Monday, March 13, 2006

Double Trouble

You could say I'm addicted to my double-double from Tim Hortons' every morning. And you'd probably be right. But despite my predilection for Tim's own brand of hot, brown, sugar-water, I'm still shaking my head at the people clamoring over themselves to get in on the action when the iconic donut chain goes public in an IPO later this month. In bullet form, let me tell you why.

It's a growth story with nowhere else to grow

Yes, yes, we've all seen those lineups outside the stores at 8:45 every morning and thought "man, that place is just a license to print money" but honestly — I have my doubts. There are currently 2,886 Tim's franchises in Canada and the United States. That's a staggering amount — more than the Golden Arches, in fact. I would argue that if they haven't hit it yet, Tim's is very close to complete saturation point in Canada. Any more, and new locations are going to start competing with each other, something sure to anger the franchisees. Furthermore, I can't shake the feeling that the Tim's love affair might be coming to an end. In every industry, people fall in love with a sexy up and comer, before it reaches hegemonic status and people start to resent it for its success. The company launches an advertising blitz with all the newfound money, but overnight, people start to view the new kid on the block as being painfully lame and stuck in the past. They move on to the next big thing, and the stock suffers. It happened to McDonalds. It happened to Wal-Mart. It can happen to Tim's, even in Canada.

If Tim's has anywhere to grow — and that's a big if, IMHO — it's going to happen in the States. Indeed, even before the IPO talk, Wendy's management was talking publicly about wanting to double the number of U.S. Tim's locations by the end of 2007. Well, forgive me for being skeptical. Let's not forget that Tim's has already been in the USA for more than 20 years and they still haven't hit anywhere close to the brand recognition, let alone loyalty, that they have in Canada. We Canucks think drinking at Tim's is an act of patriotism. But Americans aren't seeing the same love story. The US has just as many devotees of Krispy Kreme and Dunkin Donuts as Canada has Timcoholics. And for people who actually like their coffee to taste like coffee, Starbucks enjoys much more loyalty. Although I'm told actual coffee aficionadoes are more prone to find their local independent java house and never leave.

The bottom line? Wendy's is spinning off Tim's at the perfect time, because they realize the chain is at its peak in terms of growth. They're eager to get their hands on the cash, so they can use it to shore up the problmes in their core burger business. I fully expect Tim's to continue to pump out nice, stable revenues for several years to come. But the market will view Tim's as a growth stock, and I'm not so sure that the explosive growth can continue. That's a concern for me. So is this:

The smart money isn't excited

Consider this. US hedge funds like Nelson Peltz' are the ones who pushed for this IPO in the first place, so they could "unlock value" in their sagging Wendy's shares. And despite the fact that Canadian retail investors are the ones most excited about the IPO, the vast, vast majority of shares are being sold through NY-based underwriters. I don't think that was an accident. That, to me, suggests that the institutional investors who will get first crack can't wait to flip their shares to mom and pop investors caught up in the hype. As usual, the big brokerage houses throw retail investors under the bus to make a buck. "Smart money" knows things we don't. Ron Joyce certainly does. He's the man who regrets selling the chain to Wendy's in the first place in 1995 for $600 million. But even he's now come out and said he's not interested in buying a stake at the prices being mentioned. Ron Joyce is one of the richest men in Canada — who am I to disagree with his instincts?

My gut suspects that in the hours, days and weeks that follow Tim's hitting the open market, the action will be fast and furious. Share prices will almost certainly soar well past the IPO price, and I wouldn't be surprised to see capital appreciation well into the double digits.

But ultimately, as Tim's inevitably has to stop the number of new franchises they open (or even, dare I say it, close some break-even U.S. locations) the never-ending growth story Joe Q. Average investor expected will stop, and he'll be crying into his double-double about why his can't-miss investment missed.

My bold-yet-completely-untechnical prediction? A year from now, Tim's shares will be trading at less than the IPO price. And that's when I'd consider buying in.

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