fix it. There seems to be this thought out there that management cannot walk and chew gum. Like the recent Home Depot (HD) sale announcement, it is a short term gain at the expense of long term performance. Neither the Tim Horton's spin or the Home Depot sale are going to "fix" the problems at the parent nor will they make them any more apparent. They both will make shareholders happy initially and scratching their heads later. Why? Had either Wendy's or Home Depot fixed what really ailed them and kept the items they sold off, shareholders would have been rewarded in multiples down the road with two thriving businesses that would have had wonderful synergies together.

Now, am I opposed to all spins? No, just the ones done for the wrong reasons. Ones like the Wendy's and Home Depot spin are like taking diet pills instead of exercising and eating right. You'll get immediate gratification at the expense of long term benefits. In the post I referenced the Chipotle (CMG) spin by McDonald's as one that was done right. The two businesses were unrelated (Mexican food vs Burgers and eggs)and the synergies between the two on a retail level were nil. It made sense to cut Chipotle loose to shareholders so they could experience the full benefits of both operations. It was not done to mask problems. Even the recent Altria (MO) spin of Kraft (KFT) was done for the right reason, to fully recognize the full value of BOTH entities, not one.

Mr. Cohen concludes: "Now, shareholders can decide to own either Wendy's or Tim Horton's or both. As a shareholder of Wendy's, you would've received your fair share of THI in the spin-off. You can decide to do with that whatever you want, but you can easily create the old Wendy's/THI conglomerate by just keeping your shares. I don't understand why having more flexibility in building your position results in a destruction of value."

I agree, you can own one one, both or neither. You cannot replicate the old conglomerate by owning both, however. You cannot replicate the cost savings of not having two entirely separate corporate structures, the increased purchasing power of the larger combined entity, the savings from combining advertising, the savings from the integration of logistics in getting product to locations and the increased revenue that could be realized from cross selling products with each other.

Having portfolio flexibility and the destruction of value in Wendy's "Long Term" (which was the title of my original post on my blog) are two wholly unrelated items. This confuses the "price" you received for your shares vs. the "value" in the company. Shareholders had flexibility when they first bought shares and continued to have it as they held them. They could have sold them or added to their position at anytime.

The long term value in the combined entity would have come from what the two businesses could have done for each other to generate earnings for shareholders. My argument was and still is that Wendy's was better off with Tim Horton's long term than without.


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