Tender Tim Hortons when the time comes

Tim Hortons, one of our Key stocks, has agreed to its acquisition by Burger King to form a new company. You’ll receive much more than Tim Hortons’ former market price. That’s why we advise you to tender your shares and cash in when the time comes. We now rate Tim Hortons a hold. Its share price surged after the proposed acquisition was unveiled.

You face three compensation choices for each of your Tim Hortons shares: cash of C$65.50 and 0.8025 shares of the new company; cash of C$88.50; or 3.0879 shares of the new company.

In practice, you’re certain to receive a combination of cash and shares. That’s because most shareholders will pick the most profitable option when the time comes to choose. With limits on the cash and the number of shares of the new company, shareholders will receive cash and shares on a pro rata basis. Burger King will use $12.5 billion to fund the cash portion of the transaction.

The price of Tim Hortons has soared

Based on Burger King’s closing share price on August 22, the offer was initially worth C$89.32 for each of your Tim Hortons shares. That was 39 per cent above Tim Hortons share price in the 30 days through August 22. The thing is, Burger King’s shares jumped when the transaction was announced. This raised the value of your Tim Hortons shares. The companies write “based on Burger King’s closing stock price as of August 25, 2014, this represents total value per Tim Hortons share of C$94.05″. The value of Tim Hortons shares will now rise and fall with Burger King’s share price. Burger King’s shares will get converted into 0.99 of a share of the company and 0.01 of a unit of a wholly-owned limited partnership.

Tim Hortons shares now trade at a premium of over 41 per cent of their former stock market price. This offer is too good to refuse. As a result, you should vote to support the transaction. Just remember that it’s expected to give rise to capital gains taxes.

The new company will become the world’s third-largest quick-service restaurant company—and the largest in Canada. It will operate over 18,000 restaurants in 100 countries. The new company currently generates system sales of US$23 billion a year. Even so, our first impression of the new company leaves us unenthusiastic about its long-term outlook. There are five reasons for our lack of enthusiasm.

First, Tim Hortons and Burger King will operate as stand-alone companies. We don’t see Tim Hortons offering its customers Burger King’s ‘whopper’ burgers. Burger King could benefit from offering Tim’s coffee to its customers. But this benefit is small relative to the size of the proposed acquisition.

Second, the new company aims to share corporate services. For instance, they could merge certain departments, such as investor relations. But as stand-alone companies, we see comparatively limited benefits from sharing corporate services.

Third, the new company expects to profit from sharing best practices. That is, if one does something much better than the other, then it can transfer this ‘best practice’ to the other. But there’s likely little scope to improve greatly on their existing practices. Both Tim Hortons and Burger King are already successful in the quick-service restaurant industry.

Tim Hortons is largely unknown abroad

Fourth, international expansion plans for Tim Hortons may prove difficult. President and chief executive officer Marc Caira says “this transaction will enable us to move more quickly and efficiently to bring Tim Hortons iconic Canadian brand to a new global customer base.” The trouble is, Tim Hortons is little known outside of Canada—where it has 4,546 restaurants.

True, Tim Hortons operates 866 restaurants in the U.S. and 50 in the Gulf Cooperation Council (the Middle East). But it’s largely unknown in Europe, the Asia-Pacific region, Latin America and Africa. Would Pakistanis, for instance, identify with coffee shops started by a Canadian hockey player? They would likely identify more with a Pakistani cricket player. As Target Corp.’s troubles in Canada show, a strong player at home can stumble abroad.

Tax inversion creates anger and bad will

Fifth, one benefit for Burger King is that it may lower its income tax bill. When it comes to companies, Canadian income taxes are significantly lower than corporate taxes in the United States. In addition, Canada doesn’t tax foreign earnings, while the U.S. does. But this ‘tax inversion’ creates bad will in the U.S. In fact, some politicians south of the border have called upon all Americans to boycott ‘unpatriotic’ Burger King. This could reduce the growth of its sales.

For these reasons, there are risks to the new company’s medium- and long-term prospects. Also, 3G Capital will own 51 per cent of the shares. We hope that it doesn’t use its controlling stake to implement poor business decisions. Just how much does it know about selling hamburgers and coffee?

Our inclination is to sell the shares of the new company and reinvest the profits elsewhere. But we’ll examine the formal proposal when it becomes available. If you own Tim Hortons shares, the companies will mail you an information circular with all the details of the proposed transaction.

The acquisition of Tim Hortons requires some approvals. Finance Minister Joe Oliver said, “This is an acquisition which will be evaluated by Investment Canada to determine whether it’s a net benefit to the country.” We believe that the government will view the plan to greatly expand Tim Hortons’ overseas operations as a net benefit. After all, there’s often moaning about too few Canadian champions in global markets.

The transaction will also require the approval of the shareholders of Tim Hortons. We think that the shareholders will approve it. For one thing, Tim Hortons’ directors unanimously approved it. For another, the high price is attractive. You should approve it too.

Hold Tim Hortons Inc. (Quality rating: Very Conservative; Sector: Consumer; TSX—THI) and tender to cash in when the time comes. If you choose to sell your shares in the new company, you’ll be able to do so in both New York and Toronto.

Was there some sour cream in this double double?

Insider trading means trading with important knowledge that the public does not have. It’s illegal. That’s because it gives an unfair advantage to those who are privy to news that is likely to move share prices.

However, insider trading can be highly profitable. As a result, some succumb to the temptation to take advantage of important, hidden news. Consider Tim Hortons.

When we published our August 1 Investment Planning Guide, Tim Hortons traded at $59.64 a share. By Friday August 22, the shares were up by 15.3 per cent, to $68.78 a share. This told us that something was up. Sure enough, Tim Hortons later announced that it was in takeover negotiations with Burger King.

The fact that Tim Hortons shares rose sharply over a short period suggests that some may have engaged in insider trading. It’s unlikely that that many investors were simply lucky.



The Investment Reporter, MPL Communications Inc.
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