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Summary

  • Burger King is set to purchase Tim Hortons in a deal worth over $11 billion. The deal will combine the two entities into the third largest quick service restaurant worldwide.
  • Such a deal would allow Burger King to move its headquarters to Canada and enjoy tax savings, as well as free up shares and introduce synergetic savings.
  • Shares in both Burger King and Tim Hortons swelled over 19% in trading the day news of the deal broke. Buy in once they contract for a long position.

Burger King (BKW) is going to buy Canadian coffee and doughnut chain Tim Hortons (THI) for just over $11 billion. Under the terms of the takeover, Burger King would acquire Canadian coffee and doughnut chain Tim Hortons (affectionately known as "Timmy's") and together form the third largest quick service restaurant provider in the world, with a total worth of about $18 billion and roughly $23 billion in system sales.. The combined operations would be headquartered in Canada.

INVESTMENT THESIS

Burger King and Tim Horton may seem like unlikely partners but a merger of the two companies would mean a range of benefits for both brands, as well as shareholders. When the news broke initially the share price of both Burger King and Tim Hortons has skyrocketed, rising 19%, but the market is already starting to correct. Burger King soared from roughly $27 per share before the deal was announced to spike at $33.65 before settling around $30, while Tim Hortons went from just under $63 per share to almost $82 in just two days. The stock is currently at just under $80 per share. Buying into a long position as the market corrects would be good timing.

TAX INVERSION, REALLY?

Tax inversion is one imagined benefit of the deal but as the New York Times points out, in reality that may not be much of a factor. Companies had been known to try to relocate its headquarters outside of the US in order to gain access to overseas cash without being hit by a big tax bill in the States - but Burger King doesn't have a great deal of cash overseas.

In addition, companies pursuing inversion often do so to avoid paying the corporate tax rate of 35%. In this case, Burger King moving its headquarters to Canada would allow the company to take advantage of Canada's 15% corporate tax rate but the savings would not be that much. According to Burger King's 2013 annual report, its effective tax rate has been increasing for the past few years - going from 23% in 2011 to 27.5% in 2013 - but the savings may not be significant enough to warrant tax inversion.

Moreover, consider the breakdown after the merger is finalized. "The combined Burger King-Tim Hortons will generate just 20% of its revenue in the U.S. and 67% of it from Canada. So, a company making most of its money from Canada is going to be domiciled in Canada. It's a loss for the U.S. Treasury - America will no longer collect taxes on overseas Burger Kings - but it doesn't sound like grounds for a boycott," explains Marketwatch. In other words, this isn't tax inversion.

OPPORTUNITIES FOR SHAREHOLDERS

Gordon Haskett analyst Don Bilson is among the analysts who think that Burger King's takeover of Tim Hortons may be related to the fact that 3G Capital Management owns 69% of the stock in Burger King, while another 12% is owned by Bill Ackman's Pershing Square Capital Management. The combination means that there is not many shares available to the public. This limits Burger King's ability to become "a household name among big institutional investors."

In order for the tax inversion to take place, at least 20% of the combined company's stock must be held by the new foreign holders. This would create a "deeper trading pool that could help 3Q sell down in the future." 3G plans to remain majority shareholder for now, but it could make things interesting later.

BREAKFAST RISING

Of course, the gains for Burger King could be much simpler - breakfast.

NPD Group reported earlier this year that morning meals account for roughly 21% of restaurant traffic - and fast food breakfast is growing by leaps and bounds. Quick serve breakfast showed a 3% increase in the year ending December 2013 - marking its fourth consecutive rise - while quick serve lunch and dinner each declined by 1%.

But Burger King hasn't seen those gains. The company's revenue slipped 6% in the second quarter and realized only a marginal 1% increase in same store sales in the US and Canada while industry-wide fast food sales in the US rose 0.7% last year, adding to gains of 0.8% the year before.

In addition, while Burger King and Tim Hortons had said that the two would maintain separate brands in the event of a takeover, that doesn't preclude Burger King from selling Tim Hortons branded goods.

COULD TIM HORTONS BE SERVED AT BURGER KING?

Burger King could leverage economies of scale and offer many of the same items Tom Horton does. Obviously this may not work for things like doughnuts (incorporating the display case alone would prove difficult) but Tim Hortons breakfast sandwiches, iced drinks, muffins, soups, wraps, and paninis could gain ground - and of course there is the coffee.

Burger King has struggled with this. According to University at Buffalo's School of Management marketing professor Arun Jain, "the smartest, easiest, quickest thing they could do would be to serve Tim Hortons coffee. Coffee is something Burger King has been missing." Jain continued by noting that while Burger King has struggled to gain a foothold with its breakfast items and specialty coffee drinks, Tim Hortons has made strong moves to boost its traditionally morning focused traffic to beyond peak hours. Maybe Timmy's can teach Burger King a thing or two?

OPPORTUNITIES FOR TIMMY'S

A Burger King takeover of Tim Hortons would provide certain benefits for Timmy's as well. Burger King may be able to help Tim Hortons continue its expansion into non-breakfast items while the ubiquitous Canadian coffee chain benefits from Burger King's distribution network and its international experience. Tim Hortons is famous in Canada - eight out 10 cups of coffee sold in Canada are from Tim Hortons - but it's been slow to reach outside its home market.

The New York Times puts Tim Hortons market penetration into perspective, "On a per capita basis,[the company's] 3,630 outlets in Canada would be about 36,000 shops in the United States, just over double the 14,700 McDonald's has in its home market." Obviously, the place is well-liked but it has few locations outside Canada and even fewer outside areas that border Canada. Burger King can help with that.

Burger King can also help Tim Hortons push past breakfast and move into offering more hot sandwiches or adding burgers. In turn, this could lead procurement savings. Of course, the value of economies of scale will vary depending on how much the menus of each respective brand are integrated into one another, but there will surely be some cost savings due to overlap.

TAKEAWAY

Burger King's takeover of Tim Hortons makes sense on several levels. There is the tax inversion, the opening up of stakeholder equity, more menu variety, and better coffee for Burger King while Tim Hortons gets help with international expansion and possibly evening menu options. Expect some sell-off as the market corrects - those are large gains to sustain - but when the contraction happens it would be a good time to open a long-term position.