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By Lauren Tara LaCapra, Jessica Toonkel and Olivia Oran
NEW YORK (Reuters) - Canadian coffee-and-doughnut chain Tim Hortons Inc has come under pressure from a large investor to aggressively boost returns through debt-funded share buybacks and a scaling back of U.S. expansion plans, according to documents seen by Reuters and two sources familiar with the matter.
Hedge fund Highfields Capital, which owns about 1.5 percent of the company and which has a track record of bringing about change at other firms, wants Tim Hortons to borrow $3.4 billion to buy back more than one-third of its outstanding shares at $59 apiece, the documents show.
Highfields' behind-the-scenes agitation, which was previously unknown, shows how even large and relatively healthy companies are vulnerable to activist investors demanding bold strategies - and even financial engineering - to boost shareholder returns in the absence of growth.
It also highlights how U.S. activist investors are increasingly trying to shake up Canadian companies that have historically not faced such challenges from across the border.
Tim Hortons, which says it is responsible for eight of every 10 cups of coffee sold in Canada, has a market value of $8.3 billion. Its shares closed at $54.58 on Tuesday, and are up nearly 12 percent so far this year.
Highfields also wants Tim Hortons to spin off or sell its distribution business, create a real estate investment trust to house its property assets and revamp its board with new directors who have more financial experience, according to the documents.
Tim Hortons declined to comment on the discussions with Highfields, which have been going on at least since March 8.
"We are focused on continuing our track record of creating shareholder value and always welcome constructive dialogue with our shareholders," it said in a statement.
A spokeswoman for Highfields declined to comment on the matter, except to note that the firm did not provide a copy of the documents to Reuters. The documents include correspondence between Tim Hortons and Highfields executives since March and a Highfields presentation to the restaurant chain.
UNDER PRESSURE
U.S. activists have had mixed results in pushing for change at Canadian companies. Last year, Bill Ackman's Pershing Square shook up the board of Canadian Pacific Railway Ltd after a public battle. But earlier this year, fertilizer company Agrium Inc fended off a bid by its biggest shareholder, U.S. hedge fund Jana Partners LLC, to break up the company.
Tim Hortons itself was spun off from U.S. fast food chain Wendy's International in 2006, following pressure from Pershing Square and billionaire investor Nelson Peltz.
Highfields' demands come at weak moment for Tim Hortons.
Analysts have questioned whether the company, the largest of its kind in Canada, will be able to continue growing in its home market amid increasing competition from fast food brands like McDonald's Corp. Tim Hortons has tried to expand in the United States to offset sluggish growth and saturation in Canada, but results there have been mixed.
The chain has also been without a permanent chief since 2011, when CEO Don Schroeder resigned abruptly. Paul House, the interim CEO, is expected to stay on until the end of 2013 or until a new CEO is named.
During their meeting last month, House told Highfields that implementing any strategy change would have to wait until a new CEO takes over, and that some aspects of the hedge fund's plan, such as forming a REIT, were not workable, according to one of the letters. The company is working with Citigroup Inc and RBC Capital Markets, the documents show.
RBC and Citigroup declined to comment.
The Highfields executives told House in that letter that his responses were disappointing.
"We came away concerned that the company and its board lack both understanding and a sense of urgency," they wrote.
Boston-based Highfields, which manages more than $11 billion, is no stranger to activism. In 2007, the hedge fund pushed for Wendy's to sell itself, which the chain later did to Triarc, a holding company owned by Peltz, for around $2.4 billion.
In June last year, Highfields called for a breakup of insurer Genworth Financial Inc. Genworth later sold its wealth management business and its San Francisco-based alternative investment businesses, as well as separated its mortgage insurance business into a new company.
HIGHFIELDS' PLAN
Highfields bought 2.4 million shares in Tim Hortons in the fourth quarter of last year, making it the chain's tenth-largest investor as of December 31.
Arguing for a massive share repurchase, Highfields said in the documents that it would allow the company to take advantage of historically low interest rates without having an impact on the underlying business.
It argued that Tim Horton's debt levels are much lower than rivals such as Burger King Worldwide Inc, Dunkin' Donuts and Domino's Pizza Inc, and taking on the additional debt would bring leverage more in line with its peers, the documents show.
Highfields also said Tim Hortons returns so far in the United States did not justify further investments there. It recommended that the chain either enter into franchise agreements in the United States that require less capital investments or scrap U.S. expansion plans altogether, according to the documents.
At the end of last year, Tim Hortons had 804 restaurants in the United States and more than 3,436 in Canada. The majority of the company's restaurants are franchised, meaning individual restaurant owners own or operate the restaurants.
In recommending that Tim Hortons consider separating out its real estate assets into a new publicly traded REIT, the hedge fund cited the example of Canada's largest grocer Loblaw Companies Ltd, which said in December it would spin off the majority of its property assets, creating one of the country's largest REITs.
Analysts have said that Canadian retailer Hudson's Bay Co could also look at spinning off its real estate to take advantage of a rally in Canadian REIT stocks. The S&P TSX Canadian REIT index has risen more than 9 percent in the past 12 months, while Canada's benchmark S&P TSX composite index has risen just 1.8 percent.
(Editing by Soyoung Kim, Paritosh Bansal, Gary Hill and Edwina Gibbs)
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