SPROTT SCHOOL OF BUSINESS
Tim Horton’s vs. Krispy
Kreme Donuts
Acquisition Project
11/26/2008
Adam Carr-Braint
Darren Crome
Geraldine Waffo
Mark Moskvitine
Nhi Dao
Matt Washburn
John Evans
100657210
100781890
100664197
100299223
100314701
100648274
100334780
Responsibilities:
Adam – Business Plan, Acquisition Plan: Q 9
Darren – Business Plan, Acquisition Plan: Q 1,2
Geraldine – Acquisition Plan: Q 7, 8, Appendix
Mark – Business Plan, Acquisition Plan: Q 3, 7, 8
Nhi – Acquisition Plan: Q 4-6
Matt – Business Plan, Acquisition Plan: Q 9, Editor
John – Business Plan, Appendix
Executive Summary_______________________________________________
_
“Tim Horton’s Inc. is a quick service restaurant chain in Canada. Its offerings include a
range of consumer tastes, with a menu that includes premium coffee, flavored cappuccinos,
specialty teas, home-style soups, fresh sandwiches and fresh baked goods, including its
trademark donuts. Its primary business model is to identify potential restaurant locations,
develop restaurants on suitable sites, and make these new restaurants available to approved
franchisees. As of December 30, 2007, franchisees operated 97.8% of its system restaurants. It
directly owns and operates (without franchisees) 30 restaurants in Canada and 42 restaurants in
the United States. It also has warehouse and distribution operations that supply paper and dry
goods to its Canadian restaurants, and supply frozen baked goods and some refrigerated products
to most of the Company’s Ontario restaurants. In the United States it supplies similar products to
system restaurants through third-party distributors.”1
While Tim Horton’s has a dominate presence in Canada it is lacking in brand recognition,
market share, and exposure within the United States. With thousands of stores currently in
Canada their expansion will inevitably begin declining in the near future. With only a minor
presence in the U.S. we feel it is necessary for Tim Horton’s to further enter the market using an
alternative means other than opening independent stores. We propose they enter the market
through an established business line. By doing this the firm can expand faster, more efficiently
and at lower costs. Particularly we have identified Krispy Kreme Donuts as our target. Doing
business with a premier company such as this allows the value attached to the quality recognition
which Krispy Kreme doughnuts enjoys to be combined with that attached to the quality of Tim
Horton’s coffee and food products. It also allows several extra beverage products to be added to
the Tim Horton’s line up including the variety of Krispy Kreme Chillers.
To facilitate this transaction between the two firms we are proposing a friendly takeover
of Krispy Kreme. Implementing a friend takeover strategy will help the company to avoid
litigation during the fight for control of the target, and also prevent a bidding war and
overpayment for the target. The offer will be an all-cash offer. We intend to offer golden
parachutes to the targets management to aid in a smooth transition keeping both parties satisfied.
1
http://finance.google.com/finance?q=TSE%3ATHI
We intend to initiate first contact in January of 2009 and project post-integration to be realized
two years following the takeover.
Acquiring Krispy Kreme will provide Tim Horton’s a vehicle for expansion outside
Canada. It large exposure, strong brand name and compatible culture make it an attractive
takeover target for Tim Horton’s. Furthermore, Krispy Kreme has an international presence
which may prove lucrative in future opportunities.
exposure to a pre-existing customer base.
Additionally, Tim Horton’s will gain
Moreover, synergies will be created through
economies of scale, creating improved profit margins. As well, the integration of the Tim
Horton’s product line with that of Krispy Kreme will add value to both brands. For instance, it
allows the value attached to the quality recognition which Krispy Kreme doughnuts enjoys to be
combined with that attached to the quality of Tim Horton’s coffee and food products.
Business Plan
Industry
_______________________________________________
_
Tim Horton’s competes in the quick service restaurant industry. Companies that operate
in this industry provide a casual eating experience, at affordable prices, in a timely manner. The
QSR is composed of many types of product lines ranging from burgers to pizza and everything in
between. This industry can be broken into six segments; breakfast/brunch, morning snack,
lunch, afternoon snacks, dinner and evening snacks. Tim Horton’s appeals to a wide range of
consumers, with a menu that includes premium-blend coffee, flavored cappuccinos, specialty
teas, home-style soups, fresh sandwiches, yogurt and berries, and fresh baked goods.
Their
primary product offering is their coffee and donuts. As well, they offer an experience that ranges
from a causal sit down environment to a speed-oriented drive through service. They operate in
communities across Canada and the US. They operate stores everywhere from independent
locations to kiosk in various locations such as Hospitals and universities. Tim Horton’s operates
in a $22.8B industry, where they compete against hundreds of companies. The size and strength
of these companies vary by region, and there are numerous competitors in nearly every market in
which they conduct business. The competition within the quick service restaurant market is
based on a number of key facts, product quality, concept, atmosphere, customer service,
convenience and price. Competition in both Canada and the U.S. continues to intensify as
competitors expand menu offerings, new players enter the market, and quick service restaurants
begin to offer specialty coffee and other coffee-based beverages and baked goods. The growth in
this industry is at 8% and while it has been growing rapidly over the past number of years, with
the current economic uncertainty, disposable income will be decreasing having a direct impact
on their business paradigm.
External Analysis
_______________________________________________
_
Customers
The main point in analyzing the customer base of a particular company is to find out
whether the customers have an impact on that company’s prices. In other words we must find if
the customers exert control over our company. This may occur if a company has a single or a
few large customers, who are able, through leveraging the company’s dependence on them,
dictate the prices at which they are able to buy the company’s products. For Tim Horton’s this is
not the case. Tim Horton’s is a retail business, caters to the end-consumer and has a very large
consumer base. Even though Tim Horton’s depends on its customers it does not depend on any
single customer, therefore power of customers in our case is low.
Competition
Tim Horton’s is a company in a quick service restaurant industry, one of many
companies and 4th in terms of market capitalization. There are many privately held companies.
The quick service restaurant industry is highly competitive. Tim Horton’s competes with fast
food chains such as McDonalds, Yum Brands and Wendy’s, and also with coffee specialty and
baked goods companies such as Starbucks and Country Style. There are many smaller, local
firms competing in the industry as well. The companies we have indicated as main competitors
and therefore have chosen for review are McDonalds Corporation, Yum Brands Inc, and
Starbucks Corporation. The competition in this industry is extremely intense and it is vitally
important for the company to consider the actions of competitors and perform continuous
competitior analysis.

McDonalds Corporation
McDonalds Corporation is the largest company in the quick service restaurant sector.
Being the largest market capitalization company, McDonalds wields extensive resources and a
deep market penetration in the Canadian market. Although in Canada Tim Horton’s has an
appeal of a local company, which may put it slightly ahead of American companies such as
McDonalds, this advantage disappears for Tim Horton’s’ US operations. While Tim Horton’s
strives to develop a reputation for homemade breakfasts and lunches, McDonalds has been
expanding its own menu with the intent of satisfying the changing eating habits of its customers.
Specifically, McDonalds has several menu items intended to cater to customers looking for
healthier alternatives to the traditional fast food. McDonalds has coffee and a wide selection of
breakfast sandwiches that directly compete with similar items on Tim Horton’s’ menu. In
addition, McDonalds has an extensive experience of multinational expansion and much wider
restaurant network around the world. This means that McDonalds’ operations are less susceptible
to economic shocks in one particular country, unlike Tim Horton’s which is primarily located in
Canada.

Yum Brands Inc
Yum Brands is the largest company in terms of system restaurants and second largest in
terms of market capitalization. Yum is a collection of several known franchises, such as KFC,
Taco Bell, Pizza Hut and Long John Silver’s. These are extremely popular franchises with solid
penetration in Canada and other countries. Yum Brands has been successful in developing its
business in China, a very large growing market. Yum Brands is especially interested in growing
its business in emerging markets because of large untapped potential of these. According to Yum
Brands annual report for the year 2007 there are more than 500 million cell phone subscribers in
China presently, which indicates the buying potential and the speed of embracing new concepts
in that country. Yum Brands’ main strategy is to build a leading franchise in every category, such
as Chicken (KFC), Fish (Long John Silver’s), Hamburgers (A&W) and Pizza (Pizza Hut). Such a
diversified company is already an indirect threat to Tim Horton’s, because they share the
customer base, and potentially also because they may diversify further into a Coffee brand and
compete directly in the same business.

