TIM HORTON’S IN CHINA COMES PUBLIC THROUGH $345M SPAC – AN INITIAL LOOK at TIM HORTON’S INTERNATIONAL LIMITED (THCH)
Silver Crest Acquisition Corp. sold $345M worth of units (a share of stock and half a warrant) on January 19, 2021, in the midst of the SPAC boom. The Sponsorship Group is led by Leon Meng, Chairman and CEO of Ascendent Capital Partners, a private equity firm focused on Greater China. In August, 2021, Silver Crest announced its intent to merge with the Chinese master franchisee of Restaurant Brands’ (QSR) Tim Horton’s, Tim Horton’s International Limited (THIL). The majority owner of THIL is the Cartesian Capital Group, which co-founded THIL along with QSR (QSR owning 8.6% of THIL prior to the Business Combination). Cartesian has been a valued franchisee partner for QSR, having taken Burger King in China from 60 to 1200 stores within less than five years and recently signed on to develop QSR’s Popeye’s Chicken in China.
Typical of an increasing number of SPACs, to facilitate a successful transaction, SLCR Sponsors and THIL shareholders improved the terms for public investors. They reduced the valuation (at $10/share) of Tim’s China from $1.7B to $1.4B and contributed 50% of the Sponsor’s shares and warrants to Silver Crest shareholders that do not redeem. The original valuation was based on comparisons with peer growth companies, largely based on growth rate and multiples of sales, rather than earnings or cash flow, taken out to 2026 as a benchmark year. Safe to say that the current more sober marketplace is not putting as much weight on sales growth as it used to, or even earnings and cash flow that are five years away.
THE SHAREHOLDER BREAKDOWN
The Business Combination was completed, though 96% of the IPO shares were redeemed. Replacing a portion of the redemption is $94.5M of PIPE financing as will as $100M from an affiliate of Cantor, Fitzgerald. The following pro forma number of outstanding shares will change, subject to financial terms of the new capital, but the proxy material showed, with maximum redemption, 195M shares fully diluted by public and private warrants and earnout shares. Based on that number: The major shareholders would be: THIL shareholders 75.75%, remaining Silver Crest shareholders 10.76%, the Sponsor 4.75%, Note Holders 3.09%, PIPE investors 2.94%.
THE STARTING VALUATION
Silver Crest (SLCR) stock was trading at about $8.00 as the Business Combination was completed last week, and is now trading around $6.00 per share. Assuming maximum redemption (which was close to the result) there were scheduled to be 135M shares outstanding, for an equity market value of $810M. Assuming about $300M of cash in place ($200M from new investors) would provide an Enterprise Value of about $500M. Fully diluted, from public and private warrants, convertible notes, earn-out shares and new investors, there are scheduled to be 195M shares, amounting to $1.17B, but over $300M would be raised from the exercise of warrants and options, and the pro forma Enterprise Value would be closer to $600M. These numbers are approximate without further Post-Business-Combination disclosure but $500-$600M of Enterprise Value provides a rough base on which to build an investment case. We will obviously refine this estimate over time.
THE BUSINESS
After entering the market in 2019, THIL (THCH on NASDAQ) grew from 34 units at 12/31/20 to 390 system-wide stores at 12/31/21, 460 as of mid-year ’22, aiming for 2,753 locations by the end of 2026. Important operating elements are the digital ordering, including delivery and mobile ordering for self pick-up, accounting for 73.0% of 2021 revenues, and the loyalty program with 9M members in place. It is interesting that the menu has been localized, with the donuts using a starchier, chewy base, with reduced sugar, baked rather than fried, and unusual (for us) coatings like salty egg yolk.
Important partnerships are in place, with: oil and convenience store giant-Sinopec, the German METRO hypermarket brand in China, investor in THIL and technology leader- Wumart, technology leader – Tencent Holdings, and China’s largest convenience store chain with 27,800 stores and 190M loyalty club members– Easy Joy. Several Tim’s Express shops have already been opened within Easy Joy stores in Beijing, and RTD versions of Tims’ latte’ and mocha drinks are expected to be introduced in the third quarter.
