Fitch: Inversion Rules Could Test BK/THI Combo

Chicago / IL. (fr) The strategic merits of Burger King Worldwide´s (BKW) LBO of Tim Hortons (THI) will be tested by this week´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, Fitch Ratings believes new rules would not likely deter the Burger King / Tim Hortons transaction. The deal is valued at approximately twelve billion USD (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 inter-company loans (also known as «hopscotch loans»), subjecting foreign undistributed earnings to taxation irrespective of the new corporate structure, and strengthening the less-than-80 percent 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 percent of the new Canadian-based company, while Burger King and Tim Hortons shareholders will own 27 percent and 22 percent, respectively, allowing the firm to meet the less-than-80 percent ownership requirement. Moreover, cash flow from Tim Hortons operations should be able to sufficiently service the nine billion USD 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 percent 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 percent of Burger King´s 743 million USD 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 August 27, 2014 due to a potential two-turn increase in leverage on a pro forma basis. On September 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 USD of term loans and «B/RR4» to 2,25 billion USD of second lien notes being issued to partially finance the deal on September 18, 2014.

This article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at fitchratings.com. All opinions expressed in this article are those of Fitch Ratings.

bakenet:eu