Some commentators may have oversimplified the discussion of Berkshire Hathaway's (BRK.A) (BRK.B) and 3G Capital's acquisition of H.J. Heinz Co. (HNZ). This article discusses some of my perceptions about the implications of the preferred stock that Berkshire Hathaway receives in the deal and also how this deal is very unlike the simple, folksy buyout of an 'easy to understand' business that it has been painted to be.
Media's Glossing Over the Details of the Deal, Portraying it as a Common Stock Deal:
In a CNBC interview on February 14, 2013, Buffett responded to a quip by the show's host that one need not, "be that smart to do a [deal like the Heinz deal]," on the basis that Heinz is an 'easy to understand' consumer products company with a universally known brand.
that's absolutely the kind of deals I look for... if you have to be smart to do a deal, forget it, I won't be there.
What makes this statement especially humorous and ironic, is that the structure of the deal is not simple at all. In fact, the deal is quite complex and displays that, most likely, Buffett carefully crafted its terms.
Total Purchase Price...$23 billion
1) Common Stock investment (BRK)...$4.4 billion
2) Preferred Stock investment (BRK)...$8 billion
3) Common Stock investment (3G)...$4.4 billion
4) Debt financing (banks)...remainder.
Source: CNBC - "Berkshire Hathaway, 3G Buying Heinz for $23 Billion."
Berkshire's Investment is Predominantly in Preferred Stock, not Common:
Of the $12.4 billion Berkshire is putting up in the deal, $8 billion, or two-thirds, will be devoted to preferred stock and only $4.4 billion, or one-third, will be in the common stock.
This is interesting, because the preferred will pay a 9% dividend, which means that Berkshire will receive $720 million per year in dividends regardless of the performance of the common. Berkshire will also have priority over all other shareholders, including its partner in the deal, 3G.
Is Berkshire Predominantly a Financier of the Transaction, or an Owner of the Business?
Since most of its investment, in dollar terms, will be in a non-voting security (the preferred), rather than the voting common stock, it seems that Berkshire may view its participation in the deal at least as much as a financier rather than as an owner.
Did Buffett Think Heinz Stock Was a Good Value By Itself?
Also of note is that this is not a case where Berkshire believes that the common equity is cheap enough to pay cash for 100 percent ownership of the business - instead, Berkshire is relying heavily on bank financing (in an era of ultra low interest rates) so that Berkshire need not pay for the common stock out of pocket with cash.
In addition, Berkshire is getting a preferred position and a preferred stock that will pay a much higher yield (9 percent) than a position in the common would pay (currently the common trades at a P/E ratio of 23, or an earnings yield of only about 4%).
There is very little about this deal that is simple. It may seem simple, but on closer examination it appears that Warren Buffett very carefully and very intentionally deployed capital in a creative way to ensure that Berkshire gets the best of both worlds: (1) a security with a high yield, and a senior position relative to other equity investors [the preferred]; (2) AND a security that will ensure that Berkshire gets all or most of the upside in the event that Heinz performs well in the future [the common].
In addition, Buffett took advantage of bank financing to lever his returns and put up less capital than would otherwise be required, while still enjoying the benefits of the two securities received.