April 5, 2012 / 6:47 PM / 5 years ago

TEXT-Fitch revises Burger King Holdings outlook to positive

April 5 - 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) as Co-Issuers	
	
--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. 	
	
Recovery Ratings:	
	
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.	
	
Financial Covenants:	
	
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.

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