Winmark Corp: A Highly Accretive Tender Offer Has Created A Buying Opportunity
|April 16, 2015||Posted by Nat Stewart under Compounding Machines||
Solid operating performance + massively accretive buyback = opportunity
This article will be tightly focused on the opportunity that I currently believe exists in Winmark Corp. (WINA) shares. Readers who are unfamiliar with the company should read this article first, as it provides a broad overview of the company and its history.
Yesterday, (April 15th 2015) Winmark Corp. announced excellent first quarter results, with earnings up around 33% vs. the same quarter last year. This alone would have been good news. However, concurrent with the earnings release, Winmark Corp. announced a tender offer for 875,000 of its shares at $84.72– this is equal to 17% of the company’s outstanding shares! To say that this is significant is an understatement.
The rationale was stated as follows:
“The Board of Directors determined that it is in the Company’s and shareholders best interest to repurchase shares at this time given the Company’s financial performance, its access to attractive debt capital, the relatively illiquid trading market for the Company’s common stock and desire by its largest shareholder to obtain liquidity for a portion of his holdings for estate planning purposes.”
I believe that this situation (when combined with the strong operating performance) has created an excellent and timely opportunity to purchase shares in Winmark Corp.
Most investors, on seeing the tender offer price, would assume that $84.72 reflects “fair value” for the shares – After all, why else would the CEO agree to sell such a large amount at this level? I have a different perspective.
Having followed this company for years, my belief is that CEO and Majority shareholder John Morgan is an extraordinarily fair person. My insight is that while Morgan certainly wants a fair price, he can be expected (based upon history) to act in a way that will benefit all shareholders to an extent that is not initially obvious.
The SEC filing for the tender offer states that CEO and Majority shareholder John Morgan is tendering 1,666,378 shares, and two other directors are tendering a combined 192,000 shares. This means that if no external stockholders participate in the tender offer, the 875,000 shares will still be purchased, and Morgan will still own around 22% of the company. Significantly, no executives (A number of whom have very significant stockholdings relative to their incomes) beyond Morgan will be tendering any of their shares. As you will discover in just a moment, these executives made a very wise decision – their share-based wealth should increase substantially over the next few years.
The buyback will be funded by both a Credit facility and a term loan that amortizes over 10 years. The initial weighted average interest rate (from the tender offer statement, my weighted average calculation was a bit lower) will be 4.26%. It should be noted that Winmark Corp. has a high effective tax rate of about 38.5%. After taking the tax shield impact of interest into account, the effective interest rate drops to only 2.6%. Conceptually, this transaction is accretive because it replaces relatively high cost equity with much lower cost debt financing.
Let’s do a few “back of the envelope” calculations. Please examine the following table:
My estimate for 2015 EBIT is around $37.5 million. While earnings were up a 33% this quarter, the income booked from the leasing business is somewhat lumpy and I believe above trend this quarter – a 15% growth rate is a more reasonable figure given the characteristics of this business. Interest expense due to the buyback financing will be around 3.2 million, and income taxes should be around 13.2million.
This leaves net income of around 21.1 Million for 2015, up only slightly (relative to EBIT income growth) do to the increased interest expense. However, the trick is that this income will apply to a much smaller number of shares. EPS for 2014 was 3.85 per share. I estimate that without the buyback, Winmark Corp. would have earned about $4.60 per share in 2015. With the tender offer, I estimate that Winmark Corp. will earn around $5.12 per share – a .51 cent per share increase. If we capitalize this per-share increase at 20 times earnings, we find that it is worth $10.16 per share. Even if my numbers are not perfect (and I am sure that they are not) this transaction should prove to be highly accretive to continuing Winmark Corp. Shareholders.
A note about how to value this company
Winmark Corp. is an asset light, high ROIC business – a type of business that Warren Buffett has made famous with his “See’s Candy” example. This is not the type of company that should be valued based upon book value metrics – attempting to do so will only lead to confusion. A solid article that applies this concept to Winmark Corp. can be found here.
I believe that once the impact of the tender offer and continued growth are factored in, the fair value for Winmark Corp. is around $100 per share vs. the current share price of $86 per share. I get this number by capitalizing my estimate of 2015 earnings ($5 per share) at a 20 multiple, which I view as reasonable given this business’s quality and management’s track record. Note, this is not a price target – this my fair value estimate at this moment in time – meaning that I believe a purchase at any price below this level should be viewed as reasonable (Though a larger discount is always better than a smaller discount). Looking out one year, my fair value target is $115 per share, or 33% above the current market price.