Buffett’s Ketchup Fancy Plies Heinz With Junk: Corporate Finance
Buffett’s Berkshire Hathaway Inc. (BRK/A) and 3G Capital Inc.’s $23 billion acquisition of Heinz may double the company’s total debt to five times earnings before interest, taxes, depreciation and amortization, according to Fitch Ratings, the highest of any comparable food company. The cost to protect Heinz’s debt from losses soared to a record after the announcement.
While Buffett has used takeovers to build Berkshire into a $249 billion company and burnish his reputation as the world’s most successful investor, financing the deal with $14.1 billion in debt threatens to strip Heinz of the investment-grade rating that it’s had for four decades. Fitch cut Heinz to junk on Feb. 15 and credit-default swaps imply a Ba1 rating, according to Moody’s Corp.’s capital markets research group. That’s two steps lower than its Baa2 rating from Moody’s Investors Service and three below its BBB+ grade from Standard & Poor’s.
The trading “underscores the hazards of high-grade bonds in an active M&A environment,” said Martin Fridson, chief executive officer of research firm FridsonVision LLC. Investors should be aware of the “inherent danger now that leveraged buyouts as well as strategic acquisitions are once again prominent in the financial landscape,” he said.
Michael Mullen, a spokesman for Pittsburgh-based Heinz, didn’t return a telephone message seeking comment.
Instead of boosting its credit profile to match Omaha, Nebraska-based Berkshire’s AA+ and Aa2 ratings, Heinz was cut to junk in two days in the eyes of credit investors, Moody’s data show. The swap prices, which climb as investor perceptions of creditworthiness deteriorate, rose to levels implying a Baa3 rating on Feb. 14, from Aa3 the day before. They fell again to Ba1 the next day.
Heinz’s leverage may increase to five times or more after the takeover is completed from 2.5 times on Oct. 28, according to a Feb. 15 Fitch report in which the rating firm cut Heinz’s credit grade to BB+. That would make the ketchup-maker the most highly-leveraged U.S. food manufacturer with a market value greater than $5 billion, data compiled by Bloomberg show.
Heinz, which said in a Nov. 20 regulatory filing that it had about $5.04 billion of total debt at the end of October, obtained $14.1 billion in financing from JPMorgan Chase & Co. and Wells Fargo & Co. to support the deal, according to a Feb. 15 filing.
Berkshire and billionaire Jorge Paulo Lemann’s 3G will each pay about $4.1 billion for an equity stake. Berkshire is also contributing $8 billion for preferred shares which gets an annual dividend of 9 percent, Buffett’s firm said in a filing.
The credit-default swap contracts tied to the company’s debt fluctuated by 187 basis points, or more than 400 percent, in the two trading days after it was announced, CMA data show.
Some of Heinz’s debt include provisions to protect investors in event of an acquisition or a downgrade.
Holders of the company’s $300 million of 2.85 percent notes due March 2022 will receive 101 cents on the dollar in addition to unpaid interest if anyone buys more than half of the company’s outstanding voting stock, or if the rating is lowered by all three rating firms to junk, according to that security’s prospectus.
“It took the market time to digest just how leveraged, and how subordinated, senior unsecured bondholders will be as a result of approximately $10.5 billion of senior secured bank debt that will be layered ahead of bonds that don’t benefit from a change of control,” said John Kneebone, a credit analyst at Paris-based BNP Paribas SA. “Many see the potential for leverage to go higher than anticipated levels” of about 6.1 times, he said.
Heinz credit swaps surged Feb. 15 to 228 basis points at 7:37 a.m. in New York, fell to 184 at 9:07 a.m., and surged again to 224 basis points in the next 23 minutes, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
“Market speculation” that the deal wouldn’t trigger the change-of-control provision is probably incorrect, according to a Feb. 14 report from Covenant Review LLC, an independent credit research firm based in New York.
Confusion over the change of control pushed some debt below par, according to Covenant Review’s founder Adam Cohen. To exploit that loophole, Berkshire and 3G would have to create a holding company over Heinz, and then argue that the combined entity counts as a “person” in one instance but not another, Cohen said.
“That’s a really hard argument to make,” he said. “I can’t say it’s impossible but it’s pretty dumb.”
Credit-default swaps on Heinz, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, were the third most-traded entity last week among 1,000 tracked by the Depository Trust & Clearing Corp., up from 720th place the week before, according to the DTCC, which runs a central registry for the market.
A daily average of $430 million traded last week, compared with an average of $150 million over the past month.
Banks, hedge funds and other money managers had bought and sold swaps on a net $906 million of Heinz as of Feb. 15, up from $599.6 million the week before, DTCC data show.
The maker of condiments and Ore-Ida potato snacks, led by Chief Executive OfficerBill Johnson since 1998, had gained 17 percent in the past 12 months as it boosted sales in developing economies. The company traces its roots back to 1869, when Henry John Heinz and neighbor L. Clarence Noble began selling grated horseradish, according to Heinz’s website. The company introduced its famous Tomato Ketchup in 1876.
The company’s $436.6 million of 6.75 percent notes due in 2032, which hadn’t traded since August, dropped 21 cents to 107 cents on the dollar to yield 6.12 percent on Feb. 14, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The next day they sank to 101.5 cents to yield 6.6 percent.
The debt traded at 105.8 cents to yield 6.23 percent at 12:57 p.m. in New York, the data show.
“While details about the company’s financing plans or additional debt needs have not been disclosed, we believe the transaction would weaken Heinz’s credit protection measures well below current levels,” S&P analysts Bea Chiem and Jeffrey Burian wrote in a Feb. 14 note.
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