The planned $12.6 billion merger of Tim Hortons Inc with Burger King Worldwide Inc will be tested by forthcoming changes to U.S. Treasury tax rules, reports Fitch Ratings Inc. The New York-based rating agency said new rules are intended to reduce the attractiveness of tax inversion strategies that encourage U.S. companies to relocate their headquarters abroad. Fitch noted that the structure of the Tim Hortons-Burger King deal, which is being led by private equity firm 3G Capital, might help avoid challenges. The two companies issued a statement saying the merger will go ahead regardless, because it has “always been driven by long-term growth and not by tax benefits.”
Inversion Rules Could Test Burger King/Tim Horton’s Combo
Fitch Ratings-Chicago-23 September 2014: The strategic merits of Burger King Worldwide’s (B+/Watch Negative) LBO of Tim Hortons Inc. will be tested by Monday’s enactment of tightened U.S. Treasury tax rules on U.S. companies seeking to re-domicile their headquarters in countries with more favorable tax systems, according to Fitch Ratings.
The new regulation is meant to reduce the attractiveness of inversions and is effective immediately. However, we believe new rules won’t likely deter the Burger King/Tim Hortons transaction. The deal is valued at approximately $12 billion (including net debt), which would rank it as the largest restaurant LBO in U.S. history.
Upon preliminary review, some of the changes announced under the new regulation for inversions involve taxing certain intercompany loans (also known as “hopscotch loans”), subjecting foreign undistributed earnings to taxation irrespective of the new corporate structure, and strengthening the less-than-80% ownership requirement to avoid the new parent from being treated as a U.S. corporation. Fitch believes the structure of the LBO will help the firm avoid some of these challenges.
Burger King’s majority owner, 3G Capital, is expected to own 51% of the new Canadian-based company, while Burger King and Tim Hortons shareholders will own 27% and 22%, respectively, allowing the firm to meet the less-than-80% ownership requirement. Moreover, cash flow from Tim Hortons operations should be able to sufficiently service the $9 billion of dollar-denominated debt being issued to partially fund the transaction, potentially circumventing new rules on hopscotch loans between Burger King and its new Canadian-parent.
Burger King has downplayed the tax benefits of its plan to acquire Tim Hortons with the parent of the new combined company legally organized in Canada, stating that the firm’s mid-to-high 20% effective tax rate is largely consistent with Canadian tax rates. Management has indicated that the transaction is more about growth with two complementary fully franchised businesses merging to create the third-largest quick-service restaurant company in the world.
Fitch agrees that the combination of Burger King and Tim Hortons has good strategic merit and, though the near-term credit impact is negative, expects both parties to benefit from increased efficiencies of scale, brand diversification and multiple levers for future growth. Nonetheless, future potential tax benefits provided by the proposed structure should not be overlooked, even if the firm’s effective tax rate remains unchanged.
During 2013, 41% of Burger King’s $743 million of operating income before unallocated expenses was from outside of North America. Fitch expects this percentage to grow as accelerating international expansion remains a core component of the firm’s business strategy. Canada’s territorial tax system is to likely provide a more tax-efficient way to access this growing base of earnings.
Fitch placed Burger King’s ratings on Negative Watch on Aug. 27, 2014 due to a potential two-turn increase in leverage on a pro forma basis. On Sept. 18, 2014, Fitch rated the new Canadian-based entity issuing the debt to finance the transaction ‘B’/Stable and assigned expected ratings of ‘BB/RR1’ to $6.75 billion of term loans and ‘B/RR4’ to $2.25 billion of second lien notes being issued to partially finance the deal.
Carla Norfleet Taylor, CFA
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Fitch Ratings, Inc.
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The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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