Berkshire Hathaway, 3G Capital To Acquire Heinz For US$28bn

In what is likely to be the fourth largest food and drink acquisition of all time , Warren Buffett and his Berkshire Hathaway investment fund ha ve teamed up with Brazil -based private equity firm 3G Capital to strike a US$28bn deal to buy US food company Heinz - the ubiquitous tomato ketchup maker. Under the terms of the deal, which is pending regulatory and shareholder approval, the consortium has agreed to pay US$72.5 0 a share for Heinz, which represents a 20% premium on Heinz's shares at the close of trade on February 1 3.

Buffett's track record illustrates his fondness for fast - moving consumer goods companies with powerful global brands. In this sense , Heinz fits the bill, just as The Coca-Cola Company - a favourite of Buffett - has for many years. According to CNBC, Buffett has referred to Heinz as ' our kind of company. The ketchup brand has been around for 135 years. '

Great Mix In Terms Of Products, Geography
FY12 Heinz Sales By Product Segment, % Contribution To Overall Sales (LHS) & Sales By Geography (RHS)

Below we take a look at some of the key reasons why we believe Berkshire Hathaway and 3G have gone for this deal :

  • Great Brands: Heinz ketchup in particular is an iconic global brand - probably one of the most powerful in global food. As the first chart illustrates, ketchup accounts for about 45% of Heinz's business. As the ketchup brand is so iconic, not just in the US but around the world, it is difficult to see this competitive advantage being compromised or , indeed , challenged.

  • International Exposure: A key difference between Heinz and many of the US's other major food companies is the international breadth of its business - again illustrated by the first chart. Heinz has relatively strong exposure to emerging markets (more than 20% of sales) , where its brands are considered aspirational . I t has potential to accomplish more here over the next few years by continuing to leverage off its ketchup brand. Brand power is hugely important, especially whe n it can provide an edge with pricing power - an important consideration given how volatile commodity prices have been over the past few years. Other companies with iconic US brands such as Hershey's and Kellogg have not been able to transfer this power internationally to the same degree as Heinz . So while they are strong companies in their own right and can stand up to Heinz across a number of key metrics, including return on capital as the third chart illustrates, we do not believe they can stand toe-to-toe with Heinz and Coca-Cola when it comes to the aspirational global emerging consumer story. To many people, Heinz and ketchup are synonymous in the same way that Coca-Cola defines the soda industry .

  • Consistent Growth: Heinz produces food staples, and its main brands are not overly sensitive to the business cycle, especially in the US and Western Europe. The fact that its share price trades at a beta of about 0.5 reflects this. This, along with the iconic nature of its brands and the scope for more growth abroad, gives pretty good visibility in terms of growth. Predictability of earnings has always been important to Berkshire Hathaway whenever it has closed deals in food and drink, and it is seen as a key reason why the fund has largely steered cleared of less predictable sectors such as technology. Indeed, this type of firm is not likely to be a dynamic grower, as the second chart, which compares the performance of Heinz's share price to the S&P 500 index since 2001, illustrates.

  • Strong Returns On Capital: The good visibility argument becomes more important given Heinz's relatively strong returns on capital over the past few years, a factor that is likely to have attracted Buffett and 3G. Reflected by the third chart, Heinz has delivered consistently well here.

  • Ability To Generate Strong Free Cash Flow: Heinz's strong returns on capital dovetails nicely with the firm's ability to consistently generate free cash flow of close to US$1bn per annum. Its ability to perform well irrespective of the business cycle given the power of its brands is likely to be well regarded by Berkshire Hathaway and 3G.

  • Preferred Stock: Strong brands and a company that fits into the Berkshire Hathaway and 3G Capital ethos looks nice on paper; however, ultimately these decisions are driven by returns. One area Berkshire Hathaway will look to as part of its goal of realising a return on its investment will come from the US$700mn a year it is likely to net in preferred dividends - at a yield of about 6%. However, some analysts believe that Berkshire and 3G are paying a steep price for Heinz, with the US$72.50 a share offer amounting to about 22.8 trailing 12 months price/earnings, which is a steeper price than Kraft Foods paid for Cadbury in 2010 (the last mega deal in the global food industry). That said, Berkshire Hathaway does usually hold on to its investments for a long time.

Moved Very Similarly, Heinz Spiked Followed Deal Announcement
Heinz and S&P 500 Index Re-based (31-12-2000=100)

In terms of what the deal might mean operationally for Heinz, 3G Partners is expected to assume operational control of Heinz , with Berkshire Hathaway contributing from the sidelines as it usually does. 3G, which owns a majority stake in Burger King , will very likely look to continue the excellent work Heinz has achieved since about 2006 , when activist investor Nelson Peltz joined the board. The company has reined in costs and registered 30 quarters of sales growth over a period of more than seven years in some of the toughest macroeconomic conditions the US has seen for decades. We expect 3G to focus on the main element of Heinz's business, ketchup, without the pressure of quarterly results as Heinz goes private.

A Key Attraction
Selected Food Companies - Return On Capital (%)
This article is tagged to:
Sector: Food & Drink
Geography: United States

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