20/20 Hindsight

That Tim Hortons Deal

Burger King's merger with the Canadian coffee chain has mixed results so far.

Tim Hortons doughnuts are pictured in Toronto, on Wednesday, August 3 2011.

Photographer: Brent Lewin/Bloomberg
At Closing, January 19th
77.00 CAD
At Closing, January 19th
61.58 USD

Burgers and coffee: It's not the worst thing in the world, but it probably wouldn't be your first choice for a meal either, right?

That's how I feel about the merger between Burger King and Tim Hortons, which was engineered by Brazilian private equity firm 3G Capital with some financing help from Warren Buffett's Berkshire Hathaway Inc. 1 There are some tasty parts, and some less so. This week marks the two-year anniversary of the deal, which created the fast-food company now called Restaurant Brands International Inc. After analyzing the transaction, Gadfly has decided that it's meh -- the midpoint of five ratings given to mergers we review. 2

Tim Hortons Scorecard

The acquisition of Canadian coffee chain Tim Hortons has created shareholder value, but Burger King still faces growth challenges in the U.S. and Tim Hortons' anticipated international push has been slow

Source: Bloomberg

The EV/Ebitda multiple in the "Now" column refers to Restaurant Brands International, the name of the merged entity. Ebitda is from the trailing 12-month period. Same-stores sales figures are for the third quarter of 2014 and third quarter of 2016.

Buying Tim Hortons -- a Canadian chain of coffee-and-doughnut shops named after a hockey player, of course -- was technically a tax-inversion deal that left the combined company headquartered in Oakville, Ontario. But the biggest motivation wasn't taxes. It was that 3G saw an opportunity to do what they do best: gut overhead and operating costs at Tim Hortons, like they had already done at Burger King. 3 Timmy's profit margins paled in comparison to Dunkin' Brands Group Inc.

3G's Margin Magic

Burger King's margins widened significantly after 3G Capital took over. Now the private equity firm is doing the same with Tim Hortons, which it merged with Burger King two years ago:

Source: Bloomberg

See footnote at end of story for data details.

But where does Restaurant Brands go from here? The margin expansion has driven profit and created value, except that strategy has an expiration. Eventually the operations hit peak efficiency, at which point in order to keep growing you need to bring in more customers, open more restaurants (franchises) or make another big acquisition. And organic growth isn't looking that impressive at the moment. 

Revenue growth may not be as much of a concern for private equity owners like 3G that concentrate on maximizing the bottom line and cash flows. Still, Restaurant Brands is a public company and for public investors, growth potential can be important -- especially when they're considering whether to invest at this stage. 

Burger King is facing the same challenges as its U.S. rivals: keeping customers loyal when other fast, cheap options are plentiful and many consumers are on a health kick. While competitors have taken advantage of low food costs to introduce less-bad-for-you options, Burger King doubled down on, well, the opposite. Case in point: the Whopperrito, Mac n' Cheetos and chili cheese dogs. That's actually not a bad idea since people don't go to McDonald's and Burger King for salads. However, it also means constantly having to introduce new menu items that will get people's attention. 

Short-Lived Surge

Same-store sales have slowed against last year's tough comparisons. Newer items such as Burger King's A1 Hearty Mozzarella Bacon Cheeseburger and Tim Hortons' dark roast coffee fueled growth last year:

Source: Bloomberg

It's been two years and Tim Hortons' geographic profile outside of North America hasn't changed meaningfully yet, even though bringing the coffee shops to other countries where Burger King has franchise partners was a major goal. Progress on this has been slow, which in part may have to do with the Tim Hortons name being less recognizable than, say, Starbucks, as well as cultural differences, such as tea being more popular than coffee in some international markets. Just ask Yum! Brands Inc., the owner of KFC, Pizza Hut and Taco Bell that spun off its China operations this year: It's not always easy bringing a Western brand to other parts of the world. For one, the menu and message have to be adapted for the local market, which takes time and isn't cheap. 

Restaurant Brands signed a development agreement in June for Tim Hortons in Minneapolis, following agreements in Columbus, Cincinnati and Indianapolis. As for outside the U.S., the chain is also coming to the Philippines, which management says has "an affinity for coffee and donuts." It's going to take time for these investments to translate into profit growth for shareholders.

What's Next?

Restaurant Brands has performed well since the merger. But looking ahead to the next 12 months, the stock may be flat, based on analysts' average price forecast:

Source: Bloomberg

So while this merger has juiced earnings and lifted the stock, the cost-reduction benefits may start to wane and top-line growth hasn't yet hit its stride.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Berkshire provided $3 billion of preferred equity financing and got a warrant allowing it to purchase about 4 percent of Restaurant Brands outstanding common stock. Buffett and 3G had also teamed up to acquire H.J. Heinz in 2013, which they later merged with Kraft Foods. 

  2. In rating the merger, Gadfly took into account the margin improvement at Tim Hortons, the slow pace of international growth, Burger King's performance in the U.S. and current food trends.

  3. Data used for "3G's Margin Magic" chart: First Burger King bar shows average operating margin for 10 quarters leading up to the LBO by 3G Capital. Second bar shows average operating margin after being taken public again in 2012 through the second quarter of 2014 (excludes third quarter of that year because of significant non-recurring operating expenses related to the Tim Hortons merger). Tim Hortons bar shows average operating margin for 10 quarters leading up to Burger King merger. Restaurant Brands bar shows combined company's average operating margin since merger.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net

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