The world of mergers and acquisitions is a peculiar place. On the one hand, you have activists demanding that large businesses sell off pieces of their organizations to "unlock shareholder value," and on the other, you have folks suggesting that your best path is to buy growth by acquiring other businesses. (And sometimes they are the same people.) Which one is viewed as the right move, of course, is highly company-specific, though how well such big deals will turn out can be tough to guess.
Even Warren Buffett doesn't get it right every time. He revealed this weekend that Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) overpaid for its stake in the Kraft Heinz merger -- though that wasn't the only reason the company took a huge loss in the fourth quarter. But GE (NYSE:GE) CEO Larry Culp has a pretty good track record on M&A, and his move to sell General Electric's biopharma unit to Danaher -- the company where he built that M&A track record -- has Wall Street quite optimistic.
In this MarketFoolery podcast, host Chris Hill and Motley Fool chief investment officer Andy Cross discuss the situations at Berkshire and GE, and offer investors some key insights on how to interpret these big corporate maneuvers.
A full transcript follows the video.
This video was recorded on Feb. 25, 2019.
Chris Hill: It's Monday, February 25th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, it's the chief investment officer, Andy Cross. Thanks for being here!
Andy Cross: Hey, Chris! Always, great time!
Hill: You're one of those maniacs who wakes up early on a Saturday morning because Warren Buffett has posted his annual letter to shareholders. We're going to get to that. That's why I wanted to have you on. I thought, "I know who's going to be reading this thing start to finish. It'll be Andy." We're also going to dip into the Fool mailbag.
But let's start with Berkshire Hathaway, and let's start with this. They posted a loss in the fourth quarter.
Cross: Massive one!
Hill: Massive, although posting a loss, pretty rare for Berkshire Hathaway. We touched on this on Motley Fool Money last week with the Kraft Heinz…is debacle too strong of a word? Certainly the writedown to the tune of about $3 billion with Berkshire Hathaway. Most of that was due to Kraft Heinz.
Cross: That's true. Warren Buffett talked about this. First, he gets into the specifics around a lot of nerdy accounting language, which he loves talking about. Readers of the Berkshire Hathaway annual letter, of which I am one, know -- he always talks a little bit about this, especially now that they have to mark-to-market their public holdings, which causes a lot of volatility when the difference from quarter to quarter ends in a profit or loss based on how the stock market has performed. Of course, as we know, in the fourth quarter of last year, the stock market had a really rough go. He talked about the fact that that leads to a lot of volatility in their quarterly results. They don't agree with this accounting rule, by the way. He points out the fact that in the first quarter of last year, they had a minus $1.1 billion loss; second quarter, a $12 billion profit; third quarter, a $18.5 billion profit, and, Chris, as you pointed out, in the fourth quarter, a minus $25.4 billion loss.
Really, looking at the quarterly results for Berkshire Hathaway, it's almost meaningless. Their operating businesses are so consistent over time and the volatility really comes from the public equity holdings, which now, the accounting rules require them to mark at the current prices.
That being said, the writedown at Kraft Foods really hurt them as well. That hurts their profitability as well.
Hill: He was on CNBC this morning talking with our good friend Becky Quick. He was very upfront about the fact, he said, "We overpaid for Kraft Heinz." I suppose that's easy to say in hindsight. I'm wondering if you think this makes him less likely to pull the trigger on future deals. He's been very public about the fact, "We're looking to make acquisitions. We want to make them at the right price." They don't want to overpay for something. My hunch is that what happened with Kraft Heinz makes them even less likely to pull the trigger on a deal.
Cross: I don't see it that way, Chris. Kraft Heinz is a partnership deal. They went in with 3G Capital. 3G Capital's brand has really taken the hit with a lot of this because they're running the Kraft Heinz operation. They became too excited about some of the cost savings and missed a lot of the trends in the consumer products good space. That has hurt.
He talks about this in the report, as he has in the past, talking about how they have this big elephant gun, they have $112 billion in cash. He wants to deploy it. He said prices are elevated to be able to put that to work. But if he finds a business that he thinks has good long-term economic opportunities and benefits and a competitive position worth making, he will put that capital to work.
One thing I just loved is how he opens up every year and talks about the performance of Berkshire Hathaway. For the third year in a row, the Berkshire Hathaway stock beat the S&P 500, which is now the preferred metric thinking about the market price, not the book value of Berkshire Hathaway, as they have more of these operating businesses. This was the amazing stat that I saw -- over the last 54 years, Berkshire Hathaway's stock has gained 2,400,000%, or an annualized rate of about 20%, vs. the market's 15,000%, or about 10%. Over 54 years, they have doubled the annualized performance of the market. Clearly, a talented investor.
Kraft, as he points out, they overpaid for that. He's not going to sell the stock. He wants to continue to hold it. He talks about that in his report, that they will not be selling a lot of businesses. They have a lot of cash to work from, from the balance sheet as well as from their massive insurance operations. I think when he finds the right business at the right price, he'll pull that trigger.
Hill: Not that I expect Buffett to be anything less than blunt when he's giving interviews, because he always has been. I did find it oddly reassuring that he said, "We overpaid for this." I remember at the time -- I know we talked about it on this show -- we call it a merger, but it's really Heinz buying Kraft, and the premium paid for Kraft was about 35%. It was one of those things where I think a lot of us looked at the deal and said, "OK, that seems like a high price, but it's Buffett, it's 3G Capital, we trust them."
Cross: I think they went in with their eyes a little too wide-open, eyes a lot bigger than their stomach, because of some of the cost savings they thought they could get out of the merger operation. They have cut out about $1.7 billion since 2015. But I think they expected that to be more aggressive. They haven't been able to do that. Some of the brands are little staid, as we talked about. Yes, they do have a dozen or so of billion-dollