Davco's Unusual Security Takes Its Cues From Canada
By Terence O'Hara
Monday, July 19, 2004; Page E01
The country's largest franchisee of Wendy's restaurants, Maryland's Davco Restaurants, plans to go public this year by issuing an exotic, new type of security -- if the Securities and Exchange Commission allows it.
Davco, which is mostly owned by a Citigroup Inc. merchant bank, wants to issue $160 million in "enhanced income securities," or EIS, a hybrid of debt and equity. Davco is one of more than a dozen companies trying to issue EIS's, and investment bankers are watching closely to see how the SEC views the new securities. Davco first sought registration of its EIS issue in April, but SEC approval has been slow in coming as the agency's corporate finance staff picks apart the structure's implications for investors and to determine what would be adequate disclosures in Davco's prospectus.
Davco -- its formal name is Davco Acquisition Holding Inc. -- is based in Crofton and for more than a decade has been one of the five biggest fast-food franchisees in the nation. It opened its first Wendy's in 1976, making it one of the oldest Wendy's International Inc. outlets. Davco now has 153 hamburger joints from Northern Virginia to Baltimore and some on Maryland's Eastern Shore.
Davco's restaurants sell more than $200 million a year in sandwiches, fries, chili and Frosties.
Company officials did not respond to several phone calls and e-mails requesting comment. It is rare for companies in the SEC registration process to comment outside their company's SEC filings, from which comes all of the information you read here about the company and this complex deal. RBC Capital Markets is the lead underwriter, with Key Banc Capital Markets, Oppenheimer & Co. and SunTrust Robinson Humphrey backing up.
Enhanced income securities, which are also being sold under the name "income deposit securities," combine features of both stocks and bonds, with potential for capital appreciation as well as dividend and interest payments. They sound good at first blush, but the tax implications are maddeningly complicated. They are based on the hugely popular income trusts sold in Canada.
Last year about two-thirds of all corporate equity issued in Canada were sold in the form of income deposit securities, according to Bloomberg News. RBC, Davco's lead underwriter, is a unit of Royal Bank of Canada, and happens to own the trademark on "enhanced income security," which has the benefit of sounding more remunerative than "income deposit security." CIBC, a unit of the Canadian Imperial Bank of Commerce, is a lead underwriter in a number of other pending IDS issues in the United States. You get the picture: This is an import from the north.
For Davco, each new EIS will represent one share of Class A common stock and a bond whose principal amount and interest rate has yet to be set by the company. The bond part of the EIS will pay quarterly interest, and the company indicated it plans to pay dividends on the equity portion of the EIS. One nifty part: An owner of an EIS can, 45 days after the thing is issued, split it apart into a separate stock and bond, and sell one or the other. The stock and bond can also be combined back into an EIS. As to why you would do this, consult your team of tax lawyers.
For Davco, there is the added wrinkle of Citicorp Venture Capital, which financed a 1998 transaction that converted Davco from a publicly traded company into a private one. The entire deal appears to be a way for Citicorp to begin cashing out.
Citicorp owns more than 90 percent of the company, while senior Davco management, led by long-time chief executive Ronald D. Kirstien, own the rest. Kirstien and senior vice president Harvey Rothstein bought the original Maryland Wendy's franchise in 1987 from Davco's previous owners. That 1987 deal was financed by, you guessed it, Citicorp. The company went public in 1993, and was traded on Nasdaq for just five years. It will be listed on the American Stock Exchange this time, under "DVC."
Citicorp and the management investors will own all of a new Class B stock after the deal is done. That Class B stock can be converted into an EIS stock a year after the EIS offering.
Of the $161 million in cash expected to be raised, only $3 million of it will go toward upgrading some newly acquired Wendy's restaurants. The rest will go to pay down loans from Global Alliance Finance, CNL Financial Services and SunTrust Banks and buy back Class B shares from Citicorp. Citicorp also gets "registration rights" such that Davco will register any blocks of stock Citicorp wants to sell with the SEC as an underwritten stock offering, with the transaction costs paid for by Davco.
Citicorp and senior management will still control two of Davco's five board seats.
Davco has $124 million in long-term debt on its books left over from previous expansions and recapitalizations; that interest and accrued dividends to Citicorp eat away at net income. Operationally, though, the company has been profitable and generating more than enough cash to pay its debt.
So when will the deal get done? Bloomberg News gave a clue as to the holdup in late June: SEC lawyers are concerned about how the companies are estimating dividends.
"The SEC is continuing to look at this through new-product goggles," New York-based attorney Richard G. Willoughby of Torys LLP, the law firm hired by Davco for the deal, told Bloomberg.
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