Starbucks
Starbucks is an American-based company which similarly to Tim Horton’s, focuses on
coffee products. Unlike Tim Horton’s, however, Starbucks’ emphasizes a greater selection of
coffee-related products such as Italian-style espresso beverages, cold blended beverages and a
variety of complementary goods. Starbucks also sells coffee-related accessories and equipment,
a selection of teas, bottled beverages, compact discs and other specialty products. While
Starbucks concentrates on coffee and coffee-related products more closely than Tim Horton’s, it
is constantly developing new products and Starbucks’ decrease in operating margins in recent
years insures that the company will become even more competitive.
Barriers to Entry
The Fast-food restaurant industry is one that places importance on efficiency and
maintenance of low prices. This is achieved through significant economies of scope and scale
and requires significant investments to develop. For Tim Horton’s economies of scale are
achieved with a single large factory producing par-baked doughnuts and timbits to all Tim
Horton’s stores, which then finish the baking products. The enormous fixed costs associated with
investing in such a factory are spread out by the amount of stores, thus being minimized. Single
corporate office and marketing department allows Tim Horton’s to achieve economies of scope
by designing a single marketing strategy and product development for all the stores. These
economies would not be as easily achievable by a small start-up company, thus the barriers of
entry are high. Because of the high barriers, the threat of new entrants is low.
Substitutes
Tim Horton’s is in the quick service restaurant industry, which is an industry that
depends on customers having enough disposable income to spend it on elastic services such as
trips to a restaurant. Although this industry maintains comparatively low prices, customers have
an option to cook comparable foods within their own homes. Wide selections of donuts and
other baked goods are available from take-out specialty bakeries and large stores. Coffee
products can also be purchased in stores and prepared at home. Tim Horton’s has moved in to
compete with the grocery stores to sell their own brand of packaged coffee that can be prepared
at home. Another viable substitute for the quick service restaurant industry is the restaurants not
considered quick service. Such restaurants offer another choice for what essentially is the same
customer segment, while offering slightly different services. These firms differ from fast food
restaurants in that they offer more services, such as waiters/waitresses and larger menus, but also
have larger prices. Ultimately it comes down to a customers own choices and preferences. They
have a choice between the convenience and savings of fast-food restaurants and the service of
the regular restaurants. The fact that both types compete for the same customers further increases
the pressure on quick service restaurants to maintain their competitive advantage – low prices.
Suppliers
Tim Horton’s restaurants achieve their speed of production through a process of cooking
par-baked doughnuts and timbits.
These products are prepared in Brantford, Ontario at
Maidstone Bakeries, a joint venture between Tim Horton’s and IAWS Group, a provider of stateof-the-art cooking equipment. Maidstone Bakeries is the sole producer of par-baked doughnuts
and timbits for all Tim Horton’s locations. The processes of manufacturing at the Maidstone
Bakeries are proprietary and according to Tim Horton’s annual report alternate suppliers for
these par-baked products are not readily available, although Tim Horton’s keeps several weeks
worth of goods in the supply chain. Except for the above-mentioned products Tim Horton’s
keeps ready alternate suppliers for all other products.
Tim Horton’s chain restaurants purchase their coffee from Tim Horton’s Maidstone
Coffee plant although there are other coffee suppliers. Maidstone plant blends and roasts coffee,
which is then distributed along with other components such as sugar paper goods and other
restaurant suppliers to the chain locations. Tim Horton’s has multiple suppliers for each of these
components to reduce the risks. The coffee is bought on the market and Tim Horton’s
continuously monitors prices for unroasted coffee and coffee futures to insure sufficient volumes
at appropriate prices. Based on this we conclude that suppliers exert no control over Tim
Horton’s as they are both plentiful and easily replaceable, or owned by Tim Horton’s, however
the prices are not controllable by Tim Horton’s, so Tim Horton’s is entirely dependent on the
market prices and can only hedge them in the short-term by using future contracts.
Internal Analysis
_______________________________________________
_
Strengths
Tim Horton’s has several strength that give them an advantage over their competitors, they are:

The Brand
Tim Horton’s is one of Canada’s most recognizable names. They have been able to
engrain themselves in the Canadian culture by providing high-quality products at reasonable
price in a friendly environment.

Distribution
The vertically integrated manufacturing and distribution capabilities allow them to
improve product quality and consistency, facilitate the expansion of our product offering,
allow control of product availability and time delivery, provide economics of scale and labor
efficiencies and generate additional sources of income

Market Share
Tim Horton’s represents 42% of the QSR traffic with its busiest times being during the
breakfast/bunch time (63.9% of QSR traffic) and AM snack time (74.9% of QSR traffic)2.

Rental Income
Rental income is tied to the performance of individual restaurants, showing franchisees
that we are supportive of their success, because, even more than in many other franchise
arrangements. Allows for increase rental income as franchisees grows.

Customer Loyalty
Customer loyalty that was achieved through deep connection with customers on a level
enjoyed by very few companies.

Coffee Sustainability3
They work directly with their coffee farmers to improve living conditions and teach
sustainable coffee growing practices in Central and South America. They provided the
technical support and training to help them increase the amount and quality of coffee they
produce. This program that has been setup, allows Tim Horton’s a solid foundation with a
key partner in its supply chain.

Corporate Social Responsibility
Weaknesses
Unfortunately, like most business Tim Horton’s has some weaknesses, leaving themselves
vulnerable in various segments of their business, they are:

Rental income is tied to performance of individual restaurant franchises, therefore, if
restaurant sales decrease in any, or all, franchises, rental incomes decrease, this would not
happen with traditional rental agreements

The small size of each individual franchise operator, which account for 98.9% of
restaurants in Canada, carries with it, inherent firm size risks which are then passed on, to
a certain extent, to the Tim Horton’s company.
2
3
http://media.corporate-ir.net/media_files/irol/19/195616/Investor_Presentation_Q2_2008.pdf
http://www.timhortons.com/en/about/reports.html page 9
o This is especially true if franchisees start cutting costs which could impact the quality
of the products they offer.

Many competitors in the US have significantly larger sales and number of restaurants that
are already well established in their markets.

Tim’s do not provide distribution services to its US franchisees, they may not receive the
same level of service and reliability as Canadian franchisees receive

The US market competitive conditions, consumer tastes and discretionary spending
patterns differ from Canadian.

The risks of having a single source of supply for certain food products/ingredients. The
inherit risk associated with this is for any unseen circumstance arise, they would have a
significantly negative impact throughout their stores in Canada.

Exchange rate risk associated with fluctuations. As the US dollar continues to appreciate
against the Canadian dollar, it affects a number of key areas within their business. Their
concern relates to cash flows results from purchases by Canadian operations in U.S.
dollars and payments from Canadian operations to U.S. operations

Transitioning their brand in the US
Tim Horton’s has spent forty years developing their brand towards Canadians. For them
to transpose these same values into the US will be simply.
Opportunities & Threats ________________________________________
__
Threats

Current economic environment:
o When economic downturns occur, people start cutting their discretionary spending
which could include bringing coffee and food from home, rather than purchasing it.

Failure of one franchisee to uphold the food safety standards could result in an incident
which would have a damaging effect on the entire brand.

The use of third party distributors to deliver products to the US restaurants. The risk of
dealing with unknown distributors to provide essential supplies.

Intense competition with a wide variety of restaurants on a national, regional, and local
levels, including quick service restaurants and fast-casual restaurants focused on
specialty coffee, baked goods and sandwiches

The main factors in competition revolve around product quality, concept, atmosphere,
customer service, convenience and price.

Complex environment, health and safety regulatory regimes and involve the risk of
environmental liability. The US may enact laws that would only allow cars to be idle for
certain period of time (focus on level of emissions)

Significant extent on the selection and acquisition of suitable sites, which are subject to
zoning, land use, environmental, traffic and transportation, land transfer tax and other
regulations
The effect of this is quite serious as finding new opportunities new favourable places for
stores will be difficult

Changing demographic patterns and trends, including neighbourhood or economic
conditions and traffic patterns, which may cause current restaurant locations to become
unattractive or not as profitable

Changing consumer preferences and spending patterns or a desire for a more diversified
menus

Changing health or dietary preferences and perceptions

Labour shortages

Increase labour and benefits cost due to competition, increased minimum wage
requirements and employee benefits
Opportunities

Self serve kioks allow for market penetration of the brand in areas that they are not well
know and provide opportunities for additional growth and development

Expanding to new locations such as office buildings and university campuses. With the
amount of competition within this industry many of high traffic areas have been
developed, that new locations are needed.

Provide convenient access both pedestrians and drivers with the flexibility in store size
and format.

