Did Buffett Overpay for Heinz?

Berkshire Hathaway (NYSE: BRK-B  ) and investment firm 3G Capital are paying $72.50 per share for ketchup king H.J. Heinz (UNKNOWN: HNZ.DL  ) , in deal valued at $28 billion -- the largest food group acquisition on record. The price represents nearly a one-fifth premium with respect to the all-time high price of Heinz's stock, and nearly 21 times estimated earnings per share for the next 12 months! Has Berkshire CEO Warren Buffett forgotten his famous value discipline and gone and overpaid for Heinz?

"Price is what you pay, value is what you get," as the saying goes. What is Buffett getting in return? Well, Heinz is a 144-year old company with a stable of iconic brands -- not just Heinz ketchup, mind you, Heinz also produces Lea & Perrins Worcestershire sauce, for example. Those brands are at the heart of Heinz's competitive moat, and that translates into wonderful returns: Return on capital has averaged 13% over the prior 10 fiscal years and average return on equity was nearly 37%! In fact, on reviewing Heinz's business and fundamentals, I was rather incredulous when I could find no record of Berkshire ever having owned the shares previously -- Heinz is the archetype of the business that Buffett says he looks for.

Great business, middling investment?
Still, one must distinguish the business from the stock. No matter how great the former, overpaying for the latter will produce poor returns, or even losses. When KKR acquired RJR Nabisco for $25 billion in 1989 after multiple raised bids -- then the biggest leveraged buyout in history -- it sealed its fate: The investment was failure.

And speaking of leveraged buyouts... that may be one of the keys to understanding the Heinz acquisition and its price tag. Indeed, this is not a traditional Buffett acquisition in which Berkshire pays in cash or a combination of cash and shares and the target joins the fold. Instead, Berkshire and 3G Capital are equal equity partners, each putting forward $4 billion in equity; Berkshire will also invest $8 billion in preferred shares paying 9%. The balance of the financing will be provided by rolling over existing debt and raising new debt -- keep in mind that high-grade corporates are issuing bonds at near-historic low yields. Buffett also told CNBC this morning that 3G would supervise the business, saying "Heinz will be 3G's baby."

By the numbers
I looked at completed acquisitions in the food and beverages sectors with an equity value in excess of $10 billion. Acquirers paid an average enterprise value-to-EBITDA multiple 14.7 (Note: Enterprise value is total value of the firm, which sums market capitalization and net debt. EBITDA stands for Earnings Before Interest, Taxes and Depreciation and is a proxy for cash flow.) At $72.50 per share, the acquisition price for Heinz equates to an enterprise value-to-EBITDA multiple of 16.4, so we are not far off our benchmark.

While the deal doesn't look wildly cheap, it doesn't have to be: Even struck at or slightly above current fair value, the quality of the business and the structure of the deal should ensure satisfactory returns. Give him the benefit of the doubt: Uncle Warren still knows a thing or two about value. 

Warren Buffett's long track record of success has made him one of the best investors of all time. With the Buffett at the helm, Berkshire Hathaway has grown book value per share at a compounded annual rate of 19.8% for nearly 50 years! Despite an incredible historical track record, investors have to understand the key issues to watch moving forward. To help investors, The Fool's resident Berkshire Hathaway expert Joe Magyer has created this premium research report on the company. Inside you'll receive ongoing updates as key news hits, as well as reasons to both buy and sell the stock. Claim a copy by clicking here now.


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  • Report this Comment On February 14, 2013, at 4:05 PM, alancardoso wrote:

    The author of the article is missing the main point.

    Buffet is an important part of the acquisition, but it´s not by chance that 3G Capital will be running the show. For the people that don´t know these are the most agressive cost cutters in the industry, having more than 20 year of a VERY sucessfull track record - just remember Anheuser-Busch InBev. Accordingly, expect massive layoffs and corporation expense reduction going forward - and strong earnings growth.

  • Report this Comment On February 14, 2013, at 4:33 PM, mistacy wrote:

    Meanwhile, speculation comes in. The stock price is in overbought territory. Any investor would be a sucker to not take 20% overnight profit. I think there will be a nice pull back over short term.

  • Report this Comment On February 14, 2013, at 6:38 PM, turnermuseum wrote:

    Buffett once again made a deal with an appeal to the TV screens + the microphones.

    A good PR investment = a lousy fundamental buy.

