Companies & Industries

Impending 'showdown' among Tim Hortons investors brewing

Minority hedge funds vocal.

While hedge funds are pressuring Tim Hortons Inc. to reconsider its U.S. growth strategy, the donut-maker’s largest group of institutional investors are staying mum on the subject, raising the notion there may be a conflict brewing over which direction the donut-maker should follow.

Analysts say it’s too soon to tell whether a vocal few will have a significant impact on the company’s future but their criticism will ensure new CEO Marc Caira has a short honeymoon when he takes over the reins on July 2.

American hedge fund Scout Capital Management (based in Palo Alto, CA) filed an attention-grabbing 13D report with the SEC, notifying the commission that it increased its ownership stake in Tim Hortons to 5.5 per cent. In a short statement Scout reported it had engaged “and expect[s] to continue to engage” in discussions with Tim’s senior management about the company’s capital structure, as well as its “capital expenditures.”

Earlier Boston-based Highfields Capital, which has about a 4 per cent stake in Tim’s, released a letter it sent to Chairman Paul House, stating that the company should consider a new “capital light approach” to its U.S. expansion strategy, or “scrap it altogether,” as returns from the expansion thus far have not justified any more investment in the American market.

The hedge fund also recommended that Tim’s convert part of its business to an REIT, and add more debt to its balance sheet for “capital return.”

While Scout and Highfields significantly represent nearly 10 per cent of shares, they are not in the majority, and other institutional investors haven’t publicly criticized Tim’s execution of its U.S. plans.

Fidelity Management and Research Company (FMR), has an 8.5 per cent stake and is a long term investor in Tim Hortons. T. Rowe Price Associates Inc. own 5.45 per cent of shares, while Royal Bank of Canada and TD Asset Management have a 4.79 per cent 4.46 per cent stake respectively. None have publically commented on the Tim Horton’s performance in the U.S. RBC and Fidelity declined to be interviewed for this article.

According to analysts, if and how Tim Hortons alters its expansion strategy and capital structure will likely be the main point of contention amongst the company’s shareholders in the near future. The hedge funds aren’t necessarily looking to get in and drive the stock price up right away, noted Edward Jones analyst Bobby Hagedorn, but they do have a different outlook from long term shareholders, including a more significant improvement in U.S. operations in the short term.

“We don’t know a whole lot about Scout’s intentions with their Tim’s stake,” said Hagedorn.

The contributions by hedge funds to Tim Hortons are not insignificant–Tim’s stock rose 4 per cent on Tuesday after the Scout purchase was announced. But even if hedge fund investors have an agenda, “the strongest voices will be the long-term investors” who are primarily focused on the long-term creation of value, said Desjardins Securities analyst Keith Howlett.

There might be a bit of a “showdown” or ongoing discussion over the different priorities of the hedge funds, fundamental investors, and the company itself, but “the idea that they might retreat from the U.S., I think, is very unlikely,” said Howlett.

Dissatisfaction with Tim Hortons Inc.’s performance in the U.S. is not entirely unwarranted. According to data compiled by Bloomberg, Tim’s was the third-worst performing stock among 16 global restaurant companies over a one-year period.

Tim’s revenue generation from its 700 stores in the U.S. has been fine, said Hagedorn, but “it’s really been a difficulty getting a profit.”

“It’s not a lost cause yet, just maybe slower than what the market had been looking for.”

After Highfields published its letter criticizing the U.S. strategy, House responded by saying that Tim’s would stick by its plan to cross the border, but acknowledged there was room for improvement.

Up for discussion is the possibility of using master franchisees to expand on a regional basis in the U.S., said Howlett.

One large franchise owner would have the role of developing a certain number of restaurants in a particular region over a period of time, putting up their own capital to do so and perhaps subfranchising to individual owners. It’s not something Tim Hortons has historically wanted to do, noted Howlett, “but something they’re looking at now.”

However, significant changes or any implementation of a vastly different U.S. strategy are likely a couple of quarters away. New CEO Marc Caira will likely spend at least four to six months in his new role before making any announcements as to the company’s direction, Howlett said.

Tim’s capital structure is “incredibly important,” and will be a significant point of focus for investors, “but I don’t think it’ll be the first thing that a new CEO addresses,” Howlett added.