Also locate stores in select rural and off highway locations to serve a broader array of
customers to further expand brand awareness

Delay in store openings for reasons beyond company control or lack of desirable real
estate locations available for lease at reasonable rates

Development of new technologies that allow firms to deliver their service/products in a
much more efficient manner
Mission / Vision
________________________________________
__
We have created an enduring and unique relationship with our customers, who, above all
else, place great importance on the value they receive at Tim Horton’s with great tasting, highquality products all delivered at a reasonable price in a friendly environment. We intend to
continue to focus on creating new products across our menu to meet our customers’ needs and to
increase same-store sales. We will continue to focus on innovation as an enabler in our business,
whether it relates to systems, technology or our people. We will also work actively to expand our
presence in growth markets in Canada while building out our core and adjacent markets in the
US.
Quantified Strategic Objectives
______________________________
Non Financial

The success of the firm depends substantially on the value of the Tim Horton’s brand, so
plan to continue expanding and investing in activities that will increase the brand value.

Identify potential restaurant locations, develop restaurants on suitable sites, and make
these new restaurants available to approved franchisees.

Strengthen third party distribution channels by making investments in the infrastructure,
technology.

To further develop franchise incentive programs to offer additional relief to franchises in
the US, where the brand is not yet established and where restaurants are
underperforming.
Financial

Increase Operating income by 10% over the next three years

Increase same store sales:
o Within Canada 4-6% over the next year
o Within US 2-4% over the next year

Increase number of restaurants per year (210-250):
o Canada:
120-140
o US:
90-110
Business Strategy

______________________________
Continuing to grow sales in our existing stores through:
o Increased product innovation, including healthy options

New products this year included “homestyle hash browns” and “hot lunch
sandwiches”
o Improving our operational standards, including the speed with which our customers
are served
o Target marketing initiatives focusing on continued strengthening of our brand in
Canada and highlighting the value of our products

Continuing the expansion of the Tim Horton’s empire in Canada, the US and other
markets through:
o Growing the number of our stores in major metropolitan centers, especially Western
Canada & Quebec where we are currently not as prominent as in other provinces
o Growing our International & US presence, especially in existing regions and those
adjacent

For example our recent expansion into Lansing, Michigan

Through utilising acquisitions, strategic alliances and expanding our nontraditional business models

Continuing our focus on the critical elements of our business model;
o Maintaining positive relationships with our franchisees
o Maintaining a controlling interest in our restaurant sites
o Developing potential and existing vertical integration opportunities
Implementation Strategy
_____________
_
With Tim Horton’s being a leader within its industry, we feel that acquisition of a
company in the US would be an excellent way for Tim’s to further develop their strategy of
expansion. Currently, their expansion into the US has been slow and methodical – where they
have focused on the Northeast region. So far this has been an excellent strategy for them
because in order for them to gain the success that they have in Canada they will have to find
some way of exporting their brand power into the US. Moving at a slower pace has allowed
them to manage problems that they confront. This is a key element in their expansion as any of
those challenges that they face will be challenges that they will need to overcome in other
markets.
Using this strategy of expansion will allow them to develop solutions and find
innovative ways to gain a competitive advantage. When examining the options of how to aid
their expansion in the US, we examined a number of different routes and found that an
acquisition would provide them with the best solution.
There are two key elements to why an acquisition would be the best approach:
1)
The fundamental solid business approach that Tim’s has developed will allow them to
examine companies that are both/or currently experiencing financial troubles and being
mismanaged. We feel that with the successful business plan that they have developed
over their forty four years of existence will allow them to dramatically improve another
company’s situation.
2)
An acquisition would allow Tim’s to take control of key physical properties that are
currently in prime traffic locations.
The quick service restaurant industry being as
competitive as it is, finding good opportunities in saturated markets will be an extremely
difficult problem to overcome. With an acquisition, Tim’s would allow them to gain
access to physical locations that they would otherwise not have the opportunity to.
Overall, the acquisition allows Tim’s a unique opportunity to grow their business within
the US and gain information about each market that they would otherwise not have the
opportunity to do.
Acquisition Plan
Plan Objectives

______________________________
Access to markets in the USA through an already established business. It is anticipated
that this will be a quicker and more cost effective approach than opening independent
stores.
o Joint Krispy Kreme & Tim Horton’s stores enable Tim Horton’s to access the preexisting customer base of Krispy Kreme and allow them to become acquainted with
Tim Horton’s products whilst offering them the same Krispy Kreme products that
have allowed Krispy Kreme to gain a strong presence in the USA and internationally.

Facilitate the Tim Horton’s objective of penetrating international markets through the
pre-established presence that Krispy Kreme has in many markets including;
o Canada, USA, Mexico, Australia, Indonesia, Japan, Philippines, Korea, Hong Kong,
& the UK
o Also allows Tim Horton’s to exploit the brand recognition that Krispy Kreme enjoys
internationally, which, in many countries, is almost at the level of hysteria when a
new store opens

Anticipated cost reductions in baking costs for a variety of products, including
doughnuts, through access to Krispy Kreme’s large scale production – Krispy Kreme
produces 1.3 Billion doughnuts every year.

Integration of the Tim Horton’s product line with that of Krispy Kreme allows expansion
of the existing offerings of both stores. It allows the value attached to the quality
recognition which Krispy Kreme doughnuts enjoys to be combined with that attached to
the quality of Tim Horton’s coffee and food products. It also allows several extra
beverage products to be added to the Tim Horton’s line up including the variety of
Krispy Kreme Chillers.
Timetable
______________________________
This is a tentative and best case scenario timeline. It assumes a friendly acquisition process
and that Krispy Kreme is cooperative towards the proposed acquisition. The acquisition process
would be decidedly different and could take substantially longer if a hostile approach is
necessary.

First Contact:
o Tim Horton’s CEO Don Schroeder will meet with Krispy Kreme CEO James H
Morgan to introduce him to the idea of a combined business
o Anticipated to require 1 Week, 23 Jan 2009 Deadline

Negotiation & signing of Confidentiality Agreement and Term Sheet with no-shop
provision
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require 1 Weeks, 6 Feb 2009 Deadline

Negotiation of terms and signing of Letter of Intent
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require 2 Weeks, 20 Feb 2009 Deadline

Negotiation of refined valuation, deal structure, due diligence & financial plan
o Executive Vice President of Operations Ronald M Walton (Valuation, Structure, &
Due Diligence), Executive Vice President & CFO Douglas R Muir (Financial Plan)
o Anticipated to require 11 Weeks, 8 May 2009 Deadline

Decide to Proceed or Abandon Deal
o CEO Don Schroeder & Executive VP of Operations Ronald M Walton in consultation
with the entire Board
o Anticipated to require 1 Week, 15 May 2009 Deadline

Integration Plan
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require 7 Weeks, 3 July 2009 Deadline

Closing
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require 4 Weeks 31 July 2009 Deadline

Post-Acquisition Integration
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require almost 1 year, 30 June 2010 Deadline

