Fitch Ratings has affirmed the ratings of Burger King Holdings, Inc. (Burger King) and its related entities as follows:
Burger King Capital Holdings, LLC (BKCH/Parent of Burger King Holdings,
Inc.) and Burger King Capital Finance, Inc. (BKCF/Financing Subsidiary)
--Long-term Issuer Default Rating (IDR) at 'B-';
--$672 million face value of 11% senior discount notes due 2019 at 'CC/RR6'.
Burger King Holdings, Inc. (Direct Parent of Burger King Corporation)
--Long-term IDR at 'B-'.
Burger King Corporation (Operating Company)
--Long-term IDR at 'B-';
--$150 million secured revolver due 2015 at 'BB-/RR1';
--$1,532 million secured term loan due 2016 at 'BB-/RR1';
--$248 million secured Euro tranche term loan due 2016 at 'BB-/RR1';
--$798 million face value of 9.875% senior unsecured notes due 2018 at 'CCC/RR5'.
At Dec. 31, 2011, the carrying value of BKCH's and BKCF's discount notes rated by Fitch was $393.4 million. At Dec. 31, 2011, the carrying value of Burger King Corporation's debt, including capital leases, was approximately $2.7 billion.
The Rating Outlook has been revised to Positive from Negative.
Fitch expects to assign the following rating to the successor company after the closing of the recently announced merger and going public transaction:
Burger King Worldwide, Inc. (Parent Holding Co.)
--Long-term IDR 'B-'.
Rating Rationale and Triggers:
The Positive Outlook is due to improvement in Burger King's credit metrics during 2011 and Fitch's view that the firm is making meaningful progress executing its business strategy. In addition to achieving its general and administrative (G&A) cost reduction goals, Burger King is successfully refranchising lower-margin company stores, expanding outside of North America, and refining its brand image.
For the year ended Dec. 31, 2011, rent-adjusted leverage (defined as total debt inclusive of the $393.4 million aggregate carrying value of 11% discount notes at BKCH and BKCF plus 8 times gross rents-to-operating EBITDA plus gross rent) was 5.9 times (x). Operating EBITDAR-to-interest expense plus gross rent was 2.1x and FFO (funds from operations) fixed charge coverage was 2.0x. Credit metrics have improved since the firm was acquired by 3G Capital Partners, Ltd. (3G) in October 2010 mainly due to the previously mentioned $107 million reduction in G&A expenses over the past year. Rent-adjusted leverage following the buy-out was nearly 7.0x.
Fitch believes Burger King's credit statistics could experience additional improvement in the near term due to better operating performance and modest debt reduction. According to the terms of Burger King's credit agreement the firm is required to use 25% of its annual Excess Cash Flow (as defined by the agreement) for debt repayment. Fitch estimates this mandatory debt pay down to be about $80 million. Rent-adjusted leverage consistently below 6.0x, as Fitch expects, along with meaningful free cash flow (FCF) and stable operating performance could result in an upgrade to ratings.
The pace of deleveraging could be impacted by the reduction in EBITDA caused by accelerated refranchising if there is not a corresponding reduction in debt and/or rent expense. However, at Dec. 31, 2011, Burger King had $459 million of cash which could be used for voluntary additional debt reduction. Should debt reduction exceed the mandatory prepayment requirement, leverage could decline faster than currently anticipated by Fitch.
Burger King's current ratings reflect its high financial leverage and private equity ownership structure, which Fitch believes adds a level of uncertainty to the firm's on-going financial strategy. Partially offsetting these negatives are Burger King's free cash flow generation and relatively stable royalty-based franchise revenue.
Merger Transaction and Public Listing:
On April 3, 2012, Burger King Worldwide Holdings, Inc. announced that it will become a publicly traded entity via a business combination with Justice Holdings Limited (Justice). Under terms of the definitive agreement, 3G will receive $1.4 billion of cash in exchange for 29% of its ownership in Burger King. Following the merger with Justice, which is expected to close in about 60 days, the combined entity will be incorporated in Delaware and renamed Burger King Worldwide, Inc.
Fitch views the transaction as neutral to mildly positive from a credit perspective. Burger King will have access to public equity capital which could help accelerate the firm's growth strategy. However, the corporation is not expected to receive any cash proceeds as a result of the merger and will remain closely held with 3G retaining 71%. Based on Fitch's interpretation of Burger King's credit agreement and the indenture for the 2018 and 2019 notes, modification of the firm's ownership structure as described above should not cause a change of control triggering event or require mandatory debt repayment.
The 'RR1' Recovery Rating on Burger King's secured debt reflects Fitch's belief that recovery prospects on these obligations would remain outstanding at 91%-100% if the firm were to file for bankruptcy protection or restructure its balance sheet. Conversely, the 'CCC/RR5' rating on Burger King's 9.875% 2018 notes is due to Fitch view that recovery would be below average or in the 11% - 30% range in a distressed situation.
The 'CC/RR6' rating on BKCH's and BKCF's 11% discount notes due 2019 implies recovery prospects of 10% or less in a distressed situation because the notes are structurally subordinated to Burger King's debt. Unlike the discount notes, Burger King's debt is guaranteed and was issued by the operating company which holds the vast majority of the firm's $5.6 billion of assets. An upgrade in the IDR of Burger King or related entities or greater than expected debt reduction could result in one or more upgrades to issue level and Recovery Ratings assigned to all of the aforementioned obligations.
