Investors Cheer Burger King-Tim Hortons 'Combo Deal'

Monday, 25 Aug 2014 05:55 PM

 

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Investors in Burger King Worldwide Inc and Tim Hortons Inc applauded news of a potential merger between the two fast food chains, seeing both tax savings and strategic rationale for a combination.

The two companies confirmed late on Sunday that Burger King is in talks to acquire the Canadian coffee and doughnut chain, and that the combined entity would be based in Canada. Shares of Tim Hortons jumped 18.9 percent to close at $74.72 on the New York Stock Exchange on Monday, while shares of Burger King, which is majority owned by investment firm 3G Capital, rose 19.5 percent to $32.40.

Investors and tax experts said the main reason for Burger King to move its domicile to Canada is to avoid having to pay double taxation on profits earned abroad, as the company would have to do if it remained in the United States.

This element of the Canadian tax regime is seen as a bigger draw than its federal corporate tax rate of 15 percent, though that is nominally lower than the U.S. rate of 35 percent. Canadian provincial taxes typically bring the tax rate companies pay closer to 26 percent, while many U.S. companies can find exemptions to bring down their taxes to a comparable level.

Burger King's effective tax rate was 27.5 percent in 2013 and Tim Hortons was 26.8 percent.

While Burger King's pre-tax foreign income was just a few hundred million dollars last year, the benefits of a Canadian domicile will grow as the combined companies expand overseas, experts said.

"I think it has significant potential to substantially decrease Burger King's corporate income taxes in the United States," said Bret Wells, an assistant law professor at the University of Houston. The benefit would come through "earnings stripping" the U.S. tax base in a way that is not available now, he said.

With a so-called tax inversion deal, Burger King could set-up a foreign affiliate in a low-tax regime such as Switzerland, have the U.S. operations pay income to that affiliate, and repatriate the money back to Canada.

Beyond tax savings, investors and industry experts said Tim Hortons' coffee products can help Burger King chip away at McDonald's Corp's hold in the quick-serve breakfast market. And Burger King can help Tim Hortons expand in the United States and abroad, they said.

"Lots of businesses do deals to save money on taxes, but the economic fundamentals are questionable and sometimes downright lacking," said Anthony Sabino, a New York-based law professor at St John's University.

"But this situation is like the double whopper for Burger King. They are going to save money on taxes, but they're also going to have natural synergies merging with a sister food company. It's a smart play."

 

BIG PREMIUM

Toronto-based investors and analysts say they expect Burger King to have to pay top dollar to convince shareholders of Tim Hortons to sell.

Raymond James analyst Kenric Tyghe said he expects Burger King to pay between C$85.00 and C$95.00 a share for Tim Hortons, equivalent to a premium of 24 percent to 38 percent over its closing price of C$68.78 on the Toronto stock exchange last Friday. The stock closed at C$82.03 on Monday.

"As a Tim Hortons shareholder, we would expect at least C$85 a share equivalent, which is about 2.75 shares of Burger King for every Tim Hortons share," said David Baskin, president of Baskin Financial Services, which controls about 180,000 shares in Tim Hortons

"That would be a fair premium. Much less than that and they're going to start getting push back from Canadian institutions."

Not everyone is convinced that the potential merger is worth Wall Street's ebullient reaction. (See BREAKINGVIEWS-Burger King tax flip merger logic doesn't stack up )

Robert Willens, a New York-based accounting and tax expert, said locating the domicile of the combined entity in Canada would not help much on the tax side. However, he thinks it could potentially ease regulatory approval of such a deal in Canada, where a foreign takeover of Tim Hortons could face backlash.

Tim Hortons was bought by Wendy's International Inc in 1995, but later spun out in 2006 after the fast food chain came under pressure from activist investor Nelson Peltz.

In the United States, Burger King is expected to raise hackles if it follows through on the plan to domicile in Canada to reduce its tax burden.

Recent attempts by companies to do such tax inversion deals have drawn the criticism of U.S. President Barack Obama.

Tax inversions have become popular in recent months as low interest rates are making it cheaper for companies to make acquisitions.

"The United States is not a very good place in some respects for a parent company to be, because of the U.S. tax system," said Angelo Nikolakakis, a tax expert with accounting firm Ernst & Young.

© 2014 Thomson/Reuters. All rights reserved.

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