i want to tell you how great your article was. but it is time consuming to get thru msnetwork--to save time.........
thread skip my rambling and just read his article for more authoritative info.
i hope you aren't pissed that i copied it onto the thread. i heard about this company months ago, then saw insiders buying, heard about julian r., then read your article. then started buying slowly.
i also think that america and the world has enough burgers, but there really is not a great mexican or chicken franchise (boston chicken blew up). americans favorite foods are becoming lower in fat than burgers, fries, and shakes. i think there is a future in mexican food, pizza (lots of veggies please), and a choice of fried or baked chicken.
i also agree with you that after they have improved margins things should get a lot better. plus my teenagers much prefer taco bell and pizza to burgers.
BELOW IS THE ARTICLE!!!!!!
Finding Value in Fast Food
Shares of Tricon -- the new parent of Pizza Hut, Taco Bell and KFC -- are getting cheaper. They might even be good for you.
By Michael J. Burry
At first glance, Tricon Global Restaurants (YUM) -- the debt-laden, low-margin conglomerate of Pizza Hut, Taco Bell, and Kentucky Fried Chicken -- does not appear too appetizing. Spun off from PepsiCo (PEP) in October, Tricon's shares have struggled to pull away from investors' takeout windows.
But with the spinoff's shares down 8% from its first day of trading and 21% from its November highs -- and with Tricon's tremendous cash flows intact -- a classic long-term value investment opportunity is emerging.
"Spinoffs are an inefficient way of distributing shares to the wrong people," according to Joel Greenblatt, hedge-fund manager and author of the intriguing 1997 book, "You Can Be A Stock Market Genius," which outlines a strategy for investing in spinoffs. "They are unwanted businesses, and most people just avoid them."
Value investors seeking mispriced assets have to like his implication -- an area of the stock market that tends to be priced inefficiently low and therefore can offer outsized returns to timely buyers.
According to a 1993 Journal of Financial Economics study, during the period 1963 to 1988, spinoffs as a group beat the market by 10% per year during their first three years, and a third were taken over within three years at a significant premium. The conclusion? Spinoffs create value.
And buying the best spinoffs at the right time can increase returns even more. "I only buy when the anvil falls on my head," says Greenblatt. And what qualities does Greenblatt suggest we look for in potential spinoff overachievers?
Company insiders want in. Top executives of the parent company should be itching to be involved with the spinoff and should have plenty of incentives. This appears to be the case with Tricon. Andrall Pearson, PepsiCo's chairman from 1971 to 1984 and the man who supervised PepsiCo's acquisition of Pizza Hut and Taco Bell, is coming out of retirement to be chief executive of Tricon. He has been granted 1,050,000 options to purchase Tricon stock in the low $30 range. The options vest over the next three years. Pearson also already owns 15,403 shares outright.
President and heir-apparent to the CEO spot is David Novak, 45, who is credited with turning a very troubled KFC around and is widely respected throughout the industry. Novak also has a significant options stake with strike prices in the low $30 range and owns a minor share position. The directors get annual grants of $50,000 in stock options as part of their compensation. Much press has been made about Pearson's search for a board; not a single person refused an offer.
Recently, filings with the U.S. Securities & Exchange Commission showed that three Tricon insiders bought 23,800 shares on the open market at an aggregate price of $724,269, or $30.43 per share, increasing their holdings 171%.
Institutions want out. It is debatable whether Tricon meets this criterion. Tricon is a member of the S&P 500 and is not small enough to be avoided on size alone. But quite a few heavy hitters came out early against the stock.
PepsiCo shareholder Mario Gabelli publicly announced that his firm had little confidence in the fast-food business. Large shareholder Lynch & Mayer also announced it would be dumping its Tricon shares. The reason? It had bought a beverage company, not a fast-food company -- a reflex dump.
A notable exception is Julian Robertson's $16 billion Tiger family of hedge funds, which disclosed it had acquired a huge 10.8% of Tricon as of Jan. 9. Given that Tiger was up 90% in the last 6 months of 1997, investors should not mind that kind of company. This mixed picture suggests that the shares may be subject to only mild additional selling pressure.
Valuable opportunity created or revealed. In Tricon's case, this takes the form of a leveraged low-risk/high-reward situation. Tricon, with a current market capitalization of just $4.1 billion, essentially bought itself by borrowing to pay $4.5 billion to PepsiCo, creating significant leverage.
This bank debt swelled Tricon's long-term debt to $4.7 billion and gives Tricon a negative shareholders' equity of $1 billion. Now that Tricon is publicly traded, it has already filed to sell $2 billion in senior debt, rated BB+ by Duff & Phelps Credit Rating, in order to pay down variable-rate term debt with fixed-rate notes. Interest rates are low, and Tricon could have picked a lot worse time to tap the capital markets.
