Profitable *and* delicious.

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Warren Buffett Quadrupled His Ketchup Investment

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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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 delevers 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:

“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.

(Corrects Kraft S&P rating to BBB from BBB- in eighth paragraph of article published March 25. Previous versions of this article corrected the equity investments Berkshire and 3G made in Heinz to $4.25 billion from $4.1 billion in first paragraph, and updated the calculations throughout to reflect that change; corrected the name of the Financial Times blog on which Indap's math appeared in the third paragraph; and corrected the first table, in which the net debt values for Kraft and Heinz were transposed.)

  1. According to the Heinz proxy statement and, like, boring jargon, preferred stock is "equity," but come on. It is a junior fixed-income instrument.

    Also, this sentence originally said that they each contributed $4.1 billion, the number in the proxy. But the number seems to have grown after the proxy to $4.25 billion each. See, e.g., page 81 of the most recent Berkshire 10-K. 

  2. THIS IS NOT THE NAME. The name is "The Kraft Heinz Company," but it will always be Heinzkraft to me, at least until the end of this post.

  3. Heinz long-term debt ($13.6 billion) and cash ($2.3 billion) from its most recent 10-K. Kraft shares outstanding (588 million), long-term debt ($10 billion including current portion) and cash ($1.3 billion) from its most recent 10-K. Note that the $10 billion total dividend suggests that there are really more like 606 million shares outstanding, once you include options and restricted stock and so forth. I've ignored that in my math, which is conservative, but the real numbers should probably be a bit higher. On the other hand, the stock is down since noon. 

  4. Berkshire's preferred stock comes with warrants which I've entirely ignored here. But they should mean that Berkshire gets a bit more of Heinz's equity than 3G does.

  5. So there are no big banks involved in advising on the deal, because it won't need financing. Though presumably Heinzkraft will want a bigger bank than Lazard or Centerview to arrange all that investment-grade refinancing.

  6. That is: $8 billion of preferred at 9 percent is $720 million of interest cost a year. Saving $450 to $500 million means then new interest cost would be $220 to $270 million, or 2.75 to 3.375 percent of $8 billion, give or take.

  7. That's the whole bullet point. I don't know what it means.

  8. Two different ketchups I mean. Though that would be delicious.

  9. Though those sauces are available only in Europe, so I guess American consumers are less actively seeking flavor adventure.

  10. If you use Sujeet Indap's numbers, value Heinzkraft on an EV/EBITDA basis, and use an $86 stock price, then the $111 billion of enterprise value comes from about $5 billion of existing EBITDA and $1.5 billion of synergies, at about a 17x multiple. That implies that those synergies are worth $25+ billion, which is at least $10 billion more than the premium that Heinz is offering to Kraft shareholders.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net