Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

As Brazilian billionaire Jorge Paulo Lemann scouts for 3G Capital's next big acquisition, one can envision Bill Ackman gesturing, "Pssst, over here."

It's no secret that Ackman's hedge fund Pershing Square Capital Management has had a rough year, between its long position in Valeant Pharmaceuticals (the stock lost almost 70 percent over the past 12 months) and bet against Herbalife (the stock rose almost 70 percent). However, Pershing Square also owns a sizable stake in Oreo cookie maker Mondelez -- one of two food companies considered to be in 3G Capital's sights -- and he'd probably love to see it get acquired at a nice premium.

Ackman's Very Bad Year
After getting Valeant and Herbalife wrong, the hedge fund manager could use some good news. A takeover Mondelez (one of his holdings) by 3G Capital would certainly do the trick.
Source: Bloomberg

But the other possible 3G target is General Mills. And unfortunately for Ackman, General Mills looks like the better option.

3G Capital's modus operandi is centered on slashing costs, which it's done at Burger King and most recently, Kraft Heinz. Before Lemann and his team came along, H.J. Heinz had an operating margin of around 14 percent and Kraft Foods' was about 10 percent. 3G (in a deal partially bankrolled by Warren Buffett) acquired the ketchup company in 2013, and then merged it with Kraft last year, creating a food giant now valued at $93 billion. Analysts' projections imply the combined entity's operating margin could top 25 percent this year and approach 30 percent in 2017. That, incidentally, is about when 3G might be expected to strike again, based on its recent buying patterns.

Bigger Is Better?
Kraft Heinz earns more from each dollar of sales since 3G Capital combined the two food giants and took a razor to their costs. Could it do the same with General Mills or Mondelez next?
Source: Bloomberg

On paper, both Mondelez and General Mills have the type of room for improvement that 3G looks for in its targets, arguably more so Mondelez. If you exclude the gains from selling its coffee business last year, Mondelez's operating margin was about half that of General Mill's. A lower margin would argue for more scope to reduce expenses, 3G's specialty. 

However, Mondelez is already doing this on its own. The $66 billion company says it's focused on transforming into a "lean executional machine" through so-called zero-based budgeting, a meticulous approach in which the budget for a period starts from scratch and each cost must be justified. Mondelez is also upgrading its manufacturing lines to make them more efficient and getting rid of underperforming products. 3G's next transaction may not come until next year, so by that point, there may not be enough left to wring out from Mondelez in order for a deal to be worth it.   

General Mills, too, is looking for ways to save money, using what it calls "holistic margin management." The $36 billion company has also closed about 20 percent of its North American manufacturing plants, an initiative being expanded to its international facilities, and it's exiting some disappointing businesses. 

But 3G may choose General Mills over Mondelez because its food simply fits better with Kraft Heinz's portfolio. A lot of Kraft Heinz's products are based around meals. There's Kraft salad dressings, Stove Top stuffing, A1 steak sauce and Heinz condiments and gravy, to name a few. General Mills has Betty Crocker, Pillsbury and Progresso -- plate-or-bowl items, if you will. But Mondelez, which split from Kraft in 2012, mainly makes snacks, such as Ritz crackers and Chips Ahoy cookies, as well as the Cadbury chocolates business Kraft bought in 2010.

Shopping Cart
General Mills is cheaper than many of its peers. JM Smucker and Campbell Soup have also been speculated targets, but they both have insider ownership that could impede a sale.
Source: Bloomberg

General Mills' large U.S. presence -- relative to Mondelez's very global revenue base -- could also make it a cleaner target along the lines of Kraft Heinz. And it would cost a heck of a lot less for the very indebted suitor. General Mills is about half the size of Mondelez, but both generate about $2 billion or more of annual free cash flow.

Should 3G pursue a deal for General Mills, that could drum up old talk of whether Nestle should bid, too. Nestle shareholder Gabelli Funds, a unit of Mario Gabelli's Gamco Asset Management, has suggested a Nestle-General Mills mega-merger in the past. Alexia Howard, a Bernstein analyst, explained in a report last week that Nestle is unlikely to be interested in much of General Mills' U.S. business. But she says that General Mills could potentially sell or spin off those brands as it did with Green Giant, and that perhaps Nestle might be interested in owning outright the cereal joint venture it has with General Mills. (She also leans toward General Mills being the more logical target for 3G.)

It still may be months or even a year before 3G orchestrates its next big acquisition. But what's certain is that the food industry is being completely transformed through deals, and Kraft Heinz was only the beginning. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net