Tim Hortons Inc. is under pressure from an activist investor that wants the company to pare back its U.S. growth and borrow billions to fund a share buyback.
Boston-based Highfields Capital Management, which owns about 4 per cent of the coffee chain, said it met with management in mid-March to propose the strategies it believes will immediately boost earnings per share and increase shareholder value in the long-run.
The hedge fund has also pressed management to spin out the company’s real estate assets into a real estate investment trust.
Tim Hortons refused to comment on Highfields’ plan.
Highfields has pursued these strategies since amassing its position in the past six months, but many of the ideas have already been rejected by Tim Hortons. Last quarter, management dismissed the idea of creating a REIT, which suggests Highfields will need to wage a public relations campaign to get other investors behind it in order to enact change.
“These options are not new ideas, and based on our analysis and prior statements from management, not necessarily as simple as [they] would appear,” noted Royal Bank of Canada analyst Irene Nattel.
Shares climbed 4 per cent on Wednesday, bringing them just a few cents shy of their all-time high set last May. The stock tumbled through the second half of 2012, but recently recovered.
Tim Hortons has not had a chief executive officer since last year. A new CEO is expected to be named by mid-year, but until then, major strategic decisions will be hard to implement.
The lack of leadership makes it hard to handle the troubles the company is facing in the United States.
As recently as two years ago, the U.S. division recorded annual operating losses. In response, Tim Hortons shut its underperforming stores in New England that couldn’t compete with Dunkin’ Donuts, and decided to focus on states such as Michigan and Ohio, as well as border cities like Rochester and Buffalo in New York.
Since then, the company has plowed money into starting up new stores in these regions, and the division made an operating profit of $16.5-million in 2012. Changing course now could be viewed as a waste of resources. Highfields feels otherwise. “Returns to date do not justify further material investments in this business,” the fund said in a letter to management.
The facts back Highfields up. The U.S. division contributed only about 3 per cent to Tim Hortons’ overall operating profit last year, and despite years of work south of the border, analyst Derek Dley at Canaccord Genuity described the division as a “fledgling operation.”
Although markets are clamouring for the returns that REITs deliver, chief financial officer Cynthia Devine said in February that Tim Hortons only owns about 20 per cent of its restaurant base, and controls the remaining 80 per cent through leases.
“Some people don’t recognize the distinction between controlling through control of the head lease versus outright ownership,” she said, alluding to a distinction between Tim Hortons and Loblaw, which is pursuing a REIT of its own.
As for the share buyback, borrowing billions of dollars to repurchase stock would immediately boost earnings per share.
If earnings remain the same as the number of shares drops, EPS automatically jumps – but it would also bring Tim Hortons’ debt to more than four times its earnings before interest, taxes, depreciation and amortization (EBITDA).
Highfields believes that borrowing at such historically low interest rates, the way Apple did on Monday, would justify taking on new debt. But management appears to have told the hedge fund that its complicated corporate structure “would make it difficult to recapitalize the company in an efficient manner,” according to Highfields’ letter to the company.