Has Anyone Seen Burger King’s Missing Cash?

Images: Restaurant Brands International

A new mega-brand is born

In December 2014, Burger King Worldwide completed its merger with Canadian quick service chain Tim Hortons.

The combined company, boasting 19,000 restaurants, is now known as Restaurant Brands International.

It trades under the ticker symbol “QSR.”

Image: Restaurant Brands International

An extremely well-run company

In its first full year as a merged company, QSR has so far posted some impressive numbers:

• In Q2 2015, Tim Hortons’ comparable store sales increased 5.5% in constant currency.

• Burger King’s comparables also powered up, by 6.7%.• The company produced an operating income margin of

nearly 29%.

Healthy margins typically bode well…

The high operating margin should indicate that, after accounting for interest expense, taxes, and a few other items, net profit margin is high and cash flow is robust.

Yet that’s not the case here…

In the 1st half of 2015, the company generated $523 million of operating income from nearly $2 billion in sales.

But it booked only a paltry $2.4 million of net income during those six months.

Image: JeepersMedia under Creative Commons license.

…because the merger still has to be paid for:

To complete the BK/Tim Hortons merger last year, Restaurant Brands International took on roughly $9 billion in debt.

It also issued $3 billion in preferred stock, which requires the company to make regular dividend payments.

Together, these financing obligations are putting a strain on net income and cash.

Image: Flickr user “kvirk” under Creative Commons license.

The preferred stock issuance

Selling preferred stock was an important step in closing the deal. Who stepped in with a cool $3 billion in cash to purchase the shares?

One well-heeled investor

Does this gentleman look familiar?

Warren Buffett image by Flickr user thetaxhaven under Creative Commons license.

Berkshire Hathaway’s sweet deal

The preferred shares are a great deal for Warren Buffett’s holding company, Berkshire Hathaway.

• First and foremost is the relative stability of preferred stock, which fluctuates less than common shares.

• Buffett negotiated a hefty coupon, or interest rate, of 9%, to be paid quarterly.

• Buffett also received voting rights, a feature rarely seen with preferred stock.

Other features of the preferred shares

• After 10 years, Berkshire Hathaway can force a redemption of the preferred shares at 110% of the original issuance price.

• However, they can be redeemed by Restaurant Brands International voluntarily after three years have elapsed from the December 2014 issuance transaction.

Financing at a fairly substantial cost

In the meantime, debt service, mostly at rates in the mid-single digits, along with the 9% preferred dividend payment, is diminishing net income and a swallowing a good chunk of QSR’s cash. For example…

In the 1st six months of 2015:

•Interest expense on debt of $247.7 million•Dividends paid on the preferred stock of $136.2 million•Together, these items equaled a whopping 73% of operating income

Whopper image source: BK.com

From $2 billion, to $2 million:

It’s easier to see the effects this way:

Looking out over the next 12 months:

• Debt service for the next 4 quarters is expected to be $407 million.

• Preferred dividends to Berkshire Hathaway will run another $270 million.

• Based on current trends, these payments will equal roughly three quarters of free cash flow.

Cash may be King, but for now, cash obligations rule Burger King.

• Again, based on current trends, Berkshire Hathaway will pocket 5 to 7 times the amount of net income available to common shareholders over the next 12 months!

• Restaurant Brands International runs an efficient operation, but all spare cash is due to Buffett and bondholders for the foreseeable future.

• A final thought: the company has completed one debt refinancing this year, and may undertake more to bring down its total financing cost, perhaps even redeeming Buffett’s preferred shares in a few years.

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