On Friday night before the Labor Day long weekend, Burger King filed an interesting 8-K that contains details on the transaction with Tim Hortons.
Further details in the 8-K include descriptions on the termination fees, the regulatory hurdles and more color on Buffett's involvement. These information should boost investor confidence in the deal.
With three payout options for Tim Hortons' shareholders, they should achieve a better realization than the current market price of C$87.40.
Last week, I wrote an article that analyzed the Burger King (BKW) and Tim Hortons (THI) deal. I concluded by saying:
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.
It is interesting to note that Tim Hortons' share price has fallen to C$87.40. Nonetheless, new details emerged Friday night that provided further details that should make investors more confident on the deal.
Details on the Payout Structure:
The 8-K confirmed the payout structure in Tuesday's press release. There will be 3 options shareholders of Tim Hortons can take: 1) a cash and stock offer, 2) a cash offer of C$88.50, or 3) an all share offer.
At the effective time of the Arrangement, each holder of a common share of the Company will be entitled to receive $65.50 (NYSEARCA:CAD) in cash and 0.8025 newly issued Holdings common shares in exchange for each common share of the Company held by such shareholder, other than shareholders who (NYSE:A) make an election to receive cash (a "Cash Election"), who will be entitled to receive $88.50 in cash in exchange for each common share of the Company held by such shareholder, subject to adjustment in accordance with the plan of arrangement or (NYSE:B) make an election to receive shares of Holdings (a "Shares Election"), who will be entitled to receive 3.0879 newly issued Holdings common shares in exchange for each share of the Company held by such shareholder, subject to adjustment in accordance with the plan of arrangement.
Since the share price has fallen below the all cash option of C$88.50, investors may want further details on how the cash option is allocated. Ex 2-1 of the 8-K provided this information. Under section 3.4 titled "Adjustments to Arrangement Share and Cash Consideration":
If the Cash Election Amount exceeds the Available Cash Election Amount, then the following consideration shall be paid in respect of each Cash Election Share:
(I) an amount of cash equal to the product of the Arrangement Cash Consideration [C$88.50] multiplied by the greater of a fraction, rounded to six (6) decimal places, the numerator of which is the Available Cash Election Amount and the denominator of which is the Cash Election Amount and (II) zero (0) (the amount calculated in clause of this paragraph, the "Cash Fraction"); and
(ii)a number of Holdings Common Shares equal to the product of the Arrangement Share Consideration multiplied [3.0879 shares of combined entity] by the result of one (1) minus the Cash Fraction
Cash Elected Share means shares that have elected for the C$88.50 all cash option and Cash Elected Amount is calculated by multiplying the number of Cash Elected Share and C$88.50. The Available Cash Election Amount is the amount of cash left over after the shareholders who elected (or those who do not select an option) the cash and share offer or "Arrangement Mix Consideration" under the merger agreement. Therefore, if most investors choose the default cash and stock deal, those who elect the all cash deal may receive a similar amount in cash and stock as defined above.
As of August 29, the default cash and stock offer is 7.2% higher than the Tim Hortons' share price while the all stock deal is 24.0% higher. I expect some large holders to elect the all stock deal which has a higher realization and it can be hedged by shorting BKW stock. However, it should be noted that while the spread on the all share offer is high, the final realization may differ because shareholders who elect the all share option may receive some cash if the available Cash Amount is greater than the Cash Elected Amount:
If the Available Cash Election Amount exceeds the Cash Election Amount, then the following consideration shall be paid in respect of each Share Election Share:
an amount of cash equal to the result of the amount of such excess divided by the number of Share Election Shares; and
(ii)a number of Holdings Common Shares equal to the product of the Arrangement Share Consideration multiplied by a fraction, rounded to six (6) decimal places, the numerator of which is the difference between (1) the Arrangement Cash Consideration and (2) the amount calculated in clause of this paragraph and the denominator of which is the Arrangement Cash Consideration
It appears that the final realization will be very similar to the default cash and stock offer. If everyone wanted the all cash option, the final payout will be similar to default option. Similarly, if everyone wanted the juice all share option that has an annualized spread of 45%, then the final finalization will also mirror the payout of the default option. In the end, shareholders are playing a classic game theory situation.
