A&W Revenue Royalties Income Fund (AW.UN) is one of the many unique companies that 5i Research covers while also being included in our Income Model Portfolio. We initiated coverage in 2017, finding the stock attractive due to its strong fundamentals and high yield. The corporate structure is quite interesting, where AW.UN generates revenue through licensing their trademark to A&W restaurants within their royalty pool. AW.UN is entitled to 3% royalties on the gross sales reported by the 1,047 A&W restaurants in the Royalty Pool through a partnership with A&W Food Services of Canada. AW.UN’s stock has recently jumped over 20% on news that AW.UN and A&W Food Services were merging together in a strategic combination to form a single publicly traded entity. There are a number of moving parts in the transaction, and we will explore the terms of the agreement here.

Overview:

Under the proposed merger, a new company with a more simplified structure will be created that will be operate similarly to other publicly traded quick-service restaurants (QSRs). These new shares referred to as A&W Food Services NewCo will be a more growth focused QSR, while quarterly dividends are expected to be paid at the same annualized rate as the current monthly distribution for AW.UN at $1.92. The transaction provides numerous benefits to the company and shareholder including: exposure to the performance of the entirety of the business, increased potential for share price appreciation, better liquidity, and greater financial flexibility. The transaction is expected to be closed in October 2024.

Terms of the Transaction: 

AW.UN unitholders are being offered two options as a result of the transaction:

1. Become a shareholder in the NewCo and have units of AW.UN exchanged on a 1:1 basis, OR
2. Receive $37.00 in cash for each AW.UN unit currently held (this was a 30% premium on at the time of announcement)

While this seems like a simple offer, there is a caveat related to option two. The option is subject to proration, where if the total cash elected by all unitholders is less than or exceeds $175.6 million, the cash distribution is prorated so that only ~32.5% of the outstanding units are purchased for cash at $37.00 per unit. 

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To put it in simpler terms, the $175.6 million in cash being used to purchase units of AW.UN is fixed no matter how many shareholders exercise this option. The fixed number of units that will be exercised at $37.00 is 4,746,582 ($37 x 4,746,582 units=$175.6 million cash). Below we will look at what the ‘too few’ or ‘too many’ part of the transaction refers to:

• Too Few unitholders exercise the cash option. In this case, investors who elected to receive shares will have their shares exchanged for cash on a pro-rata basis. Cash electing unitholders will not be impacted and will receive $37.00 per share.
• Too many unitholders exercise the cash option. In this case, investors who elected to receive cash will receive a mix of cash and shares allocated on a pro-rata basis. Ex. If every unitholder were to elect the cash option, then theoretically, only 32.5% of units would receive cash and the remaining would be converted into shares.

This caveat is not necessarily a risk to the transaction, but it is important to know when the deal closes, as the outcome of what an investor initially tendered may change based on what all shareholders elect to do with their shares.

5i’s Thoughts

The decision to tender cash or shares really depends on ones needs. If an investor is seeking income, then tendering cash makes sense. If one is confident in the company and likes the growth prospects and flexibility of the combined business, then tendering shares would be the play. We think the new structure is a long-awaited cleanup for the A&W corporation and that the NewCo will be able to pursue growth more easily, while still offering an attractive dividend. We feel that for investors that liked the name before, that the new company should be even more attractive now. Even with the caveat of proration, we think the option between cash or new shares is a win-win for investors.

Take Care,