DBRS Downgrades Tim Hortons’ Issuer Rating to BB (low) Following Combination with Burger King

DBRS Limited (DBRS) has today downgraded the Issuer Rating of Tim Hortons Inc. (THI or the Company) to BB (low) and its Senior Unsecured Debt to B, with a recovery rating of RR6; the trends are Stable. This action follows the Company’s announcement that it has received regulatory approval for and its shareholders have voted in favour of the proposed transaction to create a new global quick-service restaurant leader that would own both THI and Burger King Worldwide, Inc. (Burger King) under a new parent company, Restaurant Brands International (RBI). DBRS has removed the ratings from Under Review with Negative Implications.

On August 26, 2014, DBRS placed THI’s ratings Under Review with Negative Implications following the Company’s announcement that it had reached a definitive agreement under which it would be combined with Burger King creating the third-largest quick-service restaurant business in the world, with $23 billion in system-wide sales from over 18,000 restaurants in 100 countries.

Under the terms of the transaction each outstanding common share of THI will be converted into $65.50 in cash and 0.8025 common shares of RBI. Shareholders of THI have the right to elect to receive an all-cash or all-share payment, which is subject to proration. All Burger King shares are to be converted into 0.99 newly issued shares of RBI and 0.01 newly issued partnership exchangeable units (which are intended to provide economic rights that are substantially equivalent, and voting rights with respect to RBI that are equivalent, to the corresponding rights afforded to holders of RBI common shares). Debt financing arranged for RBI includes a $6.75 billion Senior Secured First-Lien Term Loan B, a $500 million Senior Secured First-Lien Revolving Credit Facility and $2.25 billion of Senior Secured Second-Lien Notes. All of the debt issued by RBI is expected to be guaranteed by THI and Burger King. As such, the Issuer Rating on THI reflects DBRS’s view of the consolidated entity and would therefore be equal to an Issuer Rating on RBI. In addition, as part of the transaction, $3 billion of preferred equity has been issued to Berkshire Hathaway.

In terms of operations, management has stated that it expects the THI and Burger King brands to be managed independently but aims to leverage the Burger King platform to accelerate THI’s global growth and footprint. In addition, management expects modest synergies based on economies of scale from its combined procurement capabilities in North America, as well as shifting THI to Burger King’s shared service platform and budgeting systems.

As a result of the organizational structure, including the respective guarantees provided by THI and Burger King to the debt issued by RBI, the review of THI’s ratings is based primarily on an analysis of the combined entity, RBI. DBRS focused its analysis on the following: (1) RBI’s business risk profile, including potential benefits from enhanced scale and geographic diversification, as well as the risks associated with the integration and realization of potential revenue and cost synergies and (2) the financial risk profile and long-term financial management intentions, including any deleveraging plans.

DBRS ANALYSIS
(1) Business Risk Profile
The combination of Burger King and THI results in the third-largest global quick-service restaurant (based on system-wide sales) with system-wide sales over $23 billion. The entity combines two predominantly franchise businesses (greater than 99%) with complementary offerings and results in a significant improvement in size and scale with pro forma revenue in the $4.2 billion range and pro forma EBITDA nearing $1.5 billion. The business risk profile of the combined entity is supported by well recognized brands and strong market positions in product categories with less relative volatility. The transaction also benefits geographic diversification and provides THI with a platform to help accelerate international growth.

(2) Financial Risk Profile
In terms of financial profile, RBI is expected to have balance sheet debt of over $9 billion and preferred shares of $3 billion. Combined with pro forma earnings, DBRS estimates the combined entity will have lease-adjusted debt-to-EBITDAR excluding the preferred shares of approximately 6.23 times (x) and fixed-charge coverage of 1.96x, including the preferred dividend, credit metrics considered at the lower-end of the B range of ratings. That said, the combined entity should nevertheless generate meaningful levels of free cash flow (based on solid operating cash flow and low maintenance capex) beginning in 2016 and could deleverage significantly through a combination of debt repayment and earnings growth.

DBRS believes that THI’s Issuer Rating is best positioned in the BB (low) rating category, with a Stable trend, based primarily on the material increase in leverage as well as the investment grade characteristics of the combined entity’s business profile.

Pursuant to its announced plans and the change of control provisions contained in THI’s senior unsecured notes, RBI is expected to make an offer to repurchase THI’s outstanding Senior Unsecured Debt at the close of the transaction. Should such notes be repaid, DBRS intends to discontinue THI’s Senior Unsecured Debt rating at that time.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are Rating Companies in the Merchandising Industry, DBRS Criteria: Rating Preferred Share and Hybrid Criteria for Corporate Issuers and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.