On Tuesday, Wendy's (WEN 0.53%) announced what's referred to as a "Dutch Auction" tender offer. In an effort to show investors that management believes in the company's prospects, Wendy's will essentially use this tender offer to buy back shares. In comparison with a traditional tender offer, Wendy's offer has some very peculiar twists.
Terms of the offer
According to Wendy's preliminary earnings release that came out on Monday, earnings for the quarter and the full fiscal year are expected to come in above estimates. This is in spite of a revenue shortfall that would normally leave investors concerned about the company's future prospects. However, instead of the share price falling, shares of Wendy's had risen 6.40% by the end of the day, likely in response to the terms of the company's new buyback plan.
In its release, Wendy's stated that it will utilize $275 million of its $580 million in cash to buy back shares. Of this $275 million, $40 million will come from dividends which resulted from its 18.5% interest in Arby's. The remainder is attributable to the company's System Optimization plan. In essence, this plan focuses on selling off restaurant locations so that only 15% of Wendy's restaurants are company-owned while the rest are owned by franchisees. The downside to this strategy is lower revenue per location, but it results in higher margins.
This approach to business is so profitable, in fact, that other restaurant chains have been using it more often. One noteworthy example is DineEquity (DIN 4.08%), the parent company of Applebee's and IHOP. Over the past four years, revenue at DineEquity has plummeted by 39.9% from $1.4 billion to $849.9 million. The primary driver behind the company's falling sales has been a shift in consumer tastes away from both fast food and casual dining in the direction of quick-casual chains like Chipotle and Panera.
There has been one other reason behind DineEquity's faltering sales: franchisees. With the understanding that the landscape of dining is changing dramatically, DineEquity has shifted from focusing on owning restaurants to franchising them out. The downside to this is that shareholders will see lower revenue, but the upside is that larger margins should be the result. Thus far, the strategy appears to be working. From 2009 through 2012, the company's net income has risen from 306.7% from $31.4 million to $127.7 million. Today, no fewer than 94% of DineEquity's locations are franchised out.
What's in it for me?
Upon completion of the deal, Wendy's management will have reduced the company's shares outstanding by roughly 8%, This will serve to reward the remaining investors by dividing the company's value between a smaller number of shareholders than before, at the cost of a smaller cash position on its balance sheet.
In the long run, owning a larger percentage of Wendy's could prove profitable if the business improves further. However, the trade-off between long-term profits and short-term gains is what investors must struggle with. In the event that long-term profits take precedence, then nothing needs to be done on the investor's end. If investors are more interested in cashing out in the range of $8.50 to $9.25, then the next step is to tender their shares.
As part of the process, shareholders will inform their brokers that they wish to tender their shares at a price in this range that they deem fair. Once Wendy's begins acquiring the shares, they will do so by finding the investor who is willing to sell their shares for the cheapest price, after which the company will give them cash and they will walk away. At each price point above this level shareholders will be given cash in exchange for their shares, up until the company buys $275 million worth of them.
In the event that too many investors offer their shares on the cheap, the total price point could be on the low end of the range and the deal could involve a pro-rata acquisition of shares. On the other hand, if too many investors ask in the high range, fewer shares will be purchased but those who sell their shares will see higher profits.
Ultimately, the goal of an investor should be to pursue long-term profits instead of short-term ones. However, for those who believe Wendy's doesn't deserve to trade at much higher than its current share price, now might be the time to exit through the Dutch Auction.
The safe bet for investors who purchased shares at a lower price will be to pick a price around the current market price. However, it seems more likely than not that most of the investors who tender their shares will do so at a price higher than the market price. The rationale behind this is that it seems pointless to tender shares at the market price and risk the uncertainty of not having all of your shares purchased when they could be sold immediately and with absolute certainty.
The endgame here would be one in which Wendy's shares approach the upper limit of $9.25 because investors want to achieve the highest price point possible, while some investors play it safe by having lower expectations. These lower expectations would serve to keep Wendy's shares from sitting right at the $9.25 limit, essentially capping gains in the short term but also providing the Foolish investor with some potential upside.