Fitch Places Burger King's Ratings on Negative Watch Due to Acquisition

CHICAGO--()--Fitch Ratings has placed the ratings of Burger King Worldwide, Inc. (Burger King; NYSE: BKW) and its subsidiaries on Rating Watch Negative. The rating action follows the firm's definitive agreement to acquire Tim Hortons, Inc. (Tim Horton; NYSE: THI). At June 30, 2014, Burger King had $3 billion of total debt. A full list of ratings follows at the end of this press release.

The deal is valued at $12 billion including Tim Horton's $1.0 of net debt and represents a 30% premium over Tim Horton's Aug. 22, 2014 stock price. Fitch estimates that the purchase multiple is approximately 16x Tim Horton's C$834 million of EBITDA (USD 762 million based on an Aug. 22, 2014 exchange rate of 0.9138 Canadian $/USD) for the latest 12 months (LTM) ended June 29, 2014. Committed financing includes a $6.75 billion senior secured term loan B facility, $2.25 billion of second-lien notes, and $3 billion of preferred equity from Berkshire Hathaway.

The transaction will result in a new publicly-traded global quick-service restaurant company with two leading brands, approximately $23 billion of system sales, and over 18,000 units. 3G Capital will own 51% of the new company while Burger King and Tim Horton's shareholders will own 27% and 22%, respectively. Closing, which is subject to regulatory approval and a vote by Tim Horton's shareholders, is targeted for late 2014 or early 2015. Both firm's Board of Directors have approved the deal.

Key Rating Drivers

High Pro forma Leverage

Fitch estimates that total adjusted debt-to-EBITDAR on a pro forma basis will range between approximately 6.0x and 8.0x versus 4.9x for the LTM period ended June 30, 2014 depending on equity credit allocated to the preferred stock. Fitch will evaluate terms of the preferred stock, allocating either 100%, 50%, or 0% equity credit based on Fitch's Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Analysis criteria.

Given significantly higher debt, a one-notch downgrade of Burger King's Issuer Default Rating (IDR) is possible. However, resolution of the Negative Watch will consider the combined entity's projected EBITDA growth, annual free cash flow, and the pace of deleveraging within two years of deal closing. Fitch estimates that annual free cash flow (FCF, defined as CFO less capex and dividends) could exceed $400 million annually before the 9% preferred dividend but anticipates that deleveraging will occur mainly through EBITDA growth and modest term loan amortization. The IDR will consider synergies, execution risk, and the potential currency mismatch associated with the firm's significant Canadian cash flows and U.S. based obligations.

Recovery Analysis

Issue level and Recovery Ratings will reflect the firm's final capital structure and Fitch's estimate of the new company's enterprise value as a going concern. Ratings will consider the issuance of senior secured and second-lien debt, the repayment of Burger King's existing debt, and the potential that Tim Horton's privately placed notes are redeemed. Tim Horton's debt includes three series of privately placed senior unsecured notes with change of control provisions that require the borrower to make an offer to repurchase the notes. Fitch believes that the payoff of Burger King's debt stems from the firm's plan to evaluate its capital structure in late 2014 as it approached the first call date on its 9.875% senior unsecured notes due 2018 and 11% senior discount notes due 2019.

Strategically Sound Transaction

Fitch believes the combined entity will benefit from increased efficiencies of scale, the diversification provided by two leading nearly 100% franchised quick-service restaurant brands, and multiple levers for future growth. Burger King's ability to expand Tim Horton's internationally and to reduce cost will be complemented by Tim Horton's established position in the faster growing coffee/snack category, progress with loyalty and mobile payment, and high average unit volumes. Burger King has indicated that the transaction is not being driven by tax rates, stating that its effective tax rate is currently in the mid-to-high 20% range and is largely consistent with Canadian tax rates.

Tim Hortons is an iconic brand with over 42% market share in Canada and strong customer loyalty. The chain has generated 23 years of same-store sales (SSS) growth in Canada, and its store count has grown on a 4.2% compound annual growth basis since 2010. Burger King is successfully executing on its Four-Pillar plan for North America, with three consecutive quarters of SSS growth, and expanding internationally mainly through joint ventures and master franchise development agreements. These positive factors are partially offset by limited transparency regarding the financial stability of franchisees, the highly competitive U.S. restaurant industry, and execution risk due to uncertain success of Tim Horton's expansion beyond its core Canadian market.

Ratings Sensitivities

Future developments that may, individually or collectively, lead to a downgrade of Burger King's IDR include:

--Total adjusted debt-to-operating EBITDAR sustained above the 6.0x range, a prolonged period of SSS declines, or lower than expected FCF could result in a downgrade of Burger King's IDR.

Future developments that may, individually or collectively, lead to an upgrade of Burger King's IDR include:

--An upgrade of Burger King's IDR is not anticipated in the near to intermediate term. Management has indicated a comfortable level with net debt-to-EBITDA in the 5.0x range, which based on Fitch's calculation could be equivalent to total adjusted debt-to-EBITDAR of more than 6.0x. The firm currently does not have a long-term leverage target.

Fitch has placed for the following ratings of Burger King and its subsidiaries on Rating Watch Negative:

Burger King Worldwide, Inc. (Parent Holding Co.)

-- IDR 'B+'.

Burger King Capital Holdings, LLC (BKCH/Parent of Burger King Holdings, Inc.) and Burger King Capital Finance, Inc. (BKCF/Financing Subsidiary) as Co-Issuers

--Long-term IDR 'B+';

--11% sr. discount notes due 2019 'B-/RR6'.

Burger King Holdings, Inc. (Direct Parent of Burger King Corporation)

--Long-term IDR 'B+'.

Burger King Corporation (Operating Company)

--Long-term IDR 'B+';

--Secured revolver due 2015 'BB+/RR1';

--Secured term loan A due 2017 'BB+/RR1';

--Secured term loan B due 2019 'BB+/RR1';

--9.875% senior unsecured notes due 2018 'BB-/RR3'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014);

--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (December 2013);

--'Parent and Subsidiary Rating Linkage' (August 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=714476

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=858374

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Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA, +1 312-368-3195
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Judi M. Rossetti, +1 312-368-2077
Senior Director
or
Committee Chairperson
Glen Grabelsky, +1 212-908-0577
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA, +1 312-368-3195
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Judi M. Rossetti, +1 312-368-2077
Senior Director
or
Committee Chairperson
Glen Grabelsky, +1 212-908-0577
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com