The Heinz acquisition is the latest in a string of big buyouts so far this year. It comes on the heels of Comcast’s (NasdaqGS: CMCSA) acquisition of the 49% of NBCUniversal that it didn’t already own and the takeover of computer maker Dell Inc. (NasdaqGS: DELL) by founder Michael Dell and Silver Lake Partners.
In all, these latest deals have powered M&A activity in the U.S. to $182 billion so far this year, up from just $58 billion at this point in 2012, according to CNBC. The Heinz takeover ranks as the biggest single acquisition in the food industry’s history.
Heinz Takeover Fits Buffett’s Value Investing Style …
In all, the Heinz deal is valued at $28 billion. Investors will get $72.50 for each share they own, which is a 20% premium on the stock’s closing price of $60.48 on February 13, the day before the takeover was announced.
Berkshire and 3G will each put in about $4 billion for their 50% stakes in Heinz, with 3G operating the company. In addition, Berkshire will invest in $8 billion of preferred shares thought to be yielding around 9%. In all, Berkshire is spending between $12 billion and $13 billion on the Heinz takeover. The remainder will be funded by a rollover of the company’s existing debt, as well as financing from J.P. Morgan (NYSE: JPM) and Wells Fargo (NYSE: WFC).
In many ways, the Heinz move is par for the course for Buffett, whose value investing strategy includes buying and holding shares of companies whose businesses are easy to understand and have products that clearly stand out from the competition. He also looks at a number of fundamentals that point to increasing value, such as consistently rising earnings and cash flow; an attractive return on equity; low debt; and high-quality assets.
Heinz fits most of these criteria: from 2008 through 2012 (its fiscal year ends on April 30), Heinz’s earnings per share rose 8.4%, from $2.63 to $2.85, while sales gained 15.7%, to $11.6 billion, and operating cash flow rose 25.7%. Its long-term debt has held steady between $4.7 and $4.8 billion, but its cash reserves have grown from $617.68 million in 2008 to $1.33 billion in 2012.
In the company’s latest quarter, which ended October 31, 2012, its sales were flat at around $2.8 billion, though its earnings jumped 23.3%, to $0.90 a share from $0.73 a year earlier. Its gross margin was 35.8%, up from 34.3% a year ago.
This performance has come against the backdrop of the global recession, fierce competition from generic products and, more recently, rising ingredient costs, which have put the squeeze on most food makers’ profit margins.
Throw in the company’s well-known products (including Heinz ketchup, Classico pasta sauces and Ore Ida snack foods) and it’s not hard to see how Heinz appealed to the Oracle of Omaha, who places a high value on brand names himself: Berkshire’s current holdings include an 8.95% stake in arguably the world’s most popular brand, Coca-Cola (NYSE: KO), as well as interests in names like IBM (NYSE: IBM), Procter & Gamble (NYSE: PG), Wal-Mart (NYSE: WMT), General Electric (NYSE: GE) and Johnson & Johnson (NYSE: JNJ).
… But Did He Overpay?
The move does, however, appear to go against Buffett’s typical approach in a couple of significant ways. For one, it’s hard to argue that Heinz was undervalued: the stock had risen 16.2% in the year leading up to the deal and was trading near 52-week highs before Berkshire and 3G paid an additional 20% premium. The $72.50-a-share purchase price is also a high 23.2 times Heinz’s last 12 months of earnings.
Plus, the bank debt the partners took out to make the purchase will significantly increase the company’s current obligations, adding to its interest costs and making it harder to increase its earnings, which Heinz forecast would grow between 5% and 8% in fiscal 2013 back in October. As well, as Stephen Gandel pointed out in a February 15 Fortune article, Heinz will be on the hook for the 9% payout on Berkshire’s preferred shares, or some $720 million annually—though that does give Buffett some insurance on his investment.
It’s also unusual for Buffett to work with a partner; even more so when that partner will have operational control of the acquisition (“It’s their baby from an operational standpoint,” he told CNBC). However, 3G, which is backed by Brazilian investors, has a strong track record in finding savings and increasing sales at the companies in which it invests. A good example is Burger King (NYSE: BKW), which the group took over in a $3.3-billion deal in 2010.
As the Financial Times reported on February 15, 3G was behind the burger chain’s move to a franchise-based model, which is nearly complete. In the fourth quarter, Burger King’s net income jumped 94%, to $48.6 million, or $0.14 a share, from $25 million, or $0.07 a share, a year earlier.
Buffett Is “Ready for Another Elephant”
At the end of 2012, Berkshire held $47 billion of cash, which is far higher than the $20 billion or so that Buffett likes to have on hand. Even after the Heinz deal, he should still have around $15 billion to put toward another acquisition and still stay above his threshold—and the company’s cash pile keeps growing.
The ever-quotable Buffett likens his penchant for acquisitions to elephant hunting. “I’m ready for another elephant,” he told CNBC after announcing the Heinz acquisition. “Please, if you see any walking by, just call me.”
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