Investorial

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

We’re starting off with this quote to remind us that we should not follow opinions, but rely on our ability to reason and gather facts. Easier said than done, what are facts? Everybody has a way to interpret numbers, figures. One analyst can recommend a stock while another is downgrading it. There can be no consensus in the market for the buyer / seller principle to work - one’s man junk is another man’s treasure.

I am going to look at this post using some numbers; some publicly disclosed, some calculated. But rest assured only to the level that I can understand. Being a Bachelor of Mathematics doesn’t mean anything when it comes to analyzing financial numbers. I’ll only refer to common sense numbers, hopefully nothing beyond comprehension! I’ll also use Canadian dollars for convenience!

The IPO Story
To recap, Wendy’s decided to spin off 15% of its ownership of Tim Hortons in a public IPO. In total, 29 million shares will be made available at C$25 to C$27 per share. Here’s the press release that explains that the preliminary filing prospectus showed an initial target range of C$21 to C$23 per share. The stock IPO has garnered national attention, appearing in newspapers, television, radio, blogs and virtually any media out there! There is a mania going on and that’s why this is a story for Investorial!

Valuation Of The IPO
I wanted to see the justification for the valuation, since IPO is a manipulative game played by the underwriters. How else could tech companies who have never made a dime of profit be valued so high during the internet bubble? We have to remember that IPO underwriters are part salesman, part auditors. But the split tends to be more salesman than auditors. Since 15% is being spun off this round totalling 29 million shares, that means 100% is represented by by 193.3 million shares. I am aware that the company can also file to issue more shares, which is another issue that we won’t go into here.

So the capitalization of Tim Hortons on the upper-end of the IPO price is $5.219 Billion (193.3 million x $27 per share). We have to remember that Wendy’s is still the biggest shareholder at 85%, so it’s not conceivable for any investor to truly affect changes through their ownership if necessary.

Why Is Valuation Important?
As a value investor, one of the things I’m concerned is finding the intrinsic value of the company vs. the market perceived value. The market perceived value is best described using the baseball card analogy. It’s a matter of supply and demand. Why do you think the IPO price was jacked up? The demand from investors was strong and you cannot fault the company for taking advantage of the situation to raise more funds. My preliminary screen for a company is to check out a company’s return-on-equity. Tim Hortons’ 2005 income was approximately $181 million (courtesy of Canadian Capitalist). This represents an ROE of 3.5% - not a truly enticing figure. This leads me to believe one of 2 things; either the valuation is badly skewed in favour of the IPO or this is not as good a fundamentals story as I thought. I tend to believe it’s an overvaluation situation.

I do like the idea of Tim Hortons distributing a 1% dividend, yet it remains to be seen if Tim Hortons will be able to raise the dividend on a consistent basis. Time will tell that. As far as I know, Warren Buffett never bought into IPO situations. If I were to buy into Tim Hortons, why not wait a bit and see how the market reacts if things ever go wrong?

What Could Go Wrong?
As with any investments, there are many associated risks. A few I can see are the market’s reaction to Tim’s possible inability to grow beyond Canada. Food costs are constantly a threat to a restaurant company’s bottom line. We’ve seen what happend to restaurants during the beef and chicken crisis. What if it happend to the raw materials needed for Tim’s operations?

Hidden Gem Or Mature Company?
I believe Tim Hortons is a quality company that currently generates strong cashflow. It is my favourite coffee place, and its undoubtedly the best brand and most successful Canadian franchise story. However, one shouldn’t buy something simply because they liked it! This isn’t necessary one of those Peter Lynch stories about buying what you know, buying what you love. It may have been a Peter Lynch story when those franchises were starting to pop up all over the place if you bought a private placement of shares back then. Tim Hortons is already a mature company in the Canadian marketplace, and has not proven itself to be able to expand its brand recognition internationally… yet.

What If I Miss The Train?
I’d be happy for you if you bought the stock and it went up and up, but for me I’ll be thinking “that’s ok, another train will come!”. Many people regarded themselves as geniuses to buy into Google’s IPO around $85. Many others remain sleepless lamenting on their inaction. Remember, hindsight is 20/20. A value investor’s and/or contrarian investors’ first priority is to conserve their capital. One has to be able to control themselves emotionally, and refrain from instant gratification temptations to become a successful investor (No, I’m not including traders in this article). New trains like Google, and Tim Hortons will always come along. In the case of a contrarian investor, they’re looking for those trains that come along when nobody wants to board them; therefore getting the best seats in the house for the cheapest price!

Other Opinions
Jim Cramer cautioned to the viewers of his television show not to hold onto the stock for too long because “this is not a growth story.” I am usually the last person to echo Jim’s sentiments but looking at the mania, it is a valid concern. Many average joe investors are yearning for this stock and finding it in short supply. For many such “investors”, this is their first time buying stock or the last stock they bought was a brand name like Nortel that they recongized too! Institutional investors could have a field day making money on the IPO and I won’t be surprised if the stock reaches the mid 30s or higher on the first day of trading! I’m afraid of the consequences of a potential wealth transfer from the ignorant to the knowlegable.

There’s a Globe article (while it’s still available) about the Tim Hortons IPO Mania that explains well about people wanting what they can’t get and the fact that this hyped-up demand may all be because of brand recognition.

Conclusion
I cannot stress how much you need to draw your own conclusions. I’m merely trying to share my views on the media, the mania and the numbers as I see them. If you disagree with anything I’ve written here, please leave your comments and let me know! The cynic in me is always looking forward to differing opinions, and lively discussions! Whatever your decision is, don’t let the crowd or this article be the influence. Base it on your reasonings and data.

P.S. Somebody said that it’s better to own a Tim Horton’s franchise than the stock. Somehow, I agree with that!

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