Post-Closing Evaluation
o Executive Vice President of Operations Ronald M Walton
o Anticipated to require 1 week per evaluation, evaluations to be completed 3, 6, 12, &
24 months after the deal is finalized
Resource & Capabilities
_
____________
Mr. Roland M. Walton is the EVP-Operation and COO of the firm. He is responsible for
operations in both Canada and the U.S. He joined the Company is 1997 as EVP-Operation and
manages operations, restaurant development and the growth strategy for the company. Before
coming to Tim Horton’s, he was Vice-President for Pizza Hut USA’s Central Division. Since he
joined the company, he has directly managed several acquisition activities for the company. In
1996-1997, he helped the firm acquire thirty-seven former Rax Restaurants locations in Ohio,
Kentucky and West Virginia. These were then converted to Tim Horton’s. During the first half
of the 2000’s, Mr. Walton also helped Tim Horton’s acquire thirty-five former Hardee’s stores
and 42 Bess Eaton coffee and doughnut restaurants in the U.S.
With his excellence of
professional knowledge and skill, especially his M&A experiences, Mr. Walton will continue to
bring success to this proposed acquisition.
The risk associated with the takeover lie in overestimating the value of the merger, for
example overestimating the value of the synergy and future growth potential. Because this is a
horizontal expansion Tim Horton’s is acquiring a company that is engaged in the same sort of
business and so possesses all the necessary expertise to run Krispy Kreme successfully.
According to Tim Horton’s annual report for the year 2007, the company intends to expand to
the U.S. markets even further, but acknowledges that these markets are different from Canada
and therefore there is a task of adapting Tim Horton’s for those markets. The success of this task
depends on the company’s ability to interpret the demands of these markets. The annual report
also states that while the growth rate of sales in the U.S. is higher than that in Canada (8.9% in
the U.S., 7.5% in Canada) the United States restaurants are less profitable that Canadian
restaurants and therefore finding franchisees for those locations would be more difficult.
Tim Horton’s financial risk lies in its ability to borrow additional funds while
maintaining their covenants established during their previous raising of debt. The company
raised over $350 million to finance in part its separation from Wendy’s in 2006 and mentions
repeatedly the presence of covenants associated with this debt. The debt is due in 2011, when
almost $300 million must be paid out. However, even with this current debt the company is
significantly underlevered. According to our calculations of optimal capital structure using
market value of equity, Tim Horton’s will have an optimal structure when debt ratio is at 50%.
Currently it is below 10%. This is presented by the following chart.
Tim Hortons Optimal Debt Level
$7,000
Firm Value ($ millions)
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Debt Ratio
This leads us to believe that Tim Horton’s has an untapped borrowing ability that will
allow it to borrow more than $2,500 million, which is more than enough to finance the
acquisition of Krispy Kreme valued at just over $1,000 million.
Debt
Beta
Ke
Bond
Interest
Tax
Kd (after-
WACC
Firm Value
Ratio
Rating
Rate
tax)
(mil)
0%
0.58
6.06%
AAA
4.84%
35.00%
3.15%
6.06%
5,460
10%
1.33
11.04%
AAA
5.40%
27.40%
3.92%
10.33%
6,035
20%
1.46
11.63%
AAA
5.40%
27.40%
3.92%
10.09%
6,247
30%
1.61
12.40%
A
6.15%
27.40%
4.46%
10.02%
6,315
40%
1.83
13.42%
A-
6.35%
27.40%
4.61%
9.90%
6,434
50%
2.13
14.85%
A-
6.35%
27.40%
4.61%
9.73%
6,603
60%
2.57
17.00%
B+
9.15%
27.40%
6.64%
10.79%
5,658
70%
3.32
20.58%
CCC
12.15%
27.40%
8.82%
12.35%
4,658
80%
4.82
27.77%
CCC
12.15%
27.25%
8.84%
12.62%
4,516
90%
10.36
54.36%
C
16.65%
17.68%
13.71%
17.77%
2,852
Tactics

_
____________
Management prefers that the combined business will be quickly integrated following
closing. Therefore, a friendly takeover is appropriate in this case. Moreover, friendly
acquisition will help the company to avoid litigation during the fight for control of the
target, and also prevent a bidding war and overpayment for the target.

Management requires 100% control interest over the company.

Due to the decline of the stock market and the volatility of the current environment and
the excess cash on hand, management prefers an all cash transaction.

Management is willing to share less than 30% of the projected synergies with the target
firm’s shareholders.

Management requires that the newly combined firms be able to earn Tim Horton’s cost of
capital (7.78 %)
Search Plan
_
__________
Search Criteria
Tim Horton’s Primary Search criteria is:

The target must be in the Quick Restaurant industry

The target should be well-known in the U.S market

The target should have many stores locations operated in the United States

Maximum purchased price is $500 million.
Search Strategy
There are four potential takeover candidates identified in the initial search, which are
Krispy Kreme Doughnuts Inc., Einstein Noah Restaurant Group Inc., Nathan's Famous Inc., and
Ark Restaurants Corp.
Krispy Kreme Doughnuts Inc. is a very well known brand of doughnuts in U.S since
1937. The company owns and franchises 449 Krispy Kreme doughnut stores in the U.S and
globally. Of which, 245 stores are in the United States, which account for 30.6 percent of the U.S
market share. Among those 449 doughnut stores, 105 of them are owned by the company and
344 stores are owned by franchisees. The company revenue is generated from three primary
sources: Company Stores (stores that company owns), Franchise (franchise fees and royalties),
and KK Supply Chain (vertically integrated supply chain). Company stores generate revenue
through production and distribution of doughnuts. Krispy Kreme also sells beverages such as
drip coffees, espresso-based coffees, coffee and non-coffee based frozen drinks, and fountain
beverages. Beside inside store sales, the company also distributes sales of fresh doughnuts to a
range of retail customers, such as convenience stores, grocery stores, mass merchants and other
food service through its direct store delivery system (DSD). The KK Supply Chain produces
doughnut mixes and manufactures the company's doughnut-making equipment, which are then
purchased by Company stores and Franchises. In addition, KK Supply Chain has two distribution
centers to provide supply to Krispy Kreme stores. KK Supply Chain also supports both Company
and franchisee stores regarding product knowledge, technical skills, control of production and
distribution processes.
Tim Horton’s Secondary Search criteria is:

Target must have large U.S market share to help Tim Horton to expand their market share
in the U.S.

The target has similar product lines to enhance economies of scale and achieve synergy
from the combined firm.