There are three versions in use:
Flagship stores are typically over 150 sq. meters, with an extended menu, classic and premium coffees and alternative beverages, freshly made sandwiches, wraps, baked goods. Some are also themed, co-branded stores with partners such as Export Fans.
Classic Stores, their “mainstream shops”, are 80-150 sq. meters, offer a full menu of coffee and beverages along with freshly prepared sandwiches and baked goods.
Compact “Tims Go” are 20-80 sq. meters, for best coffee and “grab and go” mostly digital occasions. There is a partnership agreement with METRO China, an operator of nearly 100 stores across 60 cities. THIL is the exclusive coffee shop brand in METRO stores, and several of these have opened.
The Investor Presentation in ’21 provided a Targeted AUV of the “Classic” at about $570k, and $250k for “Tims Go”. The Target store EBITDA margin was 15-20% at Classics and 20-25% at Tims Go. No AUV or EBITDA margin is provided for the “Flagship”, so we assume that Flagships and Classics do similar volumes. The recent proxy material indicated that as of 12/31/21 there were 30 “Flagships”, 275 “Classics” and 85 “Tims Go”. Classics and Flagships combined are 305 versus 85 Tims, and we use that ratio of 3.6 to 1 for our calculations below that compare actual AUVs in 2021 to the Targets.
THE GROWTH PLAN
The growth plan, as pictured from the Investor Presentation in 8/21, calls for 2,753 locations by 2026, obviously aggressive but modest relative to the size of the market. Yum China has over 12,000 locations (KFC & Pizza Huts), Starbucks has over 5,700 stores, just opened its 1,000th store in Shanghai, and Luckin Coffee’s current total over 7,000 is growing by over 2,000 outlets annually. Moreover, in 2020 per capita annual consumption of coffee in China was only 19 cups, compared to 628 cups in the United States and 494 cups in Japan. Also in 2020 China reportedly had the fastest growing coffee market globally. There is, without a doubt, unlimited growth opportunity for coffee purveyors in China.
RESULTS TO DATE
The Investor Presentation from fourteen months ago called for 2,753 locations by the end of 2026. We expect that the growth will be rapid but expectations, as shown in the chart below, called for 733 units by 12/22 and only about 490 locations are opened at last report, THIL will therefore fall short relative to estimated openings in calendar 2022, no doubt reduced by numerous factors, not the least of which was the Covid early in the year.
Just below are actual operating results for calendar ’21. Results through early ’22 are not provided. The first table shows, in the right-hand column, total results in US Dollars, including about $4M from revenues derived from other than company stores.
Regarding the top line of $97.2M in 2021:
Locations went from 137-390 during calendar ‘21. We don’t know the opening pace during the year, but, if linear, the “store years” was therefore 263. If we divide the $97.2M of store revenues by 263, we get an AUV of $368k. As described above, we have assumed that Flagships do about the same as Classics, and the $368k is materially below the AUV of $500k if the 3.6:1 Flagship:Classic/Tims mix is applied to the $570/250k “Target” AUVs. To be fair, it’s very early in the awareness campaign of Tim Horton’s in China, the openings may have been backloaded so the $368 would be understated, 2021 was in the middle of Covid related distortions, and the $500k, calculated based on the 3.6:1 store mix, is a “Target”, not the early expectation.
Looking at the historical P&L:
Aside from the GAAP Operating loss close to $60M shown in Table I, the expense items and adjustments shown in Tables III and IV are noteworthy. As a percentage of company sales: Marketing was close to 8% (introduction to markets, no doubt), G&A was about 27% (way too high, but it will no doubt come down), Cost of Goods close to 33% (very high for coffee and donuts), Labor at 33% (burdened by opening inefficiencies) Rental Expense about 23% (very high), both D&A, at 12%, and Pre-opening, at 13%, are also very high, and are added back as Adjustments to get to Adjusted Store Level EBITDA at positive 4.5% (As shown in Table III). (Note that in Table III the expense percentages are shown as a percent of total expenses, rather than as a percent of store revenues.)
