Burger King and Tim Hortons stronger after joining forces

Merger agreement puts Canadian restaurant in the Top 3 and enhances its moat.

R.J. Hottovy, CFA 27 August, 2014 | 11:00PM

As expected,   Tim Hortons  THI and Burger King entered into a definitive merger agreement on Aug. 26 to create the third-largest global quick-service restaurant chain behind   McDonald's  MCD and   Yum Brands  YUM. Tim Hortons shareholders will receive $65.50 per share in cash and 0.8025 common shares of the new company, which works out to $89.32 per share in total consideration. On completion, 3G Capital will own 51% of the shares, with Burger King and Tim Hortons shareholders owning 27% and 22%, respectively. The new company will be headquartered in Canada, with both brands continuing to operate independently.

Though much attention has been given to the tax implications, we share management's view that growth strategies (namely, using 3G's master franchise joint-venture network to accelerate Tim Hortons' unit growth) and other shared-service benefits are the transaction's primary motivation.

We are raising our fair value estimates for Tim Hortons to $90 and believe that Tim Hortons' shareholders are receiving more than a fair price. In our view, the partnership can help enhance Tim Hortons' narrow moat, and we believe the combined company warrants a premium to industry averages because of its strong long-term cash-flow potential. Over the next decade, we see an opportunity for 30,000 system-wide units (implying mid-single-digit annual growth), low- to mid-single-digit comparable-store sales (backed by new margin-improving items across multiple menus), and operating margin expansion (with adjusted operating margins growing to at least the low-30% range from 28% today).

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About Author

R.J. Hottovy, CFA

R.J. Hottovy, CFA  R.J. Hottovy, CFA, is a consumer strategist for Morningstar.