Burger King And Tim Hortons: If You Can't Beat Them, Join Them

| About: Restaurant Brands (QSR)


BKW and THI confirmed that they are in discussion for a potential merger.

Tax-saving may not be the entire story behind HQ relocation. Appeasing Canadian regulators could be the bigger factor.

Immediate synergy in shared expertise in BKW gains breakfast expertise from THI and THI can leverage BKW for global expansion.

In response to a report in Wall Street Journal, Tim Hortons (THI) and Burger King (BKW) confirmed Sunday evening that they are in discussion regarding a potential acquisition of THI by BKW. Under the expected terms of the deal, BKW would create a new public-listed company that houses both brands, which will continue to operate independently. The new company will also be headquartered in Canada. 3G Capital, majority owner of BKW, will continue to be the majority owner of the combined company on a pro forma basis, with the remaining shares owned by shareholders of BKW and THI. If approved, the combined entity could leverage BKW's international footprint to expand THI's global presence. The combined entity could also become a competitive force in the North American QSR space by leveraging each other's scale and R&D.

Tax saving may not be the whole story

The deal could be considered a corporate inversion in which an American company acquires a foreign company and re-domicile outside of the US with the goal of lowering the overall tax bill. This type of deal is beginning to gain popularity as we have seen in the Pfizer (NYSE:PFE)-AstraZeneca (NYSE:AZN) deal (however, it was terminated earlier this year due to price).

Currently, the US corporate tax rate stands at ~35% while Canadian corporate tax rate is ~15%, so one could argue that the main motive behind the merger is tax saving. In my view, BKW's tax rate is already at 27% so relocating to Canada could lower the overall rate to 23-25%, which is not significant enough to pursue such acquisition in the face of the US regulators that are increasingly against corporate inversion because it lowers the US tax revenue. Moreover, BKW does not have large overseas cash holdings so relocating to Canada to save on taxes makes little sense in that companies usually pursue corporate inversion to access their overseas cash without paying the US tax rate.

The real reason for such move, I suspect, is to appease the Canadian regulators given THI's iconic symbol as a Canadian QSR chain that has withstood the US invasion led by McDonald's (NYSE:MCD) and Starbucks (NASDAQ:SBUX) in the breakfast vertical. Under the Investment Canada Act, any acquisition of a Canadian company must pass the "net benefit" test in which the deal should be accretive to the economic growth and employment opportunities in Canada. Moving the corporate HQ to Canada could create additional jobs in both the corporate and the supply chain level, and allowing THI to remain a Canadian brand could also appease the Canadian regulators in that the chain's Canadian root will not be altered.

Scale, distribution and R&D are part of the story

The combined entity could benefit from the increased scale, supply chain integration and shared R&D on menu innovation, and I see these factors are the key drivers behind the deal. On the breakfast front, THI may have done well holding off MCD and SBUX in Canada (partially thanks to the Canadian pride), but the company is facing challenges in expanding beyond the Canadian border in that the US breakfast space is heavily dominated by Dunkin' Brands (NASDAQ:DNKN) and MCD. On the lunch and dinner front, BKW is facing a tougher comp globally against not only MCD but also YUM Brands (NYSE:YUM) and Wendy's (NYSE:WEN), as well as other fast-casual QSRs. Each brand has their own expertise with THI mostly focused on breakfast while BKW mostly focused on lunch and dinner, so the merger could result in synergy in terms of menu innovation and shared supply chain to quickly introduce new products to markets.

The benefit for BKW is that the brand could gain more expertise in the breakfast segment to become more competitive against MCD and SBUX in North America. I note that 3G Capital has been aggressive on making BKW to focus more on breakfast since taking over. Acquiring THI's expertise could mean more coffee varieties and the potential expansion of baked goods category. As for THI, menu innovation is more of a secondary motive for the merger, in my view, and the real benefit lies in the potential international expansion of the THI brand beyond Canada in places such as Asia, where BKW already has an established brand and commands a degree of popularity.

Given that the baked goods breakfast market is not highly saturated in Asia, THI could find a niche in the region and be on equal footing with DNKN in terms of market share. The key is to understanding local taste/preference and I think this is where BKW's local expertise comes in, given that BKW has historically altered its menu to cater to the local taste. Finally, a rebranding campaign may be necessary for THI in Asia in that the local consumers' connection with THI may not be as same as the one with local Canadians. I note that Couche-Tard, a Canadian convenient store chain, rebranded itself with "Circle K" in Asia and it has proven to be effective.

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