Description

Dreyers Grand Ice-Cream—(DRYR-- $77.55).

This is a very simple investment idea, ideal as a cash substitute, particularly for taxable entities—individuals, on-shore funds with mostly taxable investors, etc. Last year, Nestle acquired 2/3 of DRYR. The remaining shares trade publicly (there are 29mm not owned by Nestle) and with sufficient liquidity to accumulate whatever size position may be desired.

The short (as well as) long version of the story is that investors have the right to put the shares back to the company at $83 a share between December 1, 2005 and January 13, 2006. (There is an additional put period in April of 2006 at the same price). Nestle has unconditionally guaranteed the put. If the shares are not put back to the company, the Nestle can call them during the first ½ of ’07 at $88. As a practical matter, therefore, the shares will be put back to the company at $83 in two years. The company also pays a quarterly dividend of $.06/share.

In effect, this is a two-year piece of Nestle paper which compounds (including the dividend) at 3.8% gross. Nestle is a AAA credit, trading less than 30bp over the curve (which itself is trading at less than 2% ytm). What makes the paper more interesting as a cash substitute is that because the stock is equity with a long-term holding period, the return qualifies for long-term capital gains treatment. All in, with capital gains and dividend tax treatment, the after-tax return is roughly 2.8%. This roughly twice the after-tax return on comparable maturity T-Notes as well as a regular Nestle credit. This seems an attractive risk-reward. Of course, one can should one so desire short Nestle paper and create an arbitrage.

Finally, unless short rates are up a lot over the next year, the returns will likely be heavily weighted to the next 12 months. For example, if the ytm with one year to go goes down to 1.50%, the return over the next 12 months (and one day) will be north of 4% after tax.

Note: Since Nestle controls the business, they can report whatever economics they want... which is why the Nestle guarantee is so important.

Catalyst

two-year put, ride the yield curve if short rates do not back up.