The target’s culture must be compatible with acquirer’s culture to facilitate the
integration between the two.
Target Selection
Krispy Kreme Doughnuts Inc. has been selected as the acquisition target, chosen for its
large market share in the U.S, recognized brand name, the culture’s compatibility, and the
number of store locations available in the U.S and also around the world.
The acquisition of Krispy Kreme Doughnuts would provide Tim Horton’s the vehicle to
expand its business outside Canada, especially to the U.S market. With 245 stores in the U.S, the
company could gain access to over 30 percent of the US market which is currently owned by
Krispy Kreme. Moreover, with over 204 stores across Europe and Asia, Tim Horton’s could be
more geographically diversified and therefore could reduce the business risk. For instance, there
has been a rising concern about health matter regarding Tim Horton’s products in North
America, this acquisition will allow the company to penetrate in other potential markets with less
hesitance to its products.
This acquisition will also allow Tim Horton’s to get access to the pre-existing customer
base of Krispy Kreme, and facilitate the brand awareness for Tim Horton in market outside
Canada. Acquiring a U.S based company like Krispy Kreme also gives Tim Horton’s a local
appeal in the U.S market to compete with its U.S rivals like McDonalds, Yum Brands Inc, and
Starbucks.
The similarity of products between the two companies will ensure that the economies of
scale will be take place in the combined firm and, will therefore improve the profit margin.
Moreover, the integration of the Tim Horton’s product line with that of Krispy Kreme will add
value to both brands. For instance, it allows the value attached to the quality recognition which
Krispy Kreme doughnuts enjoys to be combined with that attached to the quality of Tim
Horton’s coffee and food products.
Tim Horton’s is the leader in the Canadian market while Krispy Kreme has a more
powerful position in the U.S with over 30 percent of U.S market share. The combination of these
two will enhance the expansion for both companies into a market they have yet to be strong in.
One of the weaknesses of Tim Horton’s is that it currently does not provide distribution
services to its US franchisees. In the U.S, Krispy Kreme already has KK Supply Chain to
provide supplies for production, and supports for product knowledge and technical skills, control
of production and distribution processes to all of its stores. A successful acquisition will provide
existing Tim Horton stores necessary distribution service in the U.S.
Initial Contact
As the target is a publicly traded firm with hundreds of millions of dollars annual sales,
Tim Horton’s will have to make an initial contact with the target through an intermediary. In this
case, Tim Horton’s could use its investment bank, J.P. Morgan. Using an investment bank in this
case will protect the target and the transaction from adverse consequences resulted from the
rumors around the acquisition.
Tim Horton’s investment bank will contact Mr .James H.
Morgan, Chairman and also CEO of Krispy Kreme regarding the interest of Tim Horton’s to
purchase the company. During the initial contact, the company should prepare the necessary
legal documents including a term sheet and letter of intent to protect the rights and interests of
both parties during the transaction process.
Target Defenses
Krispy Kreme’s performance has been declining in the past few years. It has been
struggling with a declining donut sales, massive debt, and being investigated by federal
authorities regarding its accounting practices. Krispy Kreme’s management has shut down stores
for restructuring but still led to nowhere. The net loss has been ongoing since 2004 and the stock
price declined over 93% during the same period. This picture could give us an expectation that
the shareholders would like to sell their stocks to the acquirer while the target management with
the fear of loosing their jobs might dislike the offer and take actions to prevent the acquisition
from happening. As our management’s preference of a friendly takeover to avoid overpaying
and ensure smooth integration, we think a Golden Parachute could be used in this case in order to
get the target’s current management out of the way. By the completion of the acquisition, we will
put in place a better management team to manage the business at Kripy Kreme. As this strategy
will come with a cost, we propose that the exit package for target management which is two and
a half times the manager’s fiscal compensation and bonus to be realistic. Based on this, we could
then estimate the total cash required for payment to Krispy Kreme’s current management team,
which is composed of one CEO, one CFO and six Senior Vice Presidents. This would be $7.8
million ( see Figure A). In addition to this, they will also keep their stock options and the pension
package after the acquisition.
Figure A. Proposed exit package for Krispy Kreme’s management team
Title
Proposed
exit
package
James H. Morgan
CEO,
$760,283
Chairman
Douglas R. Mui
CFO
$844,705
Kenneth J. Hudson
SVP
$870,018
Jeffrey B. Welch
SVP
$1,200,368
Other
SVP
$4,140,770
Total
$7,816,143
Krispy Kreme currently pursues a Shark Repellant strategy as its takeover defense. As
stated in the company’s anti-takeover provision, “[Krispy Kreme’s] articles of incorporation,
bylaws and shareholder rights agreement contain several provisions that may make it more
difficult for a third party to acquire control of us without the approval of our board of directors.
These provisions may make it more difficult or expensive for a third party to acquire a majority
of our outstanding voting common stock. They may also delay, prevent or detering a merger,
acquisition, tender offer, proxy contest or other transaction that might otherwise result in our
shareholders’ receiving a premium over the market price for their common stock.”
The first Shark Repellant type is a Staggered Board. Krispy Kreme's bylaws states that its
board of directors must have not more than 15 nor less than nine members. Moreover, the board
of directors has authority to set the number of directors on the board. Members of the board are
divided into three classes and serve staggered three-year terms. As only one class is up for
reelection each year, anyone who wants to gain control of the board at Krispy Kreme will have to
wait at least two years to do so.
The second type of Shark Repellant of the company is an Advance Notice Provision.
Krispy Kreme's bylaws provide that shareholders must provide timely notice in writing 40 days
prior to the scheduled annual meeting of shareholders to bring business or to nominate
candidates for election as directors at an annual meeting of shareholders. These provisions allow
the company’s board to have enough time to select its own slate candidate or take action to
prevent potential takeover.
The third type of Shark Repellant is a Shareholder Rights Plan. This will be triggered if
anyone has acquired more than 15% of the company’s shares. The Right states “Krispy Kreme’s
board of directors has declared a dividend of one preferred share purchase right for each share of
Krispy Kreme common stock.
Each share purchase right entitles the registered holder to
purchase from Krispy Kreme one one-hundredth (1/100) of a share of Krispy Kreme Series A
Participating Cumulative Preferred Stock at a price of $96.00 per one one-hundredth of a Series
A preferred share . … Each Series A preferred share will have 100 votes, voting together with
the shares of common stock…At any time before an acquiring person acquires beneficial
ownership of 15% or more of Krispy Kreme’s outstanding common stock, its board of directors
may redeem the share purchase rights in whole, but not in part, at a price of $.001 per share
purchase right.” An agreement of this nature could discourage tender offers or other transactions
that might otherwise result in Krispy Kreme shareholders receiving a premium over the market
price for their common stock.
Negotiation Strategy
_
_
Buyers/Seller Issues
Due diligence will be conducted by both buyer and seller to accurately assess potential
risks and reward for each parties in this acquisition. In the mean time, there are specific issues
that the acquirer and target each face in this acquisition. Tim Horton’s will have to face the
challenge brought by the drastic underperformance of the targets recent years and be liable for
massive debt that the target currently has. Tim Horton’s must also establish a very careful due
diligence review regarding the accounting book of the target as the target’s accounting practices
were questioned by the authorities. The main issue Krispy Kreme has to consider in regard to
this acquisition is the loss of control and being operated under new management team. This
might negatively affect Krispy Kreme’s future performance as part of a combined firm.
Deal Structure
