Ashley Redmond: I’m Ashley Redmond for Morningstar.ca and I am on the line with analyst R.J. Hottovy to discuss the August 26 merger of Burger King and Tim Hortons, and what it really means for the iconic Canadian brand.
R.J., thanks so much for joining me.
R.J. Hottovy: Thanks, Ashley.
Redmond: So R.J., did you see this coming down the pipeline?
Hottovy: Frankly, no. This was a bit of surprise. We have seen a lot of M&A activity in the restaurant space over the last 12 to 18 months, but, frankly, this wasn't a deal that was on my radar screen.
And the thing, I think, that was most surprising is that it comes on the heels of Tim Hortons being a part of Wendy's for over 10 years from 1995 to 2006. So, it is surprising to see them take the plunge again with another North American quick service restaurant chain.
However, digging a little bit deeper, Burger King is a much more global chain than Wendy's, so it does seem to make some strategic sense.
Redmond: Okay. And Tim Hortons is the largest quick service restaurant in Canada and now together with Burger King, they are going to be the third largest in the world trailing behind McDonald's and Yum! Brands. So, R.J., can you explain how this move benefits Tim Hortons?
Hottovy: Sure. I think the important thing out of this deal is that, while a lot of the attention has been on the tax implications, I really do think that global unit expansion is the key priority behind this transaction. Burger King with its partnership with 3G Capital, a private equity firm, has a large pool of master franchisees that it can leverage to potentially make Tim Hortons a global brand. And much more so than what their previous international relationships were. And I think that's the primary motivator—to really turn Tim Hortons into a truly global brand.
I think that you'll see the companies prioritize Tim Hortons' expansion in Europe, potentially even Latin America and gradually Asia at some point, as well leveraging the franchise system that Burger King already has.
I also think that there are some shared services and best practices that the two companies can share between the two chains, and I think that eventually there will be a mild tax benefit out of this as well. You also get the benefit of 3G Capital being one of the best operators in the restaurant space. They've done a great job turning around the Burger King chain and they are really doing a great job on the cost cutting front there.
Redmond: We don’t often give restaurants an economic moat, but you gave Tim Hortons one, why is that?
Hottovy: Yeah, one of the things that we like about Tim Hortons and what we think makes it different, is that it has a number of things that we look for when assessing moats in the restaurant space; the first being an iconic brand that does command some pricing power. I think the Tim Hortons brand is pretty much known everywhere in Canada and I think that gives it a huge advantage in that region. I also think that it's a cohesive franchise system, so the franchises work very well with the Tim Hortons corporate entity and I think that's also a very powerful intangible asset.
On the cost side, with a heavily franchised model, the Tim Hortons model is very scalable and it does provide some cost advantages. So, I think the combination of all those things really is what sets it apart. It gives the company a lot of bargaining clout with its suppliers, whether it be food suppliers, landlords for prime real estate, or advertising entities and that helps it keep some really healthy profit margins.
Redmond: What's your current valuation of Tim Hortons?
Hottovy: We have a fair value estimate of $90 and US$82, which effectively is the offer price from Burger King. We do think that the deal has a strong probability of going through and so, as a result, we're going with the offer price on this one.
Redmond: Do you have any concerns about the merger or risk? Besides the fact that it may affect the taste of the coffee, which a lot of Canadians are worried about. But, any other risk?
Hottovy: No, and I think the companies are pretty adamant about keeping the brands and the customer-facing parts of the business very separate. I don't think you're going to see any material changes in the menu or in the coffee at the restaurants. I think Canadians can rest assured on that front.
The only risk I see is that there is still some headline risk with moving Burger King and the combined entity's headquarters to Canada. I think that there is some regulatory attention on that in the U.S., but I don't think it's enough to derail the deal.
As part of the deal as well, the company is going to take on quite a bit more debt, but I think the debt position they are taking on is manageable given that it is a highly franchised system. So, it's not something that I think is overly concerning, but those are still some risks that are involved with the deal.
Redmond: And the deal, when it does take place, is it at the end of 2015? Is that correct?
Hottovy: It will be either at the end of 2014 or early 2015, that’s when the deal would be expected to close.
Redmond: All right. We will be watching. Thanks so much, R.J.
Hottovy: Thank you.
