A quite expensive ketchup

Berkshire Hathaway Inc. Market Cap (as of 21/02/2013): $249.04bn

3G Capital Market Cap: N/A, participation of $4bn equity
H. J. Heinz Company Market Cap (as of 21/02/2013): $23.15bn

The Oracle of Omaha has finally decided to put to use some its spare cash and joined forces with 3G Capital in the biggest buyout ever in the food industry in a transaction valuing H.J.Heinz at approximately $23bn ($28bn with the inclusion of debt). The consortium will pay $72.50 per share of common stock, which represents a 19% premium on the all-time high stock price, a 20% premium to Heinz’s closing share price of $60.48 on February 13, 2013, a 23% premium to the 90-day average Heinz share price and a 30% premium to the one-year average share price. The transaction will be financed through a combination of cash provided by Berkshire Hathaway and affiliates of 3G Capital, rollover of existing debt, as well as debt financing that has been committed by J.P. Morgan and Wells Fargo. Debt financing will amount to $14.1bn, equal to 5x EBITDA and twice the current level, becoming one of the highest in the food industry. It resulted in a downgrade of the company from Fitch from BBB+ to BB+ , down to junk from its four-decades long investment grade rating. The swap prices rose as well to a level implying a credit rating of Ba1, further supporting the downgrade as appropriate given the new risk profile. J.P.Morgan and Wells Fargo will provide $8.5bn of senior secured term loan, a $2bn of euro/sterling senior secured term loan B-1 and B-2 facilities, a $1.5bn senior secured revolver and a $2.1bn second lien bridge loan. Finally, Berkshire Hathaway will pay $8bn for preferred shares with a dividend yield of 9% annually. The agreement has been unanimously approved by Heinz’s Board of Directors. However, the transaction is subject to approval by Heinz shareholders, receipt of regulatory approvals and other customary closing conditions. The deal is expected to close in the third quarter of 2013.

Overall, the transaction appears to be consistent with Buffett’s traditional investment style, focused mainly on bricks and mortar companies such as Coke, J&J and Heinz itself, even though this comes at an hefty price that has been questioned by some commentators. However, it should be emphasized that Heinz remains a company with solid cash flows as well as one that has been characterized by steady growth (albeit never explosive), with a strong brand and an increasing presence in developing markets that amounts to 25% of the overall revenues. The $12bn put forward by Buffett grant him an average annual yield of 7% , given the 9% from the 8bn preferred shares plus the 2.8% from common equity assuming that dividends are unaffected by the reshaped financial structure. Such a yield is not so easy to find when the sums involved are so large. 3G is the obvious partner in such a venture considering their successful turnaround of Burger King, less obvious is their profit expectation. In fact, there are no synergies and it is very hard to justify paying an equity premium ranging from $3.9bn to $5.4bn in such a mature company operating in a likewise mature sector only for its cash flow stability. Furthermore, consider that earnings will be put under significant pressure from debt servicing and from the $720mln required by Buffett’s preferred shares. To put this into perspective, Heinz’s net income was approximately $920mln in the last financial so…good luck to 3G.

Heinz has been advised by Centerview Partners and BofA Merrill Lynch. Moelis & Company acted as advisors to the Transaction Committee of Heinz’s Board of Directors. Lazard served as lead financial advisor. J.P. Morgan and Wells Fargo also served as financial advisors to Berkshire Hathaway and 3G.