Acquisition Vehicle and Postclosing Organization
Krispy Kreme’s has a well established brand image with 70 years of history being in the
market. For this reason, Tim Horton’s would maintain the Krispy Kreme name after the
acquisition. According to Tim Horton’s management’s preference, the company would use
corporate structure as its acquisition vehicle to facilitate the change of ownership and take total
control of the target. To enhance the immediate integration after closing, the postclosing
organization in this case would also be corporate structure.
Form of Acquisition and Payment
The form of acquisition would be for Tim Horton to purchase all of Krispy Kreme’s
outstanding stock in order to gain control of all aspects of the company. The most appropriate
form of payment for Krispy Kreme is an all cash transaction due to several reasons. First, the
size of Tim Hortons is much larger relative to Krispy Kreme, and the healthy financial condition
with excess cash and high retained earnings will give the acquirer the ability to use cash to
finance the acquisition The decline of the current stock market has depreciated the acquirer’s
current share price which makes it not beneficial to use stock exchange transaction and also give
hesitance to shareholders to accept the stock offer. Moreover, being able to pay with cash will
help the company to save on costs of issuing new debt or securities. Cash payment will also help
to prevent the dilution of ownership of the bidder and prevent potential competitors from joining
in this transaction.
Tax Considerations
Implementing the all cash transaction will incur tax for target shareholders due to the
financial gain but provide the tax shield for the acquirer. Moreover, this tax shield will also
continue to take place in the future as there were net losses during the past few years for Krispy
Kreme. According to current accounting rules, Krispy Kreme would be able to offset future
income by the net loss occurred in the past within the specified period provided by the
government.
In the event that the initial offer is rejected by the seller, we would try to put some
consideration to what the seller expects. We could include things such as rights to intellectual
property, royalties from license, and employment agreement..Such arrangements should come
with reasonable agreements to protect the new combined company such as the former company
owner cannot compete in the same industry as their former firm. Moreover, we believe that the
likelihood that the initial offer being accepted is high. The underperformance of the target in the
past few years will give us an advantage to negotiate with the target shareholders in order to
obtain the majority share. The Golden Parachute will also help us to negotiate with target’s
management team and get their approval for this acquisition.
Purchase Price Estimate
_
The purchase price offer range can be between US $163 million and US $1,134M.
Indeed, the present value of the total synergies was found to be $971 million. As a result, the
purchase price per share can range between $3 and $17. Currently, Krispy Kreme is traded at
$2.5 and our valuations indicate that the stock is being underpriced as the intrinsic value should
be around $4. Given the risky nature of the acquisition in this current trouble economic time, the
initial offer price is set to $4 which represents a 60% premium. In fact, the target’s shareholders
will receive 10% of the estimated synergies. However, the maximum Tim Hortons should be
ready to pay for Krispy Kreme is estimated to be $5.5 since the deal will be cash only. All the
calculations including the financial statements and the list of all the assumptions are presented in
the Appendix.
Financing Plan
_
_
The financial health of Tim Horton’s is a favorable condition that enables the deal to be
done with cash. In that respect, the company will be able to acquire Krispy Kreme with a portion
of the retained earnings and debt. However, the bulk of the payment should come from is
retained earnings. Like mentioned in the valuation appendix, Tim Hortons long-term debt and
equity ratio is to remain at 40% which represent 28% debt over total capital ratio. Bearing in
mind this clause, the projected combined financial statements portray a rather optimistic view of
the takeover results. The target value of $276 million is relatively small compared to the firms
retained earnings of $367M in 2007. In addition, the importance of the synergies mitigates the
financing risk. However, it is important to note that Tim Horton’s cost of capital is likely to
increase after the merger is consummated. The reason behind this increase in WACC (from
5.78% to 7.78% almost as high Krispy Kreme’s WACC) is the fact that Krispy Kreme is a risky
company carrying a high amount of liability. But overall, Tim Horton’s financial health is not
likely to suffer drastically.
Integration Plan
_
_
We know that the majority of all mergers fail to add value; this is often due to a poor
integration plan. When bringing together two major companies such as Tim Hortons and Krispy
Kreme, it is important to have a well designed integration plan intact. A situation such as this,
where we intend to impose a friendly merger yet at the same time replace the upper management
of Krispy Kreme can cause a lot of resistance. With this in mind we propose the integration
process be completed over five stages.
Stage 1:
Appoint an integration team responsible for making the transition as smooth as possible.
Members of the integration team should be involved in the acquisition from the beginning to
ensure a full understanding of the synergies to be gained.
Stage 2:
Perform a full assessment of both firms corporate culture in order to distinguish the
similarities and differences in the values and practices of each company. It is important to align
the goals of the two companies without rejecting their values. As a combined company, it will
be important to create a new vision that outlines what direction the firm is heading.
Stage 3:
Once the merger has been successfully consummated, Krispy Kreme is to be treated as a
sub-ordinate of Tim Hortons. It is important to keep the name Krispy Kreme because it has very
strong brand recognition in the United States. Generally employees are resistant to change, by
keeping the same name and allowing Krispy Kreme to operate as a sub-ordinate, Tim Hortons
can hedge against this risk.
Stage 4:
Replace the existing management of Krispy Kreme due to their poor performance. This
step can be very controversial however, due to previously determined golden parachutes;
management will be more inclined to cooperate. In addition to this, it is important to create one
central headquarters. There is no need to have two head offices, by reducing to one there will be
lower overhead costs and thus greater profits.
Stage 5:
Integrate Krispy Kremes supply chain to correspond with Tim Hortons’. The underlying
supply chain that Krispy Kreme already utilizes can be expanded to incorporate the Tim Hortons
franchises that are located in the United States in order to keep prices low via economies of
scale. Once there is an established supply chain in the U.S. additional products can be added to
the Krispy Kreme lines such as; soups, sandwiches and other Tim Hortons products. In Canada,
Tim Hortons can utilize some of Krispy Kremes successful practices. For example, Krispy
Kreme sells pre-packaged “8 second donuts” in supermarkets and in stores which Tim Hortons
can sell alongside their ground coffee beans.
During each of the five stages it is highly important to communicate every action to each
and every employee of the organization as well as the shareholders. Lack of information sharing
may cause distrust, which can be detrimental to the integration process. Meetings should be
scheduled regularly with management, the integration team and the board of directors in order to
make sure the merger is headed in the right direction, and all relevant information from these
meeting be passed down to every individual of concern to the corporation.
In addition to satisfying the concerns of the employees, it is important to address the
customers concerns during the merger. It should be made evident to the customers that their
services will not be disrupted during the event and that the current products that they enjoy will
remain available to them in addition to the new and improved menu. Constant communication
with suppliers is also highly important. Due to the broader range of products, suppliers will have
to adjust their inventories accordingly and begin distributing supplies across the border.
Appendices
Appendix 1: List of assumptions for valuation
-
-
For both standalone valuations, the forecasted data is based on the average ratios from the
historical ratios.
We assume Krispy Kreme has not growth in the stable period whereas Tim Hortons’ growth
should reflect the overall economy growth forecasted to be 2.5%.