Same-Store Sales and Operational Update:
Burger King's global system-wide same-store sales (SSS) performance improved during 2011 but trends in North America, which represents 67% of revenue and 66% of operating profit excluding corporate expenses, have remained weak. System-wide SSS declined 0.5% during 2011 after declining 2.4% during the comparable period in 2010. SSS performance in the U.S. and Canada, however, remained especially weak at negative 3.4% in 2011 and negative 4.4% in 2010.
Efforts to turn around sales in North America involve changes to Burger King's menu and marketing strategy. The firm has improved the quality of its French fries and has introduced menu items with broader appeal such as its Chef's Choice burgers, premium salads, specialty drinks, and soft serve ice cream. Burger King has also increased spending on advertising which has become more food-centric and focused on core assets such as its signature flame-grilled cooking process. If the firm is successful with its execution and changes in the menu and marketing resonate with consumers, SSS trends in North America should improve.
As previously mentioned, Burger King successfully achieved its target of $85 million - $110 million of annual G&A cost savings during 2011. The firm's operating EBITDA margin improved to 25%, up from about 20% for the comparable 12-month period due to lower G&A and the refranchising of 45 units. Significant additional G&A cost reductions are not anticipated. However, the firm's EBITDA margin is expected to increase meaningfully following its recently announced agreement with Carrols Restaurant Group, Inc. (Carrols; NASDAQ: TAST). Commodity costs are also expected to become less of a headwind for the Burger King system in 2012.
Transaction with Carrols:
On March 26, 2012, Burger King entered into an asset purchase agreement with Carrols - the firm's largest franchisee in North America with 297 units at the end of 2011. The arrangement entails the refranchising of 278 company-operated stores and a commitment to remodel approximately 450 units in the brand's 20/20 image over the next three and a half years. The transaction will be margin accretive because franchised units are more profitable than company-operated stores due to lower overall operating cost at the corporate level. However, the decline in company restaurant revenue and EBITDA give up associated with this transaction has been factored into Fitch's expectations regarding rent-adjusted leverage.
The total consideration to Burger King will include a 28.9% equity interest in Carrols and cash of approximately $15.8 million. Concentration of franchisees is viewed negatively by Fitch, but Burger King's ownership interest and representation on Carrols' board partially mitigates this concern. While Carrols is an experienced operator, Burger King will be able to exercise greater influence over the management of a large block of its restaurants in the U.S.
The Carrols transaction, which is expected to close later this year, is viewed as consistent with Burger King's strategy of actively refranchising company-operated restaurants. Once completed, Fitch estimates that the Burger King system will be more than 92% franchised, up from 90% at Dec. 31, 2011. Furthermore, the agreement reflects continued progress the firm is making to help broaden its appeal to a more diverse demographic of consumers via the re-imaging of its restaurants.
Liquidity and Maturities:
As mentioned previously, Burger King had $459 million of cash at Dec. 31, 2011. Excluding about $15 million of letters of credit, the firm also had $136 million of availability on its revolver. Burger King's liquidity is adequate and is further supported by its consistent generation of meaningful FCF. Fitch believes Burger King has the capacity to generate over $200 million of FCF annually but does not expect the firm's cash balance to remain at elevated levels.
Aggregate maturities of long-term debt are manageable with $28 million due annually through 2015. Burger King's term loans amortize at a rate of 0.25% quarterly with the balance payable at maturity on Oct. 19, 2016. Burger King's 9.875% senior unsecured notes become due Oct. 15, 2018, and BKCH's and BKCF's 11% discount notes mature April 15, 2019.
The discount notes are currently not guaranteed by Burger King, as mentioned previously, but cash required to service the notes will be funded with distributions from Burger King. This is because BKCH and BKCF have no operations or assets other than their interest in Burger King. The discount notes are also cross-defaulted to Burger King's debt resulting in a greater incentive for the operating company to service them.
Burger King's credit agreement subjects the company to maximum total leverage, not adjusted for leases, and minimum interest coverage financial covenants. Maximum leverage was 7.50x in 2011 but declines by 0.25x annually to 6.0x in 2016. Minimum interest coverage was 1.70x at Dec. 31, 2011 but increases to 2.0x by Sept. 30, 2014. Fitch estimates that Burger King's leverage, as calculated by its agreement, was 4.4x at Dec. 31, 2011 providing the company with approximately 40% EBITDA cushion. EBITDA headroom under the minimum interest coverage test is also believed to be considerable at over 40%.
Both the 9.875% notes and the 11% discount notes contain change of control and equity clawback provisions should the company engage in equity offerings prior to Oct. 15, 2013. Given the voluntary nature of any equity clawback and the structure of the merger with Justice, Fitch has not incorporated any debt reduction associated with these notes into its expectations.
Additional information is available at www.fitchratings.com. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (May 12, 2011);
--'Burger King Holdings, Inc. Full Rating Report' (June 8, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Burger King Holdings, Inc.
Carla Norfleet Taylor, CFA, +1-312-368-3195
70 West Madison St.
Chicago, IL 60602
Judi M. Rossetti, CFA, CPA, +1-312-368-2077
Wesley E. Moultrie II, CPA, +1-312-368-3186
Brian Bertsch, +1-212-908-0549
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