The finance world (and fast-food fans) is abuzz with the recent news of merger talks between Burger King and Tim Hortons. Burger King (BKW) and Tim Hortons (THI) confirmed on Sunday that they were discussing the potential of forming a holding corporation headquartered out of Canada that would be majority owned by 3G Capital. Both BK and Timmies would continue to operate as their own entities with the primary motivation being cited as tax savings on behalf of Burger King -- tax inversion has been a hot topic recently. So what exactly is a tax inversion?
In short, a tax inversion is a strategy whereby a company operating in an unfavorable tax jurisdiction merges with a company operating in a more favorable jurisdiction and establishes its headquarters there in an effort to save on taxes paid and in turn to have more funds available to return to shareholders. The reason the US is seeing a lot of inversions currently is that the States attempt to tax US companies on profits earned globally, leading to double taxation (by the states on international profits repatriated as well as by the country that the company earned those profits in initially). Canada only taxes domestic profits. One can imagine how this cost would add up for international companies with global operations and profits from foreign markets that are only expected to rise over time; but how much money are we talking about here?
The Whopper of tax savings:
If we look at the 2013 geographic breakdown of EBITDA for Burger King, we see that 52% of EBITDA comes from regions outside of Canada and the US (Canada and the States are shown as one). If we assume that this allocation of EBITDA works its way down to net income of $233.7MM we would expect $121.8MM of foreign profits to be taxed again at the US rate of 35% which amounts to $42.6MM in avoidable taxes. This number could be even higher given that it does not include Canadian profits being repatriated. While it is a rough calculation, it is a big number regardless and an ‘easy’ way to save money that is tough to ignore. There is a clear benefit to Burger King but what about Tim Hortons?
Would you like fries with that coffee?
Markets are liking the news with Tim Hortons, a company covered by 5i Research, up around 19% at the time of writing. While Tim Hortons has a great brand and foothold in Canada, it has struggled to gain acceptance in the States. A tie-up with Burger King could provide THI with the necessary management team and insight into the fiercely competitive US markets. The growth picture of THI could change greatly if they were able to unlock growth in the US. It is not hard to imagine a ‘mini-timmies’ being tacked on to Burger King locations across the US or added synergies through distributing THI coffee to all BK locations in an effort to strengthen Burger King's breakfast offering. Each company has what the other wants. Tim Hortons is trying to grow out of the breakfast niche and have a more well-rounded food offering which Burger King can likely help with. Burger King would benefit from a stronger breakfast offering to compete with companies like McDonalds. This is an area where THI can lend some expertise. A merger is an interesting notion and we think there is more to it than simply tax savings but do some risks remain?
High cholesterol and coffee jitters:
Aside from the risks of consuming too much of the food from both companies, there is some regulatory risk here as the President of the US has come out fairly strongly against the idea of tax inversions. Governments could go out of their way to make an example out of Burger King to ensure companies think twice before going this route. Another risk is that a deal simply does not come to fruition as things appear to be preliminary at this stage and a lot can still happen behind closed doors.
The news is interesting and rather surprising but it is pretty easy to see how both companies may benefit from such a transaction. We think a deal is still far from a sure thing and details are fairly limited at this point but the prospects of a burger/donut hybrid sandwich is enough to get anyone excited.