The cost of capital for the combined firm after the merger is likely to increase given the risky
financial health of Krispy Kreme. A 2% premium was added to Tim Hortons WACC to reflect this
increase.
The synergies will come from the fact that Tim Hortons will operate Krispy Kreme’s stores the
same way its own stores function. In that sense, Krispy Kreme cost of goods sold over sales ratio
which used to be 90% will be reduced by 33.9% to reflect the 57% cost of goods over sales ratio
Tim hortons presents. Likewise, the selling expenses over sales ratios are likely to be reduced by
2% given the economies of scales. Given that Tim Hortons will used Krispy Kreme facilities to sell
its own products or at least to extent to business lines, we expect sales to increase 3%. As far as
the integration expenses concerned, an allocation of $1 billion was made to account for all the
training and restructuring that will be put in place.
Appendix 2: Acquirer/Target 5-Year Forecast and Standalone Valuation (Step 1)
(A) Step 1: Target Historical Data and Ratios
Historical Ratios
Average
Minimum
Maximum
Net Sales Growth Rate
20.7%
11.7%
36.1%
Cost of Sales (Variable) / Sales %
57.0%
55.4%
57.9%
4.9%
3.7%
6.5%
10.9%
10.6%
11.2%
G&A Expenses / Sales (%)
6.8%
6.3%
7.4%
Interest on Cash & Marketable Securities
5.2%
1.9%
7.1%
Interest Rate on Debt (%)
8.2%
3.8%
9.1%
Depreciation & Amortization / Gross Fixed Assets %
Selling Expenses / Sales (%)
Tax Rate
35.0%
35.0%
35.0%
Other Current Operations Assets / Sales (%)
10.6%
9.9%
26.9%
0.6%
0.4%
0.8%
82.7%
69.5%
89.4%
9.4%
6.5%
11.7%
39.4%
13.5%
89.1%
-12.4%
-16.3%
-10.4%
59.5%
19.5%
110.2%
Other Assets / Sales (%)
Gross Fixed Assets / Sales (%)
Cash Balance / Sales (%)
Current Liabilities / Sales (%)
Capital Expenditures / Gross Fixed Assets
Debt / Equity
(B) Step 1 Continued: Acquirer Cost of Equity and Capital Calculations
Financial Benchmarks as of December 31, 2007
Prime
4.80%
10 -Year T-Note
4.09%
Commercial Paper 3-months
3.86%
Federal Funds Rate
4.25%
CD's 6 months
3.99%
Moody's A (corporate bond)
5.64%
Industry Long-term Debt/Equity
56.00%
Calculation of Cost of Equity and Capital
Risk-free Rate
Acquirer's Unlevered Beta
4.09%
Acquirer's Target D/(D+E) Ratio
28%
Acquirer's Target Tax Rate
35%
Acquirer's Levered Beta
0.60
Market Risk Premium
3.41%
Acquirer's Cost of Debt
7.50%
Acquirer's Cost of Equity
6.14%
Acquirer's Weighted Cost of Capital
5.78%
Additional Risk Premium
0.00%
Adjusted Cost of Capital
5.78%
(C) Step 1 Continued: Target Historical Data and Ratios
Historical Ratios
Average
Net Sales Growth Rate
Minimum Maximum
-15.1%
-23.2%
-6.9%
90.9%
89.0%
92.8%
4.7%
4.3%
5.3%
10.1%
5.5%
15.1%
4.9%
2.9%
6.5%
-14.2%
-19.2%
-7.6%
Tax Rate
-3.1%
-6.3%
0.6%
Other Current Operations Assets / Sales (%)
17.4%
12.0%
23.9%
8.3%
6.4%
9.9%
50.4%
36.3%
56.9%
5.2%
3.1%
7.8%
Cost of Sales (Variable) / Sales %
Depreciation & Amortization / Gross Fixed Assets %
Selling Expenses / Sales (%)
G&A Expenses / Sales (%)
Interest on Cash & Marketable Securities
Interest Rate on Debt (%)
Other Assets / Sales (%)
Gross Fixed Assets / Sales (%)
Cash Balance / Sales (%)
Current Liabilities / Sales (%)
21.1%
10.1%
29.2%
Capital Expenditures / Gross Fixed Assets
-26.1%
-68.4%
10.8%
Debt / Equity
103.4%
37.8%
134.2%
Debt/Sales
0.187773
Investment/Sales
0.008975
Other Liabilities/sale
0.45503
(D) Step 1 Continued: Target Cost of Equity and Capital Calculation
Financial Benchmarks as of December 31, 2005
Prime
7.25%
10 -Year T-Note
4.63%
Commercial Paper 3-months
4.22%
Federal Funds Rate
4.25%
CD's 6 months
5.23%
Moody's A
5.56%
Calculation of Cost of Equity and Capital
Risk-free Rate
4.63%
Acquirer's Unlevered Beta
0.44
Acquirer's Target D/(D+E) Ratio
54%
Acquirer's Target Tax Rate
35%
Acquirer's Levered Beta
0.60
Market Risk Premium
2.87%
Acquirer's Cost of Debt
14.20%
Acquirer's Cost of Equity
6.35%
Acquirer's Weighted Cost of Capital
7.91%
Appendix 3: Combined Firm's 5-Year Forecast and Valuation (Step 2)
Step 2 Continued: Synergy Estimation
Incremental sales due to
synergy
Percentage of Tim
Hortons sales
3.00%
3.50%
4.00%
4.50%
5.00%
66,113
87,708
113,79
8
145,93
2
184,41
8
33.90%
33.90
%
33.90%
33.90%
33.90%
109,38
3
92,877
78,862
66,961
56,857
2.00%
2.00%
2.00%
2.00%
2.00%
739
628
533
453
384
181,213
193,193
213,345
241,659
Cost of Sales Synergy
Aligning to Tim hortons
cost of s. /sales
Saving 33.9 from Krispy
Kreme COS
Selling Expenses Synergy
Aligning to Tim hortons
Sel. exp./sales
Saving 2% from Krispy
Kreme S&A
1000.0
Integration expense
Grand total in
Thousands
Appendix 4: Offer Price Determination (Step 3)
(A) Offer Price Supporting Data
175,235
Acquirer Share Price
$
21.19
Target Share Price
$
2.50
Proposed % of Synergy Shared with Target
10.00%
Acquirer Shares Outstanding (Mil)
188
Target Shares Outstanding (Mil)
65.4
Cash Portion of Offer Price (%)
100
Consolidated
Acquirer +
Target
Standalone Value
Acquirer
Target
Discounted Cash Flow Valuations ($Mil)
$
9,241
266
Minimum Offer Price (PVMIN) ($Mil)
$
163
3
Maximum Offer Price (PVMAX) ($Mil)
$
1,134
17
Initial Offer Price ($Mil)
$
261
Initial Offer Price Per Share ($)
$
3.99
Purchase Price Premium Per Share
Cash Per Share ($)
Share Exchange Ratio
New Shares Issued by Acquirer
Total Shares Outstanding Acquirer after
59%
$
3.99
0.00
0.000
188.465
Without
Synergy
(1)
With
Syner
gy (2)
$
9,507
$
10,47
8
Value
of
Synerg
y
PVNS (1)
- (2)
$
971
acquisition
(B) Weighted Average Valuation
Calculation
Value
Weighting Factor
Weighted
Value
Discounted Cash Flow Valuation
265.53
50% 132.76
Comparable Firms - Earnings
Valuation 3)
108.93
25% 27.23
376.91
25% 94.23
Comparable Firms - Sales Valuation
3)
Weighted Average Valuation
Offer
Price
% Shared
$millions
Synergy
202
4%
261
10%
455
30%
552
40%
649
50%
746
60%
$254.22
843
70%
(C) Step 3 Continued: Alternative
Valuation Summaries
As of 12/31/07
As of 12/31/07
PRICE/SALES VALUATION
PRICE/ EARNINGS
VALUATION
PRICE/S
ALES
COMPARABLE COMPANIES
COMPARABLE COMPANIES
P/E
Starbucks
0.5
Starbucks
18.4
McDonalds
2.5
McDonalds
13.9
Yum Brands
0.9
Yum Brands
12.3
Wendys
1.1
Wendys
25.4
Denny's
0.2
Denny's
4.2
TOTAL
5.2
TOTAL
74.3
AVERAGE
1.0
AVERAGE
14.9
TARGET PROJECTED SALES (2001)
364517.7
TARGET PROJECTED
EARNINGS (2001)
PROJECTED VALUE OF TARGET (In Thousands)
376911.3
PROJECTED VALUE OF
TARGET (In millions)
$
376.91
Appendix 5: Combined Firms' Financing Capacity (Step 4)
7333.2
108927.3
$
108.93
Projected Financials
2008
2009
2010
2011
2012
Income Statement
($Thousands)
Net Sales
2,634,386
2,903,175
3,221,565
3,612,006
4,062,253
Less: Cost of Sales
1,459,281
1,597,887
1,757,731
1,958,057
2,188,264
Gross Profit
1,175,105
1,305,288
1,463,834
1,653,949
1,873,990
Less: Sales, General & Admin.
Exp.
(457,747)
(4,499,052)
(4,977,286)
(5,568,052)
(6,248,505)
Integration Expenses
1,000
Operating Profits (EBIT)
717,358
822,951
950,581
1,099,946
1,275,808
Plus: Interest Income
11,701
14,249
14,452
16,877
19,161
Less: Interest Expense
32,641
33,024
42,320
41,844
45,415
Net Profits Before Taxes
696,418
804,176
922,713
1,074,979
1,249,554
Less: Taxes
197,350
226,670
256,063
291,531
332,491
Net Profits After Taxes
499,068
577,506
666,650
783,448
917,063
Earnings per share ($/Share)
$
2.65
$
3.06
$
3.54
$
4.16
$
4.87
Balance Sheet (12/31)
Current Assets
Cash & Marketable Securities
225,083
231,163
245,464
293,633
322,525
Other Current Assets
297,575
326,066
345,506
385,017
427,323
522,659
557,230
590,970
678,650
749,848
Gross Fixed Assets
2,007,218
2,174,089
2,340,067
2,716,233
3,026,734
Less: Accumulated Depreciation
(530,614)
(625,229)
(740,279)
(869,252)
(1,018,154)
Net Fixed Assets
1,476,603
1,548,860
1,599,788
1,846,981
2,008,580
Other Assets
267,567
305,626
333,191
379,600
427,763
Total Assets
1,932,671
1,999,037
1,937,649
2,200,217
2,347,524
Current Liabilities
396,015
428,206
458,209
513,253
568,868
260,240
260,240
260,240
260,240
260,240
Other Liabilities
70,741
75,540
80,487
86,863
93,784
Common Stock
650,600
650,600
650,600
650,600
650,600
Retained Earnings
555,075
584,450
488,113
689,261
774,032
Shareholders' Equity
1,205,675
1,235,050
1,138,713
1,339,861
1,424,632
Total Liabilities+Shareholders'
Equity
1,932,671
1,999,037
1,937,649
2,200,217
2,347,524
Total Current Assets
Long-term debt
Exiting Debt
D/E
40%
40%
40%
40%
40%
D/(D+E)
28%
28%
28%
28%
28%
Cash Flow statement
2008
2009
2010
2011
2012
499067.90
577505.51
666650.46
783448.25
917063.16
98364.5
109176.5
127414.3
139471.9
157816.7
126644.2
129023.6
132760.9
165396.9
180979.9
470788.2
557658.4
661303.9
757523.2
893900.0
72714.8
9987.7
16855.3
24801.4
46203.4
504217.8
166870.9
165978.1
376165.9
310501.5
576932.6
176858.5
182833.4
400967.3
356704.9
-973437.3
-728437.2
-829836.9
-1110321.1
-1221713.2
74283.4
6079.8
14300.4
48169.5
28891.7
150800.0
225083.4
231163.3
245463.6
293633.1
Cash Flow from Operating Activities:
Net Income to Common
Adjustments to Reconcile Net Income to Net Cash Flow
Depreciation
PIK Preferred Dividends
Net Change in Working Capital
Net Cash Flow from Operations
Cash Flow from Investing Activities