    Bye + Bye, I liked to say for decades - ketchup has been invented to mask the poor quality of food it covers, here the name masks the poor quality of the deal.

    Buffett made another move which shall virtually guarantee John Fredriksen's SDRL et. al. will outperform him in the next decade, as it has =

    if yahoo stock charts are to be believed =

    in the past decade!

  • Report this Comment On February 14, 2013, at 6:56 PM, LBonecrusher wrote:

    Can't understand WB causing massive layoffs which will hurt BHO.

  • Report this Comment On February 14, 2013, at 7:00 PM, PuddinHead42 wrote:

    Don't forget, BRK is also financing via preferred shares so he will have a nice cash flow coming in outside of his 50% stake. Smart guy.

  • Report this Comment On February 14, 2013, at 7:04 PM, poach wrote:

    Good move WB, + you have an interesting bunch of partners with similar buy and hold objectives and experience.

    You will see the same ketchup or a close derivative even after 100 years.

  • Report this Comment On February 14, 2013, at 7:10 PM, Mega wrote:

    Short answer, no.

    Did 3G overpay for Heinz? Probably. There will be very little cash flow left for equity in the new capital structure.

  • Report this Comment On February 14, 2013, at 7:24 PM, Zakgirl wrote:

    Investment and speculative insight yet again by, Buffett.

  • Report this Comment On February 14, 2013, at 8:35 PM, TMFAleph1 wrote:

    @MegaShort

    Berkshire and 3G Capital are equal equity partners in the investment.

  • Report this Comment On February 14, 2013, at 9:40 PM, NewAlchemist wrote:

    I recently thought about buying Heinz. Is it undervalued? Probably not. More like fair valued or a little overvalued right now.

    Buffet isn't buying Heinz for right now. Berkshire will own Heinz for many years - long after Warren is gone.

    When you put it in that perspective it doesn't matter if he over paid 15% for example.

  • Report this Comment On February 14, 2013, at 10:01 PM, Mega wrote:

    TMFAleph1, obviously.

    I think the preferred is very underpriced and the common is a bit overpriced.

  • Report this Comment On February 14, 2013, at 10:07 PM, TMFAleph1 wrote:

    "Buffet isn't buying Heinz for right now. Berkshire will own Heinz for many years - long after Warren is gone."

    That's not clear to me. I don't think 3G Capital's timeframe is forever, which raises the issue of the exit. Berkshire could buy them out, of course, but that would exclude the possibility of both parties achieving the optimal price.

  • Report this Comment On February 15, 2013, at 12:56 AM, dgmennie wrote:

    "Has Berkshire CEO Warren Buffett forgotten his famous value discipline and gone and overpaid for Heinz?"

    Buffett's investment decisions seem to always attract the attention Fool editorial writers. The fact is that:

    (1) Whatever Buffett decides to do, by the time he does it it is way too late for the average investor to benefit, so why bother with big headlines and verbose backseat-driver commentary?

    (2) Buffett loves aquiring big low-tech profitable businesses that could be "run by a ham sandwich," so apparently Heinz fits this aquisition strategy. Ketchup and pickles have remained relatively unchanged for decades, yet always sell in huge quantities.

    (3) Buffett bought Heinz with a partner (3G Capital) diluting Birkshire Hathaway's investment risk (if any).

    Nobody can spot the next Apple, or Google, or Linkedin among the overwhelming number of promising high-tech, bio-tech or green-tech companies that come out of the IPO woodwork every year. So you can bet Buffett does not even try. Yet he makes billions. Perhaps there is an investment lesson here that does not involve spreadsheet analysis, mathematical projections, industry stats, or guru opinions and instead depends mostly upon common sense -- something that is always in short supply.

  • Report this Comment On February 15, 2013, at 1:08 AM, TMFAleph1 wrote:

    "Whatever Buffett decides to do, by the time he does it it is way too late for the average investor to benefit, so why bother with big headlines and verbose backseat-driver commentary?"

    The aim is not to try to benefit from the individual transaction (although there is academic research that shows a strategy mimicking Buffett's investments has produced excess returns), but rather to try to gain a better understanding of Buffett's investment approach.

  • Report this Comment On February 15, 2013, at 9:22 AM, Xrat wrote:

    Could it be that 'The Sage' already owns supermarkets and can make profits through synergies? After all Heinz does make more than just ketchup..., I believe at one time they had 57 varieties!

