How Warren Buffett’s Luck Changed

Warren Buffett has taught us countless things through the years resulting from his major acquisitions. But one company that made his luck change reveals all we need to know about where we put our money.

The major purchase
Warren Buffett of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) has long made known his desire "buy a wonderful business at a fair price," and 2012 was one year where he was disappointed about his progress. Yet, that changed quickly as the calendar turned to 2013. In conjunction with private equity firm 3G Capital, it was announced on Valentine's Day that the firms had partnered to buy Heinz in a deal that valued the beloved food company at $28 billion.

When the deal was made, Buffett said:

Heinz has strong, sustainable growth potential based on high quality standards, continuous innovation, excellent management and great tasting products. Their global success is a testament to the power of investing behind strong brand equities and the strength of their management team and processes. We are very pleased to be a part of this partnership.

By the time the dust settled, and the official terms of the agreement were finalized, Berkshire had a 50% stake in Heinz worth $12.25 billion. The $28 billion figure contained the bonds and other debt it has outstanding, which included an $8 billion stake in preferred stock that pays a 9% dividend. With that in mind, it's no wonder Buffett was "pleased" with the purchase.

But the natural question becomes, why exactly did Buffett make Heinz his second-largest acquisition, trailing only the $44 billion purchase of railroad Burlington Northern Santa Fe? 

Buffett once remarked:

'Buy commodities, sell brands' has long been a formula for business success. It has produced enormous and sustained profits for Coca-Cola since 1886 and Wrigley since 1891. On a smaller scale, we have enjoyed good fortune with this approach at See's Candy since we purchased it 40 years ago.

At first glance, it's easy to see how Heinz clearly fits into the prototypical mold mentioned above. In fact, Buffett himself noted the brand first in his prepared statement. But the critical thing for investors to see isn't only the power of strong brands, but his second point, which is the power of strong management.

"The strength of their management team"
Buffett is considered -- rightfully so -- as a "value investor," who is keenly aware of the price he is paying for any business. Yet, one of the things that often goes undiscussed is his careful consideration of the folks atop the businesses he invests in.

In his 2007 letter to shareholders, when he discussed how he carefully considered investments, he himself showed price actually fell behind management when evaluating companies: "Charlie [Munger] and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag."

This is important to remember because reviewing Buffett's lengthy discussion on why he made the Heinz deal reveals that much of it focuses on the strength of Heinz itself; but he also praises the management team at 3G Capital.

Consider his quote on CNBC when discussing the purchase: 

Well, we always prefer to buy businesses, and that's what we consider Heinz to be. Well, we'll -- we'll be in Heinz forever and -- if a few of our partners decide to sell out at some point, I hope they sell to us. So, this -- this -- you know, we -- we'd like to buy -- we'd like to have bought 100 percent of Heinz, but we -- we love the idea of Jorge Paulo Lemann being our partner. So -- if it takes 50 percent of the equity to bring him in -- that's fine with us.

In effect, Buffett is saying the business and economics of the deal were absolutely something he approved of, but he was happy to reduce his stake thanks to the strong management offered by 3G Capital. He even went on to say in the six-hour 2013 question-and-answer session with Berkshire shareholders: "Charlie and I paid more than if we were doing the deal ourselves because Jorge Paulo Lemann is a great manager, because he's so classy, so we stretched a little. I like the business."

So does this mean we should only look for strong management? As you might suspect, Buffett thoroughly refutes that notion, too. In 2007, when he remarked about the four things he looks for, he went on to say:

Additionally, this criterion eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses. But if a business requires a superstar to produce great results, the business itself cannot be deemed great.

We must see both the critical distinction between management and manager, as well as the reality any company with command of a singular point on Buffett's checklist -- sensible business, strong economics, capable management, and a reasonable price -- doesn't mean it's a great investment.

As it relates to management, although Buffett once said, "it's hard to overemphasize the importance of who is CEO of a company," we must see Buffett has highlighted the management team of 3G -- including the "talented associates" of Heinz's new CEO Bernardo Hees, as well as its Chairman Alex Behring -- not just Lemann in isolation. So we cannot only focus on the ability of one singular manager.

And we must also remember that even an easy-to-grasp, great business with strong management like Heinz isn't a great investment if it is overvalued, as Buffett has also said, "a business with terrific economics can be a bad investment if the price paid is excessive."

The key distinction
So with all that in mind, the natural question of course becomes, just how well is the new management at Heinz doing? As Brooklyn Investor reveals, after excluding for various costs associated with the acquisition, the team at Heinz "increased operating earnings 47% in less than a year."

That is to say, Buffett clearly evaluated both Heinz as a company, as an investment and as an organization run by individuals remarkably well.

The reality is, at times we can so easily be trapped into thinking just one of Buffett's key considerations when making an investment is worthwhile, but we must see there is a delicate balance of all four. And when we make the right decisions with the four of those, we too can find a Heinz, or if we're lucky, two or three or ten.

Warren Buffett: This new technology is a "real threat"
Heinz is just one example of the seemingly endless success Warren Buffett has had. But at the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.


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