(Increase) Decrease in Invest Available for Sale.
(Increase) Decrease in Gross Property, Plant & Equip.
Net Cash Used in Investments
Cash Flows from Financing Activities:
Net Debt (Repayment) or Issuance
Net Cash (Used in) Provided by Financing Activities
Net Increase (Decrease) in Cash & Marketable Securities
Beginning Balances--Cash & Marketable Securities
Ending Balances--Cash & Marketable Securities
225083.4
231163.3
245463.6
293633.1
322524.8
Appendix 5: Tim Hortons’ Financial Statements
Projected Financials
2008
Income Statement ($mil)
Net Sales
2009
2010
2011
2012
-
2,204
2,506
2,845
3,243
3,688
Variable Cost of Sales
1,148
1,308
1,477
1,688
1,920
Depreciation
90
102
121
134
153
Total Cost of Sales
1,237
1,410
1,598
1,822
2,073
966
1,096
1,247
1,421
1,615
Sales Expense
240
271
307
352
399
G&A Expense
150
167
187
217
245
Amortization of
Intangibles
-
-
-
-
-
Other expense
(income), net
-
-
-
-
-
Total Sales and G&A
Expense
391
438
494
568
644
Operating Profits (EBIT)
576
659
753
852
971
Less:
Gross Profit
Less:
Plus: Interest Income
11
13
14
16
19
Less: Interest Expense
23
25
35
36
40
Net Profits Before Taxes
563
647
731
833
950
Less: Taxes
197
226
256
291
332
Net Profits After Taxes
366
421
475
541
617
Cash
206
215
232
282
313
Other Operating Assets
234
272
300
346
394
Total Current Assets
440
487
532
628
707
Investments
181
192
209
234
281
Gross Fixed Assets
1,823
2,018
2,208
2,604
2,931
Less: Accum. Depr. &
Amort.
(474)
(576)
(698)
(832)
(985)
Net Fixed Assets
1,349
1,442
1,510
1,772
1,946
Other Assets
234
272
300
346
394
Total Assets
1,764
1,906
2,019
2,352
2,621
Balance Sheet (as of
12/31/2005)
Current Assets
Current Liabilities
319
363
403
466
529
Long-Term Debt
297
347
501
554
660
Existing Debt
280
308
417
436
490
Other Liabilities
47
56
64
73
82
Total Liabilities
664
766
967
1,093
1,271
New Debt
Common Stock
Retained Earnings
295
295
295
295
295
806
845
757
965
1,055
Shareholders' Equity
1,101
1,140
1,052
1,260
1,350
Total Liabilities & Shareholders'
Equity
1,764
1,906
2,019
2,352
2,621
Addendum: Check
1
Shares Outstanding
(millions)
Effective Tax Rate
Earnings per Share
5
188
188
188
35.0%
35.0%
35.0%
35.0%
35.0%
$
2.23
$
2.52
27%
124
Free Cash Flow
EBIT (1-t)
4
188
25%
121
3
188
$
1.94
Long-Term Debt/Equity
Addendum: Working
Capital
2
$
2.87
40%
129
$
3.28
35%
162
36%
178
FREE CASH FLOWS
374
428
489
554
631
Plus: Depreciation and
Amortization
Less: Gross Capital
Expenditures
Less: Change in Working
Capital
90
102
121
134
153
-140.4
-140.4
-140.4
-140.4
-140.4
61
3
4
33
16
263
386
466
515
628
PV of CF
248
345
393
411
474
PV: 2008 - 2012
1,872
PV: Terminal Value
7,585
Total PV (Market Value of the
Firm)
9,458
Less: Market Value of Long-Term
Debt
326
Plus: Excess Cash
(Investments)
110
Equity Value
9,241
Equity Value per Share
49
Free Cash Flow
Cash flows from operating activities
Net
Income
Adjustmen
ts
2008
2009
2010
2011
2012
232,34
5
246,27
8
260,70
5
275,57
1
290,80
1
Depreication
87,775
92,163
96,772
101,61
0
106,69
1
10,272
7,683
9,220
11,064
13,276
965
644
429
286
191
-7,878
-8,744
-9,706
-10,774
-11,959
Goodwill and asset impairment
Stock based compensation
expense
Equity income
Deferred income taxes
Changes in operating
assets/liabilities
Settlement of hedges
-
-
-
-
-
Other, net
23,094
24,248
25,461
26,734
28,071
Net cash provided from
operations
346,57
4
362,27
3
382,88
0
404,49
1
427,07
1
171,26
0
191,84
5
203,49
9
215,49
3
227,84
6
8,285
10,108
12,331
15,044
18,354
Investments in joint ventures
426
304
217
155
111
Loans to Wendy's
-
-
-
-
-
12,399
13,143
13,931
14,767
15,653
150,15
0
168,29
0
177,01
9
185,52
6
193,72
8
2,666
2,746
2,828
2,913
3,000
Cash flows from investing activities
Capital Exenditures
Principal payments on notes receivable
Issuance of notes receivable
Net Cash Used in Investing
Activities
Cash flows from Financing Activities
Proceeds from issuance of debt
Proceeds from share issuance
-
-
-
-
-
Share issuance costs
-
-
-
-
-
Purchase of common stock
-65,056
113,58
4
119,26
3
125,22
6
131,48
8
-5,952
-6,894
-5,698
-4,709
-3,891
-58,152
-63,967
-70,363
-77,400
-85,140
Tax Sharing payment from Wendy's
-
-
-
-
-
Repayment of borrowing from Wendy's
-
-
-
-
-
Purchase of Treasury stock
Purchase of common stock held in trust
Dividend Payments
Principal payments on other LT debt
obligatoins
-4,466
-4,913
-5,404
-5,944
-6,539
130,96
0
186,61
2
197,90
0
210,36
6
224,05
7
Increase(Decrease) in cash and cash
equivalents
65,464
7,371
7,961
8,598
9,285
Cash and cash equivalents at beg of year
157,60
2
92,138
99,509
107,47
0
116,06
8
Cash and cash equivalents at end of year
92,138
99,509
107,47
0
116,06
8
125,35
3
Net Cash Used in Financing
Activities
Appendix 5: Krispy Kreme’s Financial Statements
Projected Financials
2008
2009
2010
2011
2012
364,518
309,511
262,805
223,148
189,474
Income Statement ($Thou)
Net Sales
Less:
Variable Cost of Sales
322,663
273,973
232,630
197,525
167,718
8,575
7,281
6,182
5,249
4,457
331,238
281,254
238,812
202,775
172,176
33,279
28,257
23,993
20,373
17,298
36,966
31,388
26,651
22,630
19,215
36,966
31,388
26,651
22,630
19,215
(3,687)
(3,130)
(2,658)
(2,257)
(1,916)
Plus: Interest Income
1,074
912
774
657
558
Less: Interest Expense
(9,729)
(8,261)
(7,014)
(5,956)
(5,057)
7,116
6,042
5,130
4,356
3,699
Depreciation
Total Cost of Sales
Gross Profit
Less:
Sales Expense
G&A Expense
Amortization of Intangibles
Other expense (income), net
Total Sales and G&A Expense
Operating Profits (EBIT)
Net Profits Before Taxes
Less: Taxes
Net Profits After Taxes
(218)
(185)
(157)
(133)
(113)
7,333
6,227
5,287
4,489
3,812
Cash
18,813
15,974
13,564
11,517
9,779
Other Operating Assets
63,408
53,840
45,715
38,817
32,959
82,222
69,814
59,279
50,334
42,738
3,272
2,778
2,359
2,003
1,701
183,770
156,038
132,492
112,499
95,522
(56,225)
(48,944)
(42,762)
(37,512)
(33,055)
Balance Sheet
Current Assets
Total Current Assets
Investments
Gross Fixed Assets
Less: Accum. Depr. & Amort.
Net Fixed Assets
239,995
204,982
175,254
150,011
128,577
Other Assets
33,400
33,400
33,400
33,400
33,400
Total Assets
273,395
238,382
208,653
183,411
161,977
76,776
65,190
55,353
47,000
39,908
68,446
58,118
49,348
41,901
35,578
23,265
19,755
16,774
14,242
12,093
Current Liabilities
Long-Term Debt
Existing Debt
New Debt
Other Liabilities
Total Liabilities
168,488
Common Stock
143,062
121,474
103,143
87,579
355,600
355,600
355,600
355,600
355,600
Retained Earnings
(250,693)
(260,280)
(268,421)
(275,333)
(281,202)
Shareholders' Equity
104,907
95,320
87,179
80,267
74,398
273,395
238,382
208,653
183,411
161,977
65,370
65,370
65,370
65,370
65,370
-3.1%
-3.1%
-3.1%
-3.1%
-3.1%
Total Liabilities & Shareholders' Equity
Addendum: Check
Shares Outstanding
Effective Tax Rate
Earnings per Share
Addendum: Working Capital
$
0.11
$
0.10
$
0.08
$
0.07
$
0.06
5,446
4,624
3,926
3,334
2,831
(3,800)
(3,226)
(2,739)
(2,326)
(1,975)
8,575
7,281
6,182
5,249
4,457
(27,731)
(23,547)
(19,993)
(16,976)
Free Cash Flow
EBIT (1-t)
Plus: Depreciation and Amort.
Less: Gross Capital Expenditures
27,970
Less: Change in Working Capital
(27,454)
(822)
(698)
(592)
(503)
4,260
32,608
27,687
23,509
19,962
Free Cash Flow
PV: 2008 - 2012
8497379%
PV: Terminal Value
252,483
Total PV (Market Value of the Firm)
337,457
Less: Market Value of Long-Term Debt
75,200
Plus: Excess Cash (Investments)
Equity Value
Equity Value per Share
3,272
265,528
4
Cash Flow Statement
Projections: Twelve Months Ended December 31
2008
2009
2010
2011
2012
7,333.2
6,226.6
5,287.0
4,489.2
3,811.7
8575.0
7281.0
6182.3
5249.4
4457.2
27454.1
-821.8
-697.8
-592.5
-503.1
43362.3
14329.
4
12167.
1
10331.
0
8772.1
(1271.6)
493.7
419.2
355.9
302.2
(27969.
7)
27731.
2
23546.
5
19993.
3
16976.
3
(29241.
3)
28224.
9
23965.
7
20349.
2
17278.
5
20007.7
45393.
3
38543.
4
32727.
1
27788.
5
(5886.7)
(2839.0
)
(2410.6
)
(2046.8
)
(1737.9
)
24700.0
18813.
3
15974.
4
13563.
8
11517.
0
Cash Flow from Operating Activities:
Net Income to Common
Adjustments to Reconcile Net Income to Net Cash
Flow
Depreciation
PIK Preferred Dividends
Net Change in Working Capital
Net Cash Flow from Operations
Cash Flow from Investing Activities
(Increase) Decrease in Invest Available for Sale.
(Increase) Decrease in Gross Property, Plant &
Equip.
Net Cash Used in Investments
Cash Flows from Financing Activities:
Net Debt (Repayment) or Issuance
Net Cash (Used in) Provided by Financing
Activities
Net Increase (Decrease) in Cash & Marketable
Securities
Beginning Balances--Cash & Marketable Securities
Ending Balances--Cash & Marketable Securities
18813.3
15974.
4
13563.
8
11517.
0
9779.1
Page 55 of 56
References
Annual Reports for Krispy Kreme Donuts and Tim Horton’s
Mergent Online
10-k Reports for Krispy Kreme Donuts and Tim Horton’s
www.financegoogle.com
Mergers, Acquisitions, and Other Restructuring Activities. Donald M. DePamphilis. Fourth
Edition
M&A Notes – Issace Otchere – 2008
Krispy Kreme Doughnuts Inc, SEC Filling, July 4 2003, Amendment to Registration of a Class
of Securities , Form 8-A, pg 3-5 http://www.secinfo.com/dsVst.2Wq.htm
Page 56 of 56