A highly regarded company goes on sale on the New York Stock Exchange this week, but after Wall Street takes its cut, you may not have an opportunity to buy shares at much of a discount.Wendy's ( WEN) is set to spin off 15% of Tim Hortons, its Canadian doughnut chain named after a former NHL star. The shares are expected to price Thursday night and trade Friday under the ticker THI. Given all the excitement about the IPO, they could quickly get expensive. "Tim Hortons is a fantastic asset and there's going to be an unbelievable amount of demand for the stock," says Shawn Kravetz, an analyst with Esplanade Capital. "You look at Chipotle ( CMG), which doesn't have nearly the quality of a Tim Hortons, and yet that stock went absolutely nuts after its IPO." Chipotle Mexican Grill debuted in January after being spun off by McDonald's ( MCD). The shares doubled in one day to close at $44, marking the biggest opening-day gain for a U.S. IPO since late 2000, according to Thomson Financial. Now investors are salivating about the next big IPO in the restaurant business. Late Monday, Tim Hortons raised the share price of its proposed offering of up to 29 million shares to $22 to $24 from the previous range of $18 to $20, based on the anticipated demand in the market. Banks managing the IPO, including Goldman Sachs ( GS) and JPMorgan Chase ( JPM), may sell another 4.35 million shares to meet that demand. In all, the company could raise as much as $800 million. In this atmosphere, investors trying to get their hands on shares of Tim Hortons early in the process, when new offerings are often priced below their intrinsic value, might be forced to eat big trading commissions with Wall Street brokerages that often are accused of favoring their most well-heeled customers in IPOs. Those investors not fortunate enough to be in the proverbial club may do best by buying shares of Wendy's now, because the fast-food giant will still own 85% of Tim Hortons when all is said and done. Wendy's says it doesn't plan to spin off the doughnut chain in its entirety until later this year.
In that sense, going long Wendy's now means going long Tim Hortons for its IPO as well. If the spinoff sees a pop in its share price on Friday that is anything like what transpired at Chipotle, then investors holding Wendy's shares may be getting a stake in both companies at a discount. The strategy's no secret -- shares of Wendy's have gained 10% over the last two weeks. Kravetz says investors are buying shares ahead of the IPO. For Kenneth Shubin Stein, a hedge fund manager with Spencer Capital Management, this strategy looks prudent, because, in buying Wendy's at $64, he says investors are still getting both companies at a good price. "There's more operational improvements that can be made at Wendy's under an improved management team," says Shubin Stein. "Once those improvements are made over time, the stock will go up." His view appears to mesh with that of Nelson Peltz, the activist shareholder whose public berating of Wendy's through his Trian Fund recently paved the way for three of its nominees to
join the company's board . Now that he has both feet in the door at Wendy's, Peltz sees the opportunity to add more value for shareholders. His track record at turning around flailing businesses in the past, like the Snapple and Arby's brands at his Triarc Cos. ( TRY), adds credibility to the claim. Meanwhile, with its 2,885 locations located mostly in Canada, Tim Hortons has a fanatical following north of the border. The company told investors at a recent roadshow that it plans to open up to 200 new restaurants in Canada and in the U.S. this year, and post same-store sales growth in Canada of around 4% to 5%, according to RetailRoadshow.com. That compares with 5.2% growth in 2005 and 7.4% in 2004, according to a regulatory filing. Its U.S. comps rose 7% in 2005 and 9.8% in 2004.
Paul House, the company's president and chief executive, said Tim Hortons could add 1,000 to 1,500 new Canadian locations by 2013, mostly in western Canada and Quebec. He said the chain wants to have 500 U.S. locations by the end of 2008, which would roughly double its current count. Also, the company plans to drive sales growth by adding to its lunch offerings, where the likes of Starbucks ( SBUX) also is planning to expand. Spinoffs, where a corporation issues stock in a subsidiary to its shareholders to create a new public entity, are popular these days. They're viewed by value-hunters as one of the few remaining areas in which price inefficiencies are routinely created in a market that's growing increasingly efficient overall. "People love pure plays, where, as investors, they know exactly what they own and they can see the cash flows and growth associated with it," Kravetz says. "So, when a lot of sunlight shines on a great asset like Tim Hortons after it's been buried in a larger, underperforming conglomerate for years, people tend to get very excited." In many cases, freeing up an asset from a bumbling parent rewards shareholders who buy a hot IPO. Since its smashing debut, Chipotle has gained more than 18%. On the other hand, an IPO can sometimes get out of hand quickly, as many dot-com investors can attest. For investors who buy Wendy's before the Tim Hortons IPO, one way to hedge that bet if the new shares show a pop that looks too good to be true is to sell them short, Shubin Stein says. "If the IPO is a raving success and you short Tim Hortons after things settle out, you have effectively isolated your ownership in Wendy's business, creating what's called the stub," Shubin Stein says. "You're short the radical part of the gain in the new shares of Tim Hortons, but you're also long thanks to your investment in Wendy's. Therefore, if you lose on the short side, you're effectively credit-neutral, because you can cover those losses through your Wendy's shares when the parent spins off the rest of the new company. If you win on the short but shares of Tim Hortons still show a net gain from the initial offering price, then you're up on both sides of the trade and you just made some good money."