Nice work.

Photographer: David Liam Kyle/NBAE via Getty Images

So Buffett Will Only Get to Triple His Ketchup Money

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.
Read More.
( Updated
)
a | A

Yesterday I did some rough math on the Heinzkraft acquisition. To recap that math: Berkshire Hathaway and 3G Capital together invested $8.5 billion in the common stock of Heinz two years ago. (Berkshire also invested $8 billion in its preferred stock.) Yesterday, they announced that they were investing a total of an additional $10 billion in Heinz's stock, in order to fund a cash payment to Kraft shareholders as part of Heinz's merger with Kraft. I did some loose calculations and concluded that the market valued the combined company at about $83 billion, giving Heinz an equity value of about $42 billion. This math was fairly uncontroversial. I then said: Well, okay, Berkshire and 3G invested $10 billion in cash yesterday,  so that's worth $10 billion. That means that their shares in Heinz -- the ones they bought for $8.5 billion two years ago -- are worth $32 billion, roughly quadrupling their money.

I got some resistance to that math. The theory behind the resistance was, more or less: No, the $10 billion in cash isn't worth $10 billion, it's worth more. The value accruing to Heinz isn't just the value of the standalone company -- it's not like Heinz has, by itself, quadrupled in value in two years.  Instead, what makes Heinz's share of the combined company worth $42 billion is the combination: Heinz has jumped in value in large part because of the Kraft deal, and to get the Kraft deal Berkshire and 3G had to kick in another $10 billion. So the real math is that they've put in $18.5 billion for a thing worth $42 billion -- still a quite respectable 127 percent return on investment.

This is a pleasant philosophical debate -- neither version is exactly "right" or "wrong" -- but it also has practical implications for some people. For instance, if you are a manager of Heinz paid in stock options, you want that full $32 billion valuation attributed to your work, and none of it to the new money coming in: You want that new money to buy in at, effectively, a $42 billion post-money Heinz valuation.  And that's a subject for negotiation in the merger agreement. The new money buys some number of shares. The more shares it buys, the better deal the new money is getting, and the lower the returns on the old money. (Since both new and old money come mostly from Berkshire and 3G, this may not matter too much.)

And now we have the merger agreement so we can find out what they did. Sort of. It's a little opaque, and some key documents -- the equity investment letters -- haven't been filed and may never be. But we can make some reasonable guesses, based on the capitalization information in the merger agreement. Here are my guesses. I have done them in two ways. One way treats 100 percent of all stock options, incentive shares, etc. as actual shares of Heinz and Kraft. The other way treats none of those things as shares, counting only actual shares outstanding and Berkshire Hathaway's warrant to buy some Heinz stock "for a nominal sum." Those should be reasonable bookends. Here you go: 

Roughly speaking, Berkshire and 3G are valuing their initial Heinz equity stakes -- which they bought for $4.25 billion each two years ago -- at about $12.8 billion each, more than tripling that money (on paper). They're attributing $14.6-$17.9 billion of value to their new $10 billion equity investment -- a 46 to 79 percent return in, um, no time at all. (Put another way, that new $10 billion came in at a valuation for standalone Heinz of about $26 to $29 billion.) But fair enough: That money is what allowed them to do this deal, and Heinz is worth more to Buffett and 3G with Kraft than without it.

(Corrects amount of initial Heinz investment in first paragraph and updates throughout, adds new footnote 2 and updates table for closing stock price.)

  1. Still not the name.

  2. I originally said $8.2 billion, the number in the Heinz buyout proxy. But Berkshire and 3G seem to have adjusted their investments up to $8.5 billion - $4.25 billion each -- before closing. See, e.g., page 81 of the most recent Berkshire 10-K.

  3. I mean, they promised to. The deal hasn't closed yet, so they haven't like written the check yet.

  4. In fact, Heinz's sales, gross margin and net income were all down in the year ended December 28, 2014, compared with the (pre-buyout) years ended April 28, 2013 and April 29, 2012. See page 51 of the 10-K.

  5. Similarly, to the extent that different limited partners are investing with 3G in this round versus the last round, the ones who were in the 2013 round want the new guys to come in at a high valuation, and the ones who are in the new round want to come in at a low valuation.

  6. Key sources are sections 3.02 and 4.02 of the merger agreement (the capitalization reps), plus section 2.01 ("Effect on Capital Stock of Kraft") and, most importantly, section 1.05(a), which covers the "Pre-Closing Heinz Share Conversion." Basically Heinz will do a reverse stock split to get the numbers right, exchanging each old Heinz share for 0.443332 new ones. All the numbers in my table reflect that conversion (so they don't match directly with the Heinz capitalization rep).

    After that, the only trick is that I assume that Heinz shareholders (plus warrantholders, optionholders, etc.) will end up with 51 percent of the company, and Kraft shareholders (optionholders, etc.) will have 49 percent. That's what the news release says: "Kraft shareholders will own a 49% stake in the combined company, and current Heinz shareholders will own 51% on a fully diluted basis." So I just solve for the number of new equity-investment shares that gets you to 51 percent. That number changes based on whether you include options or not.

    I used an $84.39 stock price for Kraft, today's close.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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