Standing Firm: The Tim Hortons Spinoff Created Value for Wendy's Shareholders

In this blog entry, Todd Sullivan defends himself against my previous argument about Wendy's (WEN) spin-off of Tim Hortons (THI). I'd like to just quickly restate my thesis:

The spin-off of Wendy's from THI created value. Why? Because both organizations can now concentrate on maximizing value of their own operations. THI is a great chain that was for a long time masking the ineptitude of Wendy's mgmt team.

To me, Sullivan's argument boils down to the fact that Wendy's and THI should have stayed together because of the "synergies" that could be created by keeping them together.

I think it's mostly self-evident that there are few synergies between a Canadian doughnut chain and an American burger chain. THI has 2,700 locations in Canada and ~330 in the US. Wendy's has about 7,000 locations in the US, and 370 in Canada. Are there really any synergies between these two in terms of "integration of logistics and getting product to locations?" I don't really think so.

Wendy's sells burgers and fries and meat and fish and potatoes. Horton's sells coffee and tea and snacks and doughnuts and yes, sandwiches also. But cost savings from combined purchasing? The two chains don't really sell similar stuff. I can see Dunkin Donuts and THI having cost savings from combined purchasing, but not a coffee & doughnut shop with a burger chain.

Aside from the fact that the entire concept of "synergies" is fuzzy in general, and is even fuzzier in the case of these two disparate businesses, I want to add a few more points:

1. McDonald's introduced premium coffee that was branded McDonald's. Wendy's can introduce premium coffee that's branded Wendy's. The ability for Wendy's to introduce premium coffee in cups that say Tim Horton's doesn't really justify keeping the conglomerate together. They can always license the THI name if they think it will help. If you read this Wall Street Journal article, though, you'll see that Americans in general don't really recognize the Tim Horton brand, so I don't think it would really help Wendy's to introduce Tim Horton-branded premium coffee in its 7000 US locations.

2. Sullivan also claims that the Wendy's management could have handled THI and Wendy's together because there's no reason why management can't "walk and chew gum" at the same time. I would argue that if the management team (which by the way has already changed its CEO since then) couldn't handle Wendy's properly, they would've eventually screwed up THI also.

3. Sullivan argues that "everyone knew the burger chain was mismanaged" before the THI spin-off "and if they did not, they just did not look into the company very well before they bought shares." I don't really agree with that statement. Until Bill Ackman and Nelson Peltz came onto the scene, it didn't seem like shareholders really cared about management ineptitude. Both Ackman and Peltz pushed for the spin-off to create value. Peltz, by the way, has significant experience in the restaurant field and he still holds Wendy's shares today, indicating that he thought and still thinks that the spin added value. Now that Wendy's is a stand-alone entity, Peltz can get his hands dirty with either fixing the company himself (which Wendy's management is doing its best not to do) or getting it sold off. None of this would've happened without activist shareholders urging a spin-off. Certainly a purchase of Wendy's would have been much harder to pull off if it was an entire conglomerate.

Spin-offs create transparency. And while it's true that a good investor would look into the entirety of the business before buying, that's not necessarily true of the broad market - that's why value investors like Sullivan and myself exist - because we see value where the rest of the market doesn't. Spin-offs are a great way to increase transparency and understand-ability in order to unlock that value quickly. That was certainly the case with Wendy's.

As Whitney Tilson writes in this FT article (.pdf) from last year, "with the stock in the high $30s, the company?s Tim Hortons subsidiary was worth nearly the entire stock price." Well, if that was the case, why wasn't the stock trading higher? It all boils down to transparency. That, after all, is why spin-offs outperform the market almost all the time.

Once again, I stand by my argument. Any Wendy's shareholder could have kept the THI piece if he wanted to. And synergies? "Synergies" is usually code-speak for justifying a transaction that doesn't make logical sense.

In this case, keeping Wendy's and THI together didn't make sense. And hey, you don't believe me? Ask Nelson Peltz. He has much more experience with both value investing and restaurants than either Sullivan or myself. He both supported the spin-off and continues holding the stock. I couldn't ask for better proof than that.