Will You Take On Mr. Buffett?

| About: The Kraft (KHC)

Do you want a solid trade idea with the potential for exceptional risk-adjusted returns? Would you like free PR for your firm? Do you manage a multi-billion dollar portfolio?

If you've answered all of these questions in the affirmative, take a look at Heinz (HNZ). The stock closed yesterday (2/21/13) at $72.19. The company reported a solid quarter on 2/21/13, earning adjusted EPS of $.99 ($.95 reported), and Heinz is on track to make $3.80 (consensus) in the coming fiscal year.

The company is trading at slightly less than 19 times forward earnings, after the Buffett offer announcement. Compare this with Hershey (NYSE:HSY) trading at 25 times trailing earnings (22 times forward earnings) with no deal premium.

HSY trades at roughly 29 times trailing twelve month Enterprise Value to EBITDA compared to HNZ at only 13.5 times trailing twelve month Enterprise Value to EBITDA.

Even after the Buffett offer announcement, HNZ is paying nearly a 3% dividend yield compared to HSY paying barely over 2% yield at the market price.

I am a shareholder of HNZ, and I would prefer to keep the company, not sell it at all. It provides an excellent opportunity for the investing public to own a piece of Americana, sleep well at night, and continue to receive steady, increasing dividends indefinitely into the future. I will vote No to the sale, and I'm trying to encourage other shareholders to join me in the No vote.

However, if we are going to be forced to sell our beloved HNZ, then we at least ought to get a valuation comparable to Hershey.

At 22 times forward earnings, the HNZ deal prices at $83.60, roughly 16% higher than the present Buffett offer. At 25 times forward earnings, the deal prices at $95, nearly 32% higher than the current offer. I don't think we ought to sell for less than $100 per share, which is approaching 40% higher than the current offer price. Using the HSY EV/EBITDA multiple of 29, you get a selling share price for HNZ of $167, a staggering 130% higher than the present Buffett offer.

What's your downside? The stock was trading a bit over $60 before the deal was announced, with a bit less than 20% deal premium. Clearly, Mr. Buffett believes the stock was undervalued at that level, but with leveraged arbitrageurs now likely in the stock, you could be looking at more than a 20% decline if the deal falls apart. You can hedge this risk using options or a short position. If you are managing multi-billions, you can probably get much better advice on how to create the hedge than I am able to provide.

Why not take a shot? Do you have any better ideas for producing near term risk-adjusted outperformance?

Disclosure: I am long HNZ, HSY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.