* Scout Capital urges Tims to raise debt, buy back shares
* Analysts, investors see room for Tims to take on some debt
* Tims shares rise 3.6 percent on the Toronto Stock Exchange
(Adds comment from Tims, details on demands, analyst comment)
By Euan Rocha and Solarina Ho
TORONTO, June 25 Scout Capital Management, a
U.S. hedge fund, said on Tuesday it is urging Canadian coffee
and doughnut chain Tim Hortons to increase its debt
levels in order to fund a share buyback, measures that Scout say
should help drive up Tim Horton's share price by as much as 100
percent from current levels.
The demands to Tim Hortons' board by New York-based Scout
Capital are similar those put forward by rival U.S. hedge fund
Highfields Capital earlier this year.
In a letter to the board on Tuesday, Scout, which has a 5.5
percent stake in the company, said the measures would allow Tims
- as the company's patrons affectionately call it - to
dramatically improve shareholder returns.
"I think certainly there is room for Tim Hortons to take on
more leverage," said R.J. Hottovy, an analyst at Morningstar.
"For a name like Tim Hortons, which does have a pretty robust
revenue stream in terms of franchisee rents and royalties, I
think that does make a lot of sense."
Scout Capital said it believed Tims could double its free
cash flow to C$4.50 per share by 2015 and push its stock price
into the C$90 to C$112 range. The shares closed up 3.2 percent
to C$56.29 on the Toronto Stock Exchange.
Scout urged the company to increase its debt to a "moderate
level" of three times earnings before interest, taxes,
depreciation and amortization, saying this would allow the
company to buy back roughly 23 percent of its outstanding
The proposal is much more conservative than the one put
forward by Highfields, which has a 4 percent stake in Tims.
According to documents viewed by Reuters, Highfields suggested
Tims raise its debt to roughly five times EBITDA and buy back
some 37 percent of its shares.
Tim Hortons has indicated that it will likely raise its debt
levels and buy back shares, but nowhere near the extent that
Highfields is seeking.
"We are a very healthy company and we want to stay a very
healthy company," interim head Paul House told Reuters after the
company's annual shareholders meeting in Toronto last month.
The emergence of two large investors, which combined own
close to 10 percent of Tims' shares, is however, likely to put
more pressure on the company to act at least on some of the
Big decisions on acceptable debt levels, buybacks and the
other proposals put forward by the two hedge funds are, however,
going to likely come only after Nestle veteran Marc
Caira takes over as Tims chief executive next week.
Scout, like Highfields, has urged Tims to curtail the use of
its cash flow for real estate investments or new store openings
in the United States.
"If new stores make sense and unit economics are good,
well-capitalized franchisees will be happy to invest their own
capital," said Scout, in a letter filed with regulators.
Scout, unlike Highfields, has not suggested that Tims spin
out its real estate holdings into a real estate investment
trust, an idea that Tims has panned since it only owns about 20
percent of its real estate footprint.
Scout also said it wants to see Tims' management
compensation structure tied more to per share metrics like free
cash flow per share or earnings per share, as it argues Tims'
existing approach to executive compensation is responsible for
the company's underperformance versus its peers.
Scout, which invests in businesses that are "misunderstood
and incorrectly valued by the markets," disclosed its stake in
Tim Hortons last week and said it was pushing the company to
Founded in 1999, the fund has been a mostly a passive
investor to date, though last month it said it was also taking
an activist role at DineEquity Inc, owner of Applebee's
and IHOP restaurants.
"We believe Tim Hortons' Canadian franchisee system is among
the strongest and most passionate in North America," Scout said
in the letter to Tims' board. "With relative market share in
Canada of nearly three times the nearest competitor, there are
few businesses on the planet like Tim Hortons."
However, Scout said Tims' shareholder returns and
performance have lagged those of its peers. The fund said it
would like to present its case directly to Tims' board, but the
company has not yet responded to its request.
"We welcome constructive dialogue with our shareholders and
are committed to continuing our ongoing discussions with them,"
said a spokeswoman for Tims, who declined to provide any further
detail on the matter.
(Reporting by Euan Rocha and Solarina Ho; Editing by Janet
Guttsman, Lisa Von Ahn and Leslie Adler)