In a February article on Tim Hortons (THI) when the stock was at C$56.00, I stated that the stock was undervalued because investors were not pricing its future earnings power correctly and doubted its ability to grow. In the Q2 earnings report this month, Tim Hortons demonstrated its strong organic growth capability through new menu offerings and the shares soared to C$68.00. Now, with the Burger King (BKW) deal, the shares are rising near C$90.00.
Implications of the Deal:
In a press statement this morning:
Under the terms of the transaction, which has been unanimously approved by the Board of Directors of both companies, Tim Hortons shareholders will receive C$65.50 in cash and 0.8025 common shares of the new company per Tim Hortons share. Based on Burger King's unaffected closing stock price as of August 22, 2014, this represents total value per Tim Hortons share of C$89.32 and 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. As an alternative to the default mixed transaction consideration described above, each Tim Hortons shareholder will have the ability to elect to instead receive, for each Tim Hortons share held, either (NYSE:I) C$88.50 in cash; or (ii) 3.0879 common shares of the new company, in each case subject to pro ration.
There are three payment options for Tim Hortons' shareholder. The all-cash offer is effectively a put option on the stock at C$88.50, which is extremely attractive when the shares are now trading near C$89.00 after the press statement is released. The all-share offer and the cash and share offer provide a very cheap call option on Burger King stock, which impacts the value of the share payments. Therefore, with a put option at C$88.50 and assuming the deal goes through, shareholders should hold onto the stock.
The deal is unlikely to face significant regulatory hurdles. On the Canadian side, the combined company is moving the headquarters to Canada and it'll remain listed on the TSX. The US regulators may scrutinize the tax aspects, but congress may not get its act in time to prevent the transaction from not going through. With mid-term elections around the corner, congress is unlikely to pass any tax related bills. Finally, the financing aspect of the deal is solid. Even Warren Buffett is committing $3 billion of capital to finance this deal, believing the deal will probably pass. The press release had the following statement on financing:
Burger King has obtained commitments for $12.5 billion of financing to fund the cash portion of the transaction, including commitments for a $9.5 billion debt financing package led by JPMorgan and Wells Fargo. The obligation of JPMorgan and Wells Fargo to provide this committed debt financing is subject to a number of customary conditions, including execution and delivery of certain definitive documentation. It is expected that the debt financing for the transaction will consist of a $6.75 billion senior secured term loan B facility, a $500 million senior secured revolving credit facility and senior secured second-lien notes in the amount of $2.25 billion.
Berkshire Hathaway has committed $3 billion of preferred equity financing. Berkshire is simply a financing source and will not have any participation in the management and operation of the business.
Merger Arbitrage View:
Because there are two share payment options, I have listed the scenarios in figure 1 below. Arbitragers should execute the one with higher return, which is the all-share option at the moment. Investors could achieve a 20%+ annualized return if they arbitrage the all-share offer and assuming the deal closes in 6 months or less.
Figure 1: Merger Arbitrage Payout Calculations
Note: Numbers updated as of August 29, 2014
There are some currency risks, as the Tim Hortons' deal is priced in Canadian dollars, while Burger King's shares are priced in US dollars. Also, the transaction is being taxed as explained in the press release:
The transaction is expected to be taxable, for U.S. federal income tax purposes, to the shareholders of Burger King, other than with respect to the partnership units received by them in the transaction. The transaction is expected to be taxable to shareholders of Tim Hortons in the U.S. and Canada.
This deal is a win-win situation for both parties. The transaction is likely to go through and Tim Hortons' shareholders should hold on to their stock for now for a better price realization. There is also an opportunity to conduct a merger arbitrage play if Tim Hortons' share price is near or below C$89.00.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. The stock mentioned in this article does not represent financial advice. Investors are recommended to conduct further due diligence before committing capital to any investment.