Details on the Outside Date:
The next big question is when would the merger be completed by? In the Ex-2.1 of the 8-K, it provided the Outside Date as March 31, 2015, which is in the merger agreement under article 9. Therefore, the deal is expected to be completed by the end of next March, which is approximately 7 months from today. Therefore, value for Tim Hortons' shareholders should be realized in about 7 month and merger arbitragers has a good spread if they bet on the deal. The 7 month time window is also consistent with cross border deals completed in the past including the CNOOC/Nexen deal and the Petronas/Progress. Both were announced in July 2012 and completed by February in the following year.
Details on the Termination Fees:
The 8-K has the following language:
The Arrangement Agreement provides that a termination fee of $345 million is payable by the Company in certain circumstances, including if the Company terminates the Arrangement Agreement to enter into an agreement that constitutes a "Company Superior Proposal" or the board of directors of the Company changes its recommendation to shareholders in support of the Transactions. A termination fee of $500 million is also payable by Parent in certain circumstances as a result of the failure to obtain certain regulatory approvals.
Italicize phase is my emphasis
Tim Hortons is unlikely to find another bidder that will beat the BKW bid. Therefore, the main focus in the paragraph above is the C$500 million fee BKW will pay to Tim Hortons in an event that the merger fails because of regulatory issues. The $C500 million is approximately 4% of the deal price of C$12.5 billion. The 4% break-up fee is in the higher end of the typical 3-4% terminal fee in most merger agreements.
Details on Regulatory Hurdles:
On the regulatory hurdles, the 8-K described the following:
Conditions to the Transactions. The implementation of the Arrangement is subject to customary closing conditions, including among other things, the approval by the Company's shareholders of the Arrangement and the receipt of all required regulatory approvals (including competition approvals and approval under the Investment Canada Act). The Merger is conditional only upon the consummation of the Arrangement.
What's interesting in the paragraph above is what is not included, which is potential US regulatory hurdles given it is structured as a tax inversion transaction. Given companies need to report material information, it should be a positive sign that BKW does not anticipate significant hurdles due to the tax inversion aspect of the deal. There was no additional color provided in Schedule E of EX-2.1 which lists all the required regulatory approvals.
Details on Buffett's Involvement:
Finally, the 8-K provided further insights on Buffett's participation in this deal:
In connection with the Transactions, Berkshire Hathaway Inc. ("Berkshire") and Holdings have entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") pursuant to which Berkshire will purchase 30,000 Class A 9% Cumulative Compounding Perpetual Preferred Shares of Holdings (the "Preferred Shares") and a warrant (the "Warrant") to purchase common shares in the capital of Holdings ("Holdings Common Shares") representing 1.75% of the fully-diluted common shares of Holdings as of the closing of the Transactions, including after taking into account the common shares of Holdings underlying the Warrant, for an aggregate purchase price of $3 billion, upon the terms and subject to the conditions set forth therein.Italicize phrase is my emphasis
I don't think Buffett would put his reputation and money ($3 billion) to work in a failed deal especially when he is given an attractive warrant to purchase a 1.75% stake in the new combined company. Therefore, in Buffett's opinion, this deal would probably go through.
I still believe that Tim Hortons' shareholders should achieve a higher realization once this deal is completed, which is approximately in 7 month according to the Outside Date provided in the new 8-K. The shares are trading below 7.2% (12.6% annualized) under the default cash and stock deal. The additional details provided in the new 8-K on the payout structure, the Outside Date, regulatory hurdles, terminal fees, and Buffett's involvement add confidence to the deal and the deal spread should narrow over time.