Watch What Buffett Does With the Heinz Acquisition (Merkel)

by David Merkel, Aleph Blog

I participate in an online group of Johns Hopkins students and Alumni, mainly discussing company analysis and valuation.  This is what I posted on the Heinz acquisition by 3G and Buffett:

There are two ways to look at this: like Buffett or like 3G. Let’s look at both:

(1) 3G will be the active partner. Their stake is equity only, and own 70%. They very well may have cost savings or product or marketing synergies. They are businessmen, not speculators. They will use Heinz to create a better & more global company.

(2) Buffett gets 30% of the equity for $4B, and $8B of preferred stock paying a 9% coupon. It doesn’t matter much where he places the equity in his holding company, but the preferred will go into some of the insurance companies, where it will be financed by cost-free float, require minuscule amounts of capital, and be taxed at preferential rates.

Over a long enough period of time (~20 years), the preferred pays for the whole deal, and any value of owning 30% of Heinz is gravy. (They sell gravy too.)

After the Burlington Northern acquisition, I wrote this post to justify the price paid: The Forever Fund. Regarding Heinz, ask the same questions — what would take to create a company like Heinz from scratch, i.e. replacement cost, including all of the regulatory hurdles.

Between Buffett and 3G, you likely have the financing and the savvy for a significant joint venture that will be mutually profitable. Nothing is a slam-dunk, but this looks good.

Full disclosure: long BRK/B

To sum this up: Buffett gets focused talent; he doesn’t have to concern himself with managing Heinz. He gets a stable asset that he can cheaply finance that will throw off a minimum of 6% on average (assuming 3G performs adequately; they have done better than adequate in the past).

3G gets patient capital.  They can take short and long-term steps to maximize the value of Heinz without a lot of interference or second guessing.  And if they do it very well, their upside is levered by Buffett’s preferred financing.

If they blow it… that’s another thing, but Buffett would hold the option of restructuring Heinz with a new partner, or finding talent to run it internally at BRK.  After all, it”s not like he doesn’t have the liquidity to do it.

Full disclosure (David Merkel): long BRK.B