A Taste for Tim Hortons?

Haven't heard of Tim Hortons? You might soon -- it's the piping-hot doughnut-and-coffee sensation from Canada that is stirring investors' appetites this week with a closely watched IPO, with plans to expand stores in the U.S. soon.

Even though many a U.S. investor hasn't yet tasted a doughnut, let alone sipped coffee from Tim Hortons, the restaurant chain has managed to whet U.S. investors' appetite with its initial public offering of 29 million shares, and this week increased its asking price by 20%. The IPO, prompted by activist investors in parent company Wendy's International (WEN), is expected to price on Thursday and could raise as much as $700 million if it sells on the high end of its range of $22 to $24. Previously, the offering, led by Goldman Sachs and RBC Capital Markets, was being shopped at $18 to $20 apiece. The stock will be listed in both the New York Stock Exchange and the Toronto Stock Exchange.


  And why not? Not only has Tim Hortons has left Starbucks (SBUX) a distant second in Canada's coffee market, it has the reputation of being a well-run company with a long-running record of sales growth. Tim Hortons "dominates the whole landscape in Canada...with tremendous growth in revenues over the past 10 years, growing at a compounded annual rate of 17.4%," says Jack Schuessler, CEO of Wendy's, which bought Tim Hortons in 1996 for $450 million, less than 10 times its current value. Wendy's retains about 83%, which it plans to spin off to shareholders by yearend.

At first glance, the excitement is reminiscent of the investor enthusiasm that welcomed January's stock offering from Chipotle Mexican Grill (CMG), the restaurant chain partly owned McDonald's (MCD). On the first day of trading, Chipotle's stock doubled, to $44, and is currrently trading around $52 (see BW Online, 09/23/05, "Chipotle's IPO: One Hot Tamale?").

However, Tim Hortons, based in Oakville, Ontario, is no Chipotle, because its offerings of donuts and coffee are relatively tame compared to spicy free-range chicken and pork burritos. Chipotle has been a hot stock -- and not just because its sales rose last year at a clip of over 30%. Chipotle is also riding a wave of changing American tastes, with consumers starting to favor foods with more distinctive flavors and spices (see BW, 12/20/05, "Of Donuts, Debt, and Deals").


  Nowadays, say "donuts" and many investors think of fallen stock-market darling Krispy Kreme (KKD), the donut chain that is now wrestling with losses and slumping sales after executives spent big on new stores and indulged in improper accounting. After hitting a high of $49 in 2003, its shares now trade at $9.

Still, Tim Hortons has been a strong performer. Its 2,597 restaurants in Canada and the 288 in the U.S. (mostly in the Northeast) generate 31% of Wendy's sales and 58% of profit. Indeed, this unit has been Wendy's fastest growing business for years. "Clearly it's already a viable business, and investors who understand a high-quality, well-run business will definitely be attracted," says Peter Cohan, an investment expert and president of Peter S. Cohan and Associates, a management consultancy in Marlborough, Mass.

Wendy's, the No. 3 U.S. hamburger chain according to its own website, would love to keep Tim Hortons and continue to reap the profits. However, Wendy's is spinning off the unit under pressure from high-profile activist shareholders like William Ackman and Nelson Peltz, who say the stock is undervalued (see BW Online, 2/20/06, "Attack of the Hungry Hedge Funds ").


  Clearly investors are attracted by Tim Hortons' pedigree. The company was started in 1964 by Canadian hockey legend Tim Horton, who wanted an off-season income. Horton teamed with Ron Joyce, his first franchisee, who expanded the chain to small towns across Canada and eventually made Tim Hortons the top fast-food chain in Canada. (Tim Horton died in 1974.) Plans are to increase the store count 40% in Canada, to 4,000 stores, and 500 in the U.S. by 2008.

But some investors have doubts about the success of such a rollout. As Wendy's Schuessler points out: "(In Canada) We have 22% share of the food service industry. And in the coffee and baked goods share, Tim's has 74%." And therein lies the problem, points out Piper Jaffray analyst Peter Oakes. In a research note, he says there isn't much room to grow in Canada: "Tim Hortons Canada already sports a per capita unit penetration level double that of McDonald's USA."

So, Tim Hortons must turn its eyes southward to the U.S., where competition from Starbucks and Dunkin' Donuts will be fierce (see BW Online, 3/1/06, "Mickey D's New Brew").


  Robert S. Goldin, executive vice-president at food consultant Technomic in Chicago, points out that Americans aren't that wild about donuts -- as even Dunkin' Donuts realized when it introduced premium coffee and a host of new beverages, making beverages over 60% of its sales. Still, Goldin says that there might be room for at least one more strong competitor. "The beverage category has defied gravity -- Starbucks just keeps growing, both in number of units and same store sales," says Goldin.

Of course, Wendy's CEO thinks there's an opportunity. Schuessler points out the array of baked goods on Hortons' shelves. "We can do many things with our donuts. We can have themes like chocolate. We have great bagels. We've rolled out a new hot breakfast sandwich in the U.S.," he says, adding that the chain also recently introduced hot smoothies.

But food consultant Goldin believes that the fare might not necessarily promote fast growth. Rather, using a football metaphor, a steady "three yards and a cloud of dust" kind of progress, which might still be attractive to some investors. And since a Canadian football field has 110 yards between the goal lines, it figures Tim Hortons could have some extra room to grow.