Scout Capital Management, the hedge fund with $6.2 billion assets under management (AUM) co-managed by Adam Weiss and James Crichton, intensified its demands on Tim Hortons Inc. (NYSE:THI) (TSE:THI), a Canadian coffee and doughnut chain to boost its shares repurchase program by optimizing its capital structure.
Letter To Board Of Directors Of Tim Hortons
In a letter to the board of directors of Tim Hortons Inc. (NYSE:THI) (TSE:THI), the hedge fund emphasized that it has a long history of successful investments in the global consumer industry, and believes that the coffee and doughnut chain is a good business. Its brand is iconic with loyal customers in Canada.
Scout Capital also said that Tim Hortons Inc. (NYSE:THI) (TSE:THI) has the ability to substantially increase shareholder returns. “With an appropriate capital structure and more judicious allocation of capital spending, we believe Tim Hortons can double free cash flow per share to C$4.50/share by 2015,” according to the hedge fund.
Stock Price Of Tim Hortons
The hedge fund estimated that the stock price of Tim Hortons Inc. (NYSE:THI) (TSE:THI) could reach as much as C$90 to C$112, an increase of 65 percent to 105 percent based on peer multiples. Scout Capital projected that the company’s earnings per share (EPS) and stock value could grow five times.
Scout Capital suggested that the company should to add leverage to a moderate 3x debt/EBITFA and 4.4x debt EBITDAR to generate the funds needed funds to improve its shares buyback by 23 percent in the near-term and 7 percent to 9 percent annually in the future.
The hedge fund urged the board of directors of the company to limit using its cash flow for real estate investments or new stores in the United States. Scout Capital noted that over the past decade Tim Hortons Inc. (NYSE:THI) (TSE:THI) allocated $600 million to expand its business in the U.S. but the returns are not sufficient.
Scout Capital recommended the company align management incentives with sustainable value creation by adding per share metrics such as free cash flow per share and/or EPS, capital efficiency metrics, and total shareholder returns vs. peers.
The hedge fund noted that the singular metric (EBIT target) used by the board to incentivize management contributes to the mistakes of the company’s strategy and execution because it does not compare stock performance with peers and does not reward management for good capital allocation or balance sheet decisions.
Scout Capital pointed out, “It is our belief that the Company’s long-term history of shareholder under-performance vs. its peers is a result of the first two problems we highlight in this letter—balance sheet optimization and capital allocation discipline; and that these two problems are related to a third one—poor alignment between management incentives and long-term shareholder value…”
Scout Capital hopes to discuss its recommendations with the board, management, and investors of Tim Hortons Inc. (NYSE:THI) (TSE:THI). Last week, the hedge fund increased its stake in the company to 8,400,000 shares or 5.5 percent.
Tim Hortons Is Also Facing Demands From Highfields
Tim Hortons is also facing demands from Highfields Capital to return capital to shareholders through stock buyback. It also recommended the spin off or sale of its distribution business, creation of a real estate investment trust to house its property assets, and the appointment of new directors with broad financial experience.