Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shares of H.J. Heinz (HNZ) spiked on Thursday after the diversified food manufacturing company agreed to sell itself to 3G Capital and Warren Buffett's Berkshire Hathaway (BRK.A). Shares of Heinz rose 20% to $72.50 per share, while shares of Berkshire rose by 1.0%.

The Deal

3G Capital and Berkshire Hathaway announced that they have agreed to acquire H.J. Heinz, the food manufacturer known from the famous Ketchup brand, for $72.50 per share.

The consortium will pay a 20% premium compared to Wednesday's closing price of $60.48, and a 19% premium compared to Heinz's previous all time high. Factoring in the premium and the assumption of debt, the offer values Heinz at a little over $27 billion. The deal is intended to accelerate Heinz's transformation into becoming in a global business. As part of the deal, the global headquarters will remain in Pittsburgh and the firm will continue with its philanthropic support of community initiatives and investments.

CEO and Chairman of Berkshire Hathaway Warren Buffet commented on the deal, "Heinz has strong, sustainable growth potential based on high quality standards, continuous innovation, excellent management and great tasting products. Their global success is a testament to the power of investing behind strong brand equities and the strength of their management team and processes. We are very pleased to be a part of this partnership."

The deal will be financed with cash at hand at Berkshire Hathaway and 3G, a rollover of existing debt and a new debt financing commitment from J.P. Morgan (JPM) and Wells Fargo (WFC).

For the full year ending on April 2012, H.J. Heinz generated $11.65 billion in revenues, on which the company net earned $923 million. The $23.3 billion valuation of the equity of the firm values Heinz at 2.0 times annual revenues and 25 times annual earnings. The company is valued at 14 times its annual EBITDA.

The deal is subject to shareholder and regulatory approval and is expected to close in the third quarter of 2013.

Well Known Terrain

Heinz is obviously most well known for its ketchup business, but the Pittsburgh based company also produces Classico pasta sauces and Smart Ones frozen meals, among others. Warren Buffett is no stranger in the domain of consumer goods which can be found on grocery shelves across the country.

Berkshire holds investments in Coca-Cola (KO), Anheuser-Busch (BUD) and See's Candies. 3G is the investment firm led by JorgePaulo Lemann. Lemann was behind the 2008 acquisition of Anheuser-Busch and the 2010 acquisition of Burger King.

Despite the fact that both firms are experienced in the industry, the takeover represents the largest deal in the food industry ever. With the expertise of 3G, the consortium hopes to accelerate the global growth ambitions.

No Significant Hurdles Expected

The $72.50 offer which the partnership makes for Heinz seems like a done deal. The offer represents a 19% premium compared to the all-time highs for the shares and has been unanimously approved by the board of directors.

Heinz' CEO William Johnson is positive on the deal as well, "Taking the company private would give Heinz the flexibility to make decisions more quickly, without the burden of having to report quarterly earnings."

While it has not been decided whether Johnson would be replaced as CEO of the company, one should not have to feel sorry for him. Johnson stands to make roughly $100 million on his 1.38 million shareholding in Heinz.

Not Your Typical Deal

The deal is a bit different than normal for Berkshire Hathaway and 3GCapital. Normally Buffett acquires a well-led business with the intention to leave management in place and grow the business. 3G Capital approaches companies which are often in rougher weather with the intentions to replace management and restructure the business. Heinz seems to be a compromise.

As the business is healthy and is reporting positive organic sales growth, it seems like a Buffett deal. However, the deal multiples are rather high, and some attempts to cut costs might be needed to justify the price tag. Rather than just cutting costs, 3G might aim for price hikes as well. Heinz has a collection of very strong brands with a very strong competitive position, allowing the firm to raise prices.

Deal Structure

The $72.50 offer for Heinz values the firm's equity at $23.3 billion. At the end of October, Heinz operated with $5.04 billion in short and long term debt and $1.01 billion in cash and equivalents for a net debt position of little over $4 billion. Adding the net debt position to the equity offer values the deal at $27.3 billion.

The deal value seems a bit rich at approximately 14 times annual EBITDA and 25 times annual earnings. However 3G and Berkshire plan to use leverage and some degree of cost cutting to make the price attractive overall.

Both 3G Capital and Berkshire will each hold a 50% common equity stake by contributing $4.4 billion each. Berkshire will furthermore make an $8 billion preferred stock investment which stands to yield an astonishing 9%. In exchange for this, 3G will actually manage the business and it seems inevitable that some degree of cost cutting will take place. Add the $4 billion current net debt position and a fresh loan of an estimated $6 billion from the banks, and voila you have raised $27 billion.

Over the past book year, Heinz generated $1.49 billion in operating cash flows. The company should be able to finance the $10 billion total debt position at roughly 3%, for annual interest payments of roughly$300 million. Add the $720 million in preferred dividend payments on preferred stock, and the company is still generating enough cash flow to cover the $400 million in investments it has made last year.

Smart Buffett

Buffett has cut an amazing deal receiving $720 million in secured dividend payments on his $8 billion preferred equity investment. Even if he receives no dividends on the common equity investment, Berkshire still receives 5.8% per annum on the total investment in the firm.

The fact is that free cash flow generation needs to improve to make the deal really worthwhile for common equity holders, which is 100% of the 3G Capital investment and just 35% of Berkshire's investment. With 3G officially in control, they can make the though choices of cost cutting, job losses and possible divestments of non-core assets. These moves will undoubtedly cause uproar in the Pittsburgh communities, but Buffett can claim he is not in control and choices are being made by 3G.

Buffett has struck again. Acting as both financier and equity investor in this deal, he gets better terms on his overall investment than normal debt and equity holders. He furthermore has an added benefit that the structure allows him to preserve his public image when cost saving measures will take place.

Implications For Investors In Berkshire

Investors in Berkshire Hathaway have already given their approval to the deal by sending shares to all time highs at an incredible $150,000 per share.

For the first nine months of the year of 2012, Berkshire generated $117.7 billion in revenues. The company net earned $10.3 billion over the period on time. As such, Berkshire is on track to generate annual revenues of $155-160 billion for 2012, on which the firm could earn $13.5-$14 billion. This values the partnership at 1.6 times annual revenues and 18 times annual earnings, given that the partnership is valued at approximately $250 billion.

The deal will most likely be accretive to Berkshire's shareholders as the firm transfers $8 billion in low yielding cash and short term investments into preferred equity which yields 9%. As such, earnings could increase by approximately $600-$700 million based on the preferred equity investment alone, thereby boosting annual earnings by approximately 5%.

Long term holders in Berkshire Hathaway could hold on to their positions.

Source: Buffett Strikes Again - How Heinz Deal Terms Are Superior For Berkshire Hathaway