Heinz Needs Faster Global Growth And Better Margins To Justify $28 Billion Acquisition Price

Feb.15.13 | About: The Kraft (KHC)

H. J. Heinz & Co. (HNZ) shot up 20% in Thursday's trade following the announcement of a buyout deal with Berkshire Hathaway (NYSE:BRK.A) and 3G Capital. The two financiers have partnered to buy Heinz's equity at $72.5 a piece, 19% above its all time high and 30% above its one-year average price. This is also around 25% higher than our our $57 price estimate for Heinz. However, we believe that by capturing more market share and improving the profitability of Heinz's portfolio, one could justify the premium. Tempting acquisition valuation led the company's board to unanimously approve the transaction. With the largest acquisition deal in the food industry by value ($28 billion including debt), Heinz is now set to go private.

Heinz Stands Tall on Brand Equity and Global Portfolio

Heinz, a global player in manufacturing and marketing a wide range of processed food products, primarily deals in ketchup, condiments, sauces, frozen food, soups, baked beans, pasta meals, infant nutrition, and other processed food products. Heinz Ketchup, one of the key brands of the company, holds 60% share in the U.S. ketchup market, 70% in Canada and about 80% in the U.K. Other popular brands of the company include Classico sauces, Ore-Ida selling potato-based frozen foods, and Weight Watchers Smart Ones selling low-fat, low-calorie, and high-fiber meals to diet conscious consumers. The key factors driving such high valuations for the company are world-class iconic brands and a strong global portfolio, with around two-thirds of sales coming from outside the U.S. and almost 25% of sales coming from emerging markets during the last quarter.

Berkshire Hathaway, 3G Capital Expand Their Menu

Berkshire Hathaway, the Oracle of Omaha's investment company that among other assets also owns minority stakes in Kraft Foods (KRFT) and The Coca-Cola Company (NYSE:KO), now also owns 50% of world famous ketchup, Heinz. The deal as described by Warren Buffett himself is his kind of deal, an investment in a fairly predictable business, with a comparably low price elasticity for demand and deals in a product that sells by name. 3G Capital that owns more than 70% of Burger King (BKW) is known for pushing the company's turnaround through geographic and menu expansion, aggressive advertising campaigns, and efficiency drive led by increased implementation of lower cost franchisee-owned model. It would also be responsible for managing operations at Heinz going forward.

Although valuations are arguably high given the current outlook, which is factored into our $57 price estimate, aggressive expansion in the emerging markets over the coming years coupled with faster decision making under private ownership and leaner, efficient operations, could potentially make the valuations look fair. For example, if the company is able to increase its market share in the global ketchup, condiments, and sauces market to around around 14% over the forecast period from current 10.7%, along with pushing EBITDA margins of the segment to more than 22% from current 18%, the $72.50 valuation would not look stretched at all.

Disclosure: No positions.