RealMoney Silver - Wallflowers: A Fast-Food Operator Enters the Limelight

Wallflowers: A Fast-Food Operator Enters the Limelight
By Bill Trent
RealMoney.com Contributor
5/5/2008 10:05 AM EDT

Editor's Note: This is the first of a series of stories focusing on companies that have little or no Wall Street following. These firms are often referred to as "wallflowers." Many times, shares of these companies are quite undervalued, as most portfolio managers do not get a chance to hear their story. Today we are looking at Triarc, a company worth more than $600 million, but which has just a single analyst following it.

It may seem odd, on the heels of its deal to acquire Wendy's (WEN) , to classify Triarc (TRY) as a wallflower. Certainly it has not shied away from publicity of late. However, in market terms, a wallflower is an under-covered stock, and with just one analyst currently covering the name, Triarc certainly qualifies.

Triarc operates the Arby's chain, of which there were 1,106 company-owned restaurants and 2,582 restaurants owned by 462 franchisees as of year-end 2007. Wendy's had 1,414 company-owned stores and 5,231 franchised restaurants Together, they would form the third-largest quick-service chain.

Wendy's generated $125 million in free cash flow in 2007, and this prices the acquisition at a 5% free cash flow yield -- not bad for an all-stock transaction. The deal is expected to produce $60 million in annual cost savings for the combined company; this is about equal to Triarc's 2007 free cash flow deficit. On a combined basis, and assuming those synergies are realized, I estimate the free cash flow yield to be about 4%.

Triarc CEO Roland Smith will be in charge of the combined companies, and he has said he expects an additional $100 million in improved operating efficiency between the stores through improved costs associated with food, labor and general operating expenses. He notes that Wendy's franchisees turn in higher margins than company-owned stores; this suggests potential room for operating efficiencies at the company-owned stores.

Cleaning House

One very real potential catalyst for Triarc shareholders is the possibility that its time as a wallflower will soon end. Eight analysts currently cover Wendy's, and it seems likely that a decent portion of them will assume coverage of the combined company after the deal closes. Most of those analysts were not enthusiastic about Wendy's, but any coverage will likely be better than no coverage. At least investors will have heard of the company.

On a more fundamental basis, I believe the advantages to the deal for Triarc shareholders come from removing some sticking points for potential investors. The larger market cap and smaller debt-to-equity ratios will help, as will adopting the more recognized Wendy's name. So will Triarc's plan to eliminate the Class B shares by converting them into A shares, resulting in a cleaner corporate structure.

Another benefit is that it will reduce the degree of control held by Nelson Peltz and Peter May. They controlled 34% of the voting power at Triarc, and for all intents and purposes that gave them control. In fact, this was the top risk factor listed in the 10-K. Although the pair also owned 9.8% of the shares at Wendy's, after the merger their combined voting stake will be just 13%. That level is far less likely to raise governance hackles.

What Is It Worth?

I believe that with the restructuring and other deal-related anomalies, estimating earnings is likely to be something of a guessing game. Instead, I'd look to a more stable valuation metric such as price-to-book-value. According to Zacks Research Wizard, the average price-to-book in the restaurant industry is 4.0 times.

I don't believe the new Wendy's will deserve the industry average, but it could merit 3 times book value. At that valuation, the shares could rise nearly 19% to $8.11.

And that's not bad for a start.