Bloomberg View: Warren Buffett wins big on backing Brazil’s 3G – and ketchup

Berkshire Hathaway chairman Warren Buffett is celebrating his 50th anniversary in charge of the one-time textile miller with another really big, very smart deal. Teaming up with Brazilian outfit 3G added a harder edge to the affable Oracle of Omaha who admitted at last year’s AGM that Berkshire sometimes holds onto managers and businesses too long. Yesterday’s acquisition of Kraft by its Berkshire/3G owned competitor Heinz shows when it comes down to it, Berkshire’s boss is really all about business – and making money for his shareholders. If you haven’t bought Berkshire shares yet, take the hint. – Alec Hogg     

By Matt Levine

File photo of commemorative ketchup bottles with portraits of Warren Buffett at the exhibition of Berkshire Hathaway companies at the annual meeting in Omaha
File photo of commemorative ketchup bottles with portraits of Warren Buffett at the exhibition of Berkshire Hathaway companies at the annual meeting in Omaha

(Bloomberg View) — Two years ago, Brazilian private equity firm 3G Capital and Warren Buffett’s Berkshire Hathaway teamed up to acquire Heinz in a leveraged buyout. Heinz at the time was a $28 billion company, but Berkshire and 3G didn’t put up that much money: Each of them contributed $4.25 billion of equity, and Berkshire invested another $8 billion in the preferred stock of new Heinz.

Today Heinz is acquiring Kraft, more or less: Heinz’s shareholders, mostly Berkshire and 3G, will end up owning 51 percent of the combined Heinzkraft, while Kraft’s existing public shareholders will own the other 49 percent. Kraft is an even bigger company than Heinz — its equity was worth $36 billion as of yesterday — so Berkshire and 3G will pay Kraft’s shareholders $10 billion in cash to make up the difference. Here is the deal infographic, just in case you find that helpful. (It is a … I’m going to say mayonnaise jar full of brands? Definitely some brands, in a jar, plus some disclaimers. The disclaimers didn’t fit in the jar.)

By my math — based on Sujeet Indap’s math at the Financial Times’s Lex Live blog, and on where Kraft’s stock was trading earlier today — the combined company will have an enterprise value of about $111 billion and an equity value of about $83 billion:

You could continue to follow this logic. If new Heinzkraft is worth $83 billion, and Kraft shareholders’ chunk of that is worth $41 billion, then Heinz’s shareholders’ chunk is worth $42 billion. They’re paying $10 billion cash for that, so the rest must come from the value of the Heinz shares that they’re contributing:

Remember, they bought Heinz for $8.5 billion in cash equity (plus Berkshire’s $8 billion preferred):

And that’s just capital gains. (Paper capital gains, but still.) Berkshire has also gotten 9 percent dividends on its preferred stock. Good work everyone!

[Update: There’s another way of looking at the math, which is to include the $10 billion that Berkshire and 3G are investing today as part of their investment, and not just the $8.5 billion that they put in two years ago. In that case, they’ve contributed $18.5 billion for a thing with an equity value of about $42 billion, for a 127 percent return. But that’s a 127 percent return on all of the money they have invested or will invest, including for the Kraft dividend that they just announced today.]

Not only have 3G and Berkshire Hathaway quadrupled the value of their investment in two years, but this new deal also de-levers their leveraged buyout. The investor presentation lists as prominent “transaction highlights” the fact that the new company will be “strongly committed to Investment Grade capital structure for long-term sustainability,” and that it will “refinance $9.5bn of existing Heinz High-Yield debt with Investment Grade debt at transaction close.” (Heinz’s second lien notes are junk-rated at B1/BB; Kraft has investment-grade Baa2/BBB- ratings.) And the company plans to call Berkshire’s preferred stock in 2016, replacing it with debt, “with $450-500 million in annualized cash savings,” implying that Heinzkraft expects to issue debt in the 3 percent area.

Here is an argument that part of 3G’s advantage is “its ability to nail giant deals that break the conventional rules of private equity,” with a longer time horizon than most buyout firms and flexibility to partner with specific co-investors on specific deals. And that’s probably true. But for the most part, there doesn’t seem to be much financial magic going on here. Mostly, 3G is just good at operating food companies, and Buffett is just good at staying out of the way of his operating partners. As Heinz’s chief executive officer says in the news release:

Over the past two years, we have transformed Heinz into one of the most efficient and profitable food companies in the world while reinvesting behind our key brands and continuing our relentless commitment to quality and innovation.

The investor presentation touts Heinz’s “big, bold bets on innovation,” including, um, yellow mustard, and we should spend a minute wallowing in the innovation. The “Consumer Insight” for yellow mustard includes, “Low involvement ‘yellow mustard is yellow mustard,'” and “#1 category driver is taste,” while the insight for sriracha and jalapeño ketchup is: “Millennials looking for flavor varieties — savory / spicy and ethnic flavors are trending.” And for Heinz Hot Sauces, the insight includes, “Consumers actively seeking for flavor adventures to be incorporated into their regular meals.”

But when shareholders return from their adventures in flavor, what they are really excited about is the promise of “$1.5 billion in run-rate annual cost savings by 2017.” Here’s a plausible guess at what that means:

File photo of Financial investor Warren Buffett during an announcement ceremony at Northwestern University in Evanston
File photo of Financial investor Warren Buffett.

“It’s the press-release version of saying they’re going to fire people,” said Meyer Shields, an analyst at Keefe Bruyette & Woods. “When you look at the fact that the deal is not accretive until 2017, that tells me that it’s only accretive after all these efforts to reduce expenses.”

3G has “eliminated more than 7,000 positions in 20 months after taking over Heinz with Buffett,” cutting full-time employees from 31,900 to 24,500. Note, though, that that’s 3G’s doing, not Warren Buffett’s:

“Historically, that’s not the Berkshire way,” Shields said of the cuts. “Having 3G as cover has worked so far.”

It’s a great team, no? Buffett can look cuddly, 3G can be ruthless. Buffett offers Kraft shareholders a long-term investor with a nice halo, while 3G offers them operational expertise and a track record of successful cost-cutting. It’s worked out great for them so far. – BLOOMBERG VIEW

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