Can Tricon go bankrupt? Not likely, according to Duff & Phelps. The central factor is that Tricon did not operate itself into either the negative equity or the long-term debt. On the contrary, cash flows from its refranchising program along with its operating cash flows should total in excess of $800 million for the full year, and at least that much annually for the foreseeable future. This is typical: Greenblatt points out that spinoffs are not often structured to fail.
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Comparison
Click the "Price Ratios" button
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<Picture>Tricon
<Picture>Wendy's
<Picture>McDonald's
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The largest near-term risk to buyers comes from weak shareholders.
What's the upside? Tricon trades at 0.46 times 1997 full-year sales with operating margins of 9.5%. McDonald's (MCD), with an operating margin of 20.4%, trades at a price-to-sales ratio of 2.91, and Wendy's (WEN), with a margin of 14.1%, gets a price-to-sales ratio of 1.32. Since absolute earnings are similar from both Tricon's franchised and company-owned stores, operating margins should improve as the refranchising program moves forward. If improving margins lead to the industry average price-to-sales ratio of 1.2, the upside is at least 159% -- no sales growth necessary.
Another valuation method commonly used in the restaurant industry is the price-to-EBITDA ratio. EBITDA is earnings before interest, income tax, depreciation and amortization -- a figure that can parallel cash flow. Tricon sells at a tiny ratio of 3.2, whereas McDonald's trades at a ratio of 9.6 and Wendy's trades at a ratio of 6.9.
Of course, Tricon's leveraged situation rightly lowers its EBITDA valuation. But the company says it plans to pay off its debt within five years out of operating cash flows and refranchising fees. As it does, this ratio should rise, and each full point rise in the ratio adds $8.36 to the Tricon's stock price. A move to Wendy's EBITDA valuation gives an upside of at least 120% -- no growth in net income necessary.
Note that these models depend solely on operating cash flows and refranchising operations, not necessarily growth. Of course, most analysts expect long-term revenue and net income growth in the 12%-to-15% range, which provides significant additional potential appreciation.
The largest near-term risk to buyers comes from weak shareholders. Tricon will report a loss on Feb. 13, when it takes a $525-million charge to restructure domestic Pizza Hut operations as well as to provide reserves for growth in international markets.
Before making a run for the broker, however, investors should understand the risks. After all, the bears can just as easily make a case for some short-term indigestion.
Duff & Phelps Credit Rating estimates that the $525 million will provide cash flow of up to $150 million during 1998 and thereafter. Nevertheless, negative earnings are rarely a cause for celebration in a momentum-driven market, and by definition there are no long-term Tricon shareholders yet.
"When spinoffs fall, they discourage a lot of believers," says Greenblatt. "It takes patience to see the rewards. It will take a while for the entrepreneurial actions to kick in."
"When spin-offs fall, they discourage a lot of believers."
-- Joel Greenblatt
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For more on investing in spinoffs, see our interview with Greenblatt: Sleuthing Out the Hiding Places
Moreover, the restaurant industry has been a severe underperformer, with five-year average earnings growth of just 7.4% trailing the Standard & Poor's 500 Index's 12.6%. Standard & Poor's January 1998 restaurant-industry report cites the "overstored" condition of the U.S. market as a prime reason that most future growth -- optimistically pegged by analysts at 21.6% annually over the next five years -- will necessarily come from international expansion.
The report also highlights fast food's growing pains as the U.S. population ages -- shifting the demographics away from the industry's core younger consumers. Again, this trend points to the critical nature of an international growth strategy -- a strategy Tricon's managers had, until recently, worked to perfection.
In fact, in recent years, overseas revenues of Tricon's component parts have compounded over 20% per year, while overseas profits have climbed greater than 30% per year, driving much of Tricon's growth. These gains are largely attributable to the international portability of the Pizza Hut and Kentucky Fried Chicken concepts. KFC has proven especially popular in China, where one KFC took in $48,000 in one day this past summer.
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These growth operations have now stumbled in the face of the Asian crisis. "We are getting hit," says Tricon's manager of shareholder relations, James Alderman. In particular, "Asia has been a huge growth area for us, and that may come down a bit."
But even as the dollar profits of Asian stores already in operation suffer, it becomes much cheaper to add additional units. Hence, over the long term, Tricon's proven concepts and relative financial strength should see it through to much stronger days in Asia -- at the expense of local rivals. "We will ride it out long-term," says Alderman.
It is a rare find, likely made possible by the post-spinoff status of the stock, when a stable of some of America's most enduring consumer franchises can be had for just over three times EBITDA and less than half of revenues. Patient investors looking for even cheaper prices may wish to wait out a potential string of bad news over the next six months or so, but investors hungry for value might find the current price tasty enough. |