Other than first quarter ’22 same store sales ahead by 3.4%, there have been no results provided relative to calendar ’22. Management pointed out that this is better than the 8% decline for Yum China in Q1’22, which also suffered from pandemic related closures starting in March and a two-month lockdown of Shanghai in April and May. These factors have likely affected the number of openings in calendar ’22, putting THIL behind “plan”. THIL reportedly was allowed to resume some operations in Shanghai in mid-April and has seen “a very good recovery of business since July”.
TABLE I
The growth plan, shown above, and the summarized sales and EBITDA expectations, shown below, and provided fourteen months ago, were the basis on which the Business Combination was structured. The variety of factors since then, affecting the general capital markets, SPACs in particular, and the fundamental developments at THIL combined to encourage the stakeholders of SLCR/THIL to improve the structure for the public investors, as described early in this article.
The two sets of projections, below, from proxy material and the Investor Presentation, are slightly different in terms of Adjusted Store EBITDA in 2023 and beyond, but immaterially so. Both projections only showed estimates for 2021, and we could find no projections that included 2021 reported results. Actual 2021 results came in below estimates, with $101.3M of total revenues, $97.2 of store revenues, store adjusted EBITDA of $4.3M vs. earlier estimates of $105M, 103.9M, and $5.7M respectively. Worthy of note are the projections (in the table below) of store level Adjusted EBITDA margins, moving from about 5% in ’21 to 9.0% in ’22 to 12.2% in ’23 to 19.2% in ’26.
We would be negligent if we did not point out that two major investment banking firms, B of A Securities and UBS resigned and/or were terminated as joint placement agents in the course of this transaction. As stated in the proxy material, both were “unwilling to be associated with the disclosure in this proxy/statement/prospectus or the underlying business or financial analysis related to the Business Combination”. We have no desire to play judge or jury in this situation, which is described on pages 89-91 of the proxy material filed on 7/21/22, further within pages 115-128 of the proxy material.
THE BOTTOM LINE
Based on the number of openings in 2022 lagging earlier estimates, with only about 100 openings reported (the as of date is unclear) against 343 planned (733-390), THIL will therefore fall short relative to openings in calendar 2022. This is no doubt reduced by numerous factors, not the least of which was the Covid early in the year. However, THCH is adequately financed and supported by above noted partners, not the least of which is their franchisor, Restaurant Brands, Int’l (QSR). We expect the AUVs to be (at the least) adequate to encourage unit expansion more or less as planned. There is enough financial muscle here to provide the marketing that will encourage consumers to visit locations that can be expected to be reasonably well placed.
Our expectation regarding store level and corporate margins is not so optimistic. As we have pointed out above, all kinds of expense categories are running way too high at the store level, and corporate G&A will likely surprise on the upside. While a number of very important partnerships can provide hundreds, if not thousands, of easily accessible locations over time, stores still have to be constructed, employees trained and customers convinced to spend their hard earned RMB at Tim Horton’s.
While we expect store level and corporate margins to lag previously stated expectations, projections can be reset over the next 6-12 months as reported results are brought current. The current valuation, currently on the order of $600M, is a long way down from the $1.7B implied value of fourteen months ago. If store level AUVs can approach the “Target” presented, THIL management seems experienced enough to produce store level margins close to expected levels. Projected 2026 store level EBITDA margins of 19.2% ($229M) and 13.1% ($157M) Corporate EBITDA margin, respectively are a dream at this point. A huge hurdle to meeting the 13.1% Adjusted Corporate EBITDA objective in 2026 is that the Corporate G&A below the store level will most certainly be more than 6.1% (19.2%-13.1%), considering the ongoing aggressive unit expansion rate.
In conclusion: Investors never have all the answers they would like, and decisions are invariably made with incomplete information. There is an exciting fundamental game plan here, but 2026 is a long way off. There will no doubt be exciting announcements that support long term prosperity, but resetting of shorter term expectations will have to take place, which could mark down THCH further. There are a lot of very inexpensive restaurant stocks. This one is worth watching, but there is no rush to own it.
Roger Lipton