Courting , Burger King Has Plans for a Fast-Food Empire

By DAVID GELLES and IAN AUSTEN August 25, 2014 9:22 pmAugust 26, 2014 9:18 am

When Daniel Schwartz took over as chief executive of Burger King last year, he set about pinching pennies.

Mr. Schwartz, 34, had little affinity for traditional corporate luxuries. So he sold the company jet, ended an annual $1 million party held at an Italian villa and moved executives at the company’s Miami headquarters from posh offices employees called Mahogany Row to an open floor plan full of cubicles.

Mr. Schwartz further reduced expenses by selling more restaurants to franchise owners, reducing the amount of money and employees needed to run the business.

This continued a strategy Mr. Schwartz began in 2010, when he led the buyout of Burger King by 3G Capital, a Brazilian investment firm. And it seemed to work. Since Burger King went public in 2012, the company’s value has more than doubled.

But after years of cutting costs at Burger King, Mr. Schwartz and 3G are now prepared to spend big money on the brand. Burger King is in advanced talks to buy Tim Hortons, a Canadian chain of coffee-and- shops, for more than $8 billion, in what would be the largest-ever acquisition of a restaurant chain. According to a person briefed on the matter, the billionaire Warren E. Buffett’s Berkshire Hathaway will provide a little less than 25 percent of the deal financing by taking preferred shares.

If completed, the deal would provide several clear benefits for Burger King and 3G Capital, which would remain the majority owner. But the deal would also steer the company into perilous territory for fast-food restaurants by bringing together multiple brands under one roof.

Previous attempts at consolidation in the restaurant industry have sputtered. Wendy’s and Arby’s combined in 2008 but split just three years later. Wendy’s also once owned Tim Hortons, but sold it in 2006.

Darden Restaurants, which owns brands such as Olive Garden and LongHorn Steakhouse, has come under pressure from activist investors, and it sold the Red Lobster chain to a private equity firm this year. In each case, extracting cost savings from a disparate group of brands was easier said than done.

“The portfolio approach has not worked well in casual dining,” said Lynne Collier, an analyst at Sterne Agee, referring to midprice chain restaurants like those owned by Darden.

But, Ms. Collier said, portfolios of diverse fast-food brands might be more promising. And instead of simply combining one burger company with another, Burger King appears to be willing to diversify its offerings beyond standard fast-food fare. In doing so, Burger King would be aiming to emulate the success of Yum Brands, the company that owns KFC, Pizza Hut and Taco Bell. Yum is among the best-performing restaurant companies in the world, benefiting from strong international sales.

Dunkin’ Brands, owner of Dunkin’ Donuts and the Baskin-Robbins ice cream chain, has also demonstrated that a fast-food company can thrive with more than one brand under the same roof.

In both cases, Yum and Dunkin’ Brands have taken to positioning their restaurants next to each other in some places. “You can line them up side by side in the same building,” Ms. Collier said.

It is a strategy that would not work with multiple burger chains but might work for Burger King and Tim Hortons.

And for Burger King, whose investors are eager for continued growth, a big takeover may be the best choice on the menu.

“At a certain size, you have to look at acquisitions if you want more growth,” Ms. Collier said.

And Burger King is well positioned to spend now, with its stock riding high after 3G Capital’s operational changes paid off. “Since taking over in late 2010, the new management team has focused intensely on improving the brand image through several initiatives, including restaurant remodels, more attractive menu items, approachable marketing and improved operations,” Alvin Concepcion, a Citigroup analyst, said in a note before news of the potential Tim Hortons deal surfaced.

By betting on a big deal to expand, Mr. Schwartz and 3G Capital appear to be intent on creating a large international fast-food empire.

Acquiring Tim Hortons would give Burger King access to a lucrative new revenue stream. Tim Hortons reported almost $3 billion in sales in 2013 and has shown steady growth in recent years.

Tim Hortons would also give Burger King more exposure to the fast-growing coffee and breakfast food market, which is led by companies like Starbucks and Dunkin’ Brands.

In addition to giving Burger King exposure to popular new categories, it would help the company withstand pressure it faces from a range of competitors. So-called fast casual restaurants like Chipotle are appealing to a new generation of health-conscious consumers. And regional burger chains, like In-N-Out Burgers, Five Guys and Shake Shack, which is preparing to go public, are taking market share from traditional fast- food chains.

Finally, buying Tim Hortons would allow Burger King to reincorporate in Canada, which has a lower corporate tax rate. While such a move, called an inversion, may not substantially reduce its overall tax bill, it would give the enlarged company easier access in the future to cash it earned overseas.

For Tim Hortons, the deal would provide a way forward. Having largely eliminated or marginalized most of its domestic competitors, Tim Hortons now saturates the Canadian market to such an extent that the potential for substantial growth there through new stores is all but gone. Instead, the company is trying to find ways to increase what customers spend.

“This is a very profitable company,” said Will Mitchell, a professor of strategic management at the University of Toronto Rotman School of Management. “It’s not struggling in terms of profits; it’s struggling in terms of profitable growth.” Like many successful Canadian companies, Tim Hortons has long looked to the United States as a place to expand. The result has been mixed, at best. The company is still subsidizing some American franchises and has closed some stores, which are concentrated in the Northeast.

Niraj Dawar, a professor of marketing at the Ivey Business School at the University of Western Ontario, said that the best prospects for expanding Tim Hortons internationally most likely rested in markets outside the United States, where Burger King is already active.

“The U.S. market is saturated,” he said.

“But there are many other markets where Burger King plays where there isn’t this saturation of coffee outlets.”

In a statement, Tim Hortons said that its talks with Burger King were being driven by “the potential to leverage Burger King’s worldwide footprint and experience in global development to accelerate Tim Hortons growth in international markets.”

That sounds remarkably similar to what Tim Hortons hoped for when it was taken over by Wendy’s International in 1996.

In his autobiography, “Always Fresh,” , a co-founder of Tim Hortons, said it rapidly became apparent that his company was being dragged down by its new American owner.

“Wendy’s simply did not perform, leaving Tim Hortons as the company’s only means of growth,” Mr. Joyce wrote.

Yet Mr. Schwartz and 3G Capital apparently believe they have a strategy that will work where Wendy’s was unable to succeed.

Another potential stumbling point is Tim Hortons’ prominence in Canada — the elimination of several , including the Dutchie, was widely covered this year — meaning that a deal would receive close political and public scrutiny.

On Tuesday, Peggy Nash, a member of the New Democratic Party, which is the official opposition in Parliament, told reporters that her party would push for a thorough review of any transaction under foreign ownership laws.

“It seems pretty clear why Burger King would want to move its headquarters to Canada,” she said, referring to potential tax benefits as well as the strong profitability of Tim Hortons. “What’s less clear is what Canadians get out of the deal.”

Michael J. de la Merced contributed reporting.

Correction: August 26, 2014

An earlier version of this article misstated the age of the Burger King chief executive Daniel Schwartz, based on information supplied by a company representative. He is 34, not 33.