Could Tony the Tiger Be Next Buffett Elephant?: Real M&A

Could Warren Buffett use his elephant gun to bag a tiger named Tony?

Kellogg Co., the more than century-old maker of breakfast cereal and Pop Tarts, surged the most since 2009 last week amid speculation it might become the industry’s next takeover target. The company’s well-known products, including Frosted Flakes with cartoon pitchman Tony the Tiger, may entice billionaire Buffett, who teamed up with 3G Capital last year to acquire H.J. Heinz & Co., said Gardner Russo & Gardner. Kellogg meets several of Buffett’s financial criteria for acquisitions.

With an enterprise value of $30 billion, Kellogg would surpass Heinz as the biggest food company purchase on record, according to data compiled by Bloomberg. That may not deter Buffett, who said in his latest letter to Berkshire Hathaway Inc.’s shareholders that he’s still looking for big targets, or “elephants.” Kellogg also may appeal to PepsiCo Inc., owner of Quaker oatmeal, or Nestle SA, said Edward Jones & Co.

“They have some very rock-solid brands with a lot of market share,” Brian Yarbrough, a St. Louis-based analyst at Edward Jones, said in a phone interview. “Just because it’s a big company doesn’t mean you can’t get a deal done. The whole gamut, from private-equity players all the way down to other food companies, could see value in potentially doing it.”

Kris Charles of Battle Creek, Michigan-based Kellogg said the company doesn’t respond to speculation. A representative for 3G declined to comment, and Buffett didn’t respond to a request for comment sent to an assistant.

Another Elephant

The acquisition of Heinz for more than $23 billion sparked speculation that Buffett’s Berkshire Hathaway and 3G Capital may turn next to other food companies such as Campbell Soup Co. J.M. Smucker Co., Cheerios-maker General Mills Inc. and Kellogg all rose when the deal was announced last February.

At the time, Buffett told CNBC that even after the Heinz purchase, he was “ready for another elephant.”

“The cash builds from month to month, so the gun is always getting reloaded,” he said. His letter to shareholders of Omaha, Nebraska-based Berkshire Hathaway this year referenced a continuing “search for elephants.”

On April 3, Kellogg rose 6 percent, more than double its gain in the first three months of the year. More than 25,000 bullish options contracts for the maker of Special K cereal changed hands that day, 45 times the four-week average, as investors speculated it could be the subject of takeover activity.

Shares of Kellogg climbed 2.7 percent to $66.10.

Pricing Power

Kellogg fits the mold of a company that Buffett would like, according to Ken Harris, a managing partner at Cadent Consulting Group LLC in Chicago. The billionaire could once again join forces with 3G, which is now running the Heinz business the two acquired, Harris said.

“Buffett could be interested,” he said in a phone interview. “If 3G has another team to manage it and the bandwidth, maybe they could do it.”

Like Heinz’s ketchup, Kellogg’s products will probably be around a century from now, fitting Buffett’s preference for brands with staying power, said Tom Russo, a partner at Gardner Russo & Gardner. The Lancaster, Pennsylvania-based firm is an investor in Berkshire Hathaway.

“The notion of solid brand values, which is what the consumer has in their relationship with Kellogg and with Heinz, that’s paramount,” Russo said in a phone interview. “That gives you pricing power and pricing power gives you good returns on capital.”

Buffett Criteria

Kellogg also meets several of Buffett’s financial criteria for acquisition candidates. The 83-year-old usually prefers “simple” businesses with “consistent” earnings power and “good” returns on equity while employing little or no debt, according to his annual report.

Kellogg’s capital expenses account for at least 10 percent of net fixed assets, its return on equity last year exceeded 10 percent and it has a lower price-earnings ratio than the average U.S. stock, according to data compiled by Bloomberg.

The earnings multiple, also the cheapest among every global food manufacturer of more than $10 billion, may be deserved because of the revenue declines at Kellogg’s U.S. cereal business, said Joseph Agnese of S&P Capital IQ.

Even so, “the name becomes more attractive when it’s trading near the low end of its historical ranges for longer-term buyers,” the New York-based analyst said in a phone interview.

Kellogg’s underperformance could interest 3G, which has a reputation for aggressively cutting costs and improving struggling business, said Yarbrough of Edward Jones.

‘Opportunity Here’

Kellogg in November announced a four-year efficiency plan, deemed Project K, which it expects to result in between $425 million and $475 million in annual cash savings by 2018.

“Think about what 3G could do,” Yarbrough said. The savings would “probably be 1.5 times to 2 times that with the way they run businesses. If you’re a firm that’s looking to buy something and fix it, there’s an opportunity here.”

Kellogg also could appeal to PepsiCo and Nestle, said Yarbrough, who estimated a potential takeout price of $80 to $90 a share, or at least a 24 percent premium from yesterday’s close.

PepsiCo, which rejected a call from activist investor Nelson Peltz to break it up, could use an acquisition of Kellogg to bolster its breakfast offerings and add brands like Pringles and Keebler cookies to its snacks portfolio, he said.

Nestle Cash

Nestle had an about $8 billion cash hoard at the end of 2013 that will get even bigger this year with the sale of part of its holding in L’Oreal SA. While it may make more sense for Nestle to buy General Mills because of the companies’ cereals joint venture, a takeover of Kellogg instead can’t be ruled out, Yarbrough said.

General Mills has a market capitalization of $32 billion, compared with Kellogg’s $23 billion.

Representatives for Vevey, Switzerland-based Nestle and Purchase, New York-based PepsiCo declined to comment.

Pepsi Chief Executive Officer Indra Nooyi said at a conference last year that the company would look to create value through “responsible, tuck-in acquisitions, generally less than $500 million a year in total.” Investing in the business and dividends are its top priorities, she said.

Potential hurdles for any buyers may be the company’s size and the challenge of convincing its largest shareholder, the W.K. Kellogg Foundation Trust, to sell its about 20 percent stake, said Agnese of S&P.

Even so, because the trust doesn’t own controlling shares, it can’t automatically block a takeout should one occur, Citigroup Inc. analysts wrote in a report last week. And there’s a precedent for big food company takeovers in Heinz.

Heinz “provides a good example of a possibility where it could occur with a company of this size,” Agnese said. “Buyers could be interested in their strong brand names, international presence and strong presence within consumers’ homes.”

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