  • Report this Comment On February 15, 2013, at 10:28 AM, kjcrowfo87 wrote:

    what if warren buffett bought a bunch of calls on the stock before he bought it... there may have been a lot of call sells as this stock generally doesnt move much... so a lot of the long term holders may not of participated in the 20 percent "overpayment"

  • Report this Comment On February 15, 2013, at 10:51 AM, TMFAleph1 wrote:

    @kjcrowfo87,

    Thanks for your comment, but I don't understand it -- can you elaborate?

  • Report this Comment On February 15, 2013, at 9:45 PM, dsciola wrote:

    Interesting deal...appears like a big waste at first, but given the relative multiple to the industry average, mebbe could yield good returns

    Alex, can u explain more y the structure is so good for WB/BRK? Specifically, y so good if he's splitting the equity with 3GC, but leaving mgmt of HNZ basically up to 3GC and also rolling over/issuing new debt at low-yields.

    I'de assume if WB still hasn't lost his edge, he'd have a hand in running the biz and max'ing its returns, whereas per above it seems more like 3GC will be doing all of it and mostly by trimming whatever fat/cost-cutting can be done on HNZ...

    You also bring up BRK's great track record, which undoubtedly is true. What about 3GC's track record? May be harder to dig up given they are a PE firm, but I'de be curious to see what their returns have been, prior investments and exits, etc. That could prolly get some more insight into the potential value of this deal.

    Also to Mistacy, ru referring to BRK being overv'd and likely encountering a future pullback, or u referring to HNZ?

    THX

    Dom

  • Report this Comment On February 16, 2013, at 12:39 AM, TMFAleph1 wrote:

    <<Specifically, why so good if he's splitting the equity with 3GC, but leaving mgmt of HNZ basically up to 3GC and also rolling over/issuing new debt at low-yields.>>

    What's not to like for Berkshire if they are equal equity partners and 3G Capital will be the one making the time and effort to oversee the investment?

    As Buffett told CNBC on Thursday morning: "Any partnership where I don't have to do the work is my kind of partnership,"

  • Report this Comment On February 16, 2013, at 6:26 PM, dsciola wrote:

    OK, so basically he really trusts 3GC to know what they are doing.

    Whats the advantage with "rolling over/issuing new debt at low-yields?"

  • Report this Comment On February 17, 2013, at 11:32 AM, TMFAleph1 wrote:

    Cheap leverage.

  • Report this Comment On February 17, 2013, at 9:37 PM, mikecart1 wrote:

    I knew I should have bought Heinz when I lived right next to the Pittsburgh factory. However, I think the products are overrated. I rarely use them and think with growing health concerns, Heinz products are going to decline in popularity.

    :)

  • Report this Comment On February 19, 2013, at 4:21 PM, ElCid16 wrote:
  • Report this Comment On February 19, 2013, at 4:28 PM, ElCid16 wrote:

    Per the link I just posted, Buffett got 30% of the equity for $4B. He is also investing $8B in preferred, paying a 9% coupon. 30% of the company's annual FCF is about $300MM.

    "Over a long enough period of time, the preferred pays for the whole deal..."

    "Nothing is a slam dunk, but this looks good."

  • Report this Comment On February 19, 2013, at 8:28 PM, NewAlchemist wrote:

    Today's WSJ has an opinion piece taking a shot at Buffet today.

  • Report this Comment On February 20, 2013, at 6:13 PM, TMFAleph1 wrote:

    @ElCid16

    That's incorrect: Buffett told CNBC that Berkshire and 3G will be *equal* equity partners.

    http://www.cnbc.com/id/100460608/CNBC_Transcript_Billionaire...

  • Report this Comment On February 22, 2013, at 1:32 PM, gene132 wrote:

    Heinz is a firm that can easily be broken up and sold for more cash than the market capitalization. In effect, it is worth more parted out than together-and most of the food products can be made much more cheaply..this is the sort of asset stripping deal that Carl Icahn likes. Sell it off, pocket a lot of cash, and let the employees live with the consequences.

  • Report this Comment On July 05, 2013, at 8:13 PM, jaybird43 wrote:

    I don't know about most fools, but most of us small fry only care if we pay too much for a security. Warren can take care of himself(and he does since Berkshire pays no dividends). worry about no.1. Like did I pay too much for Slw at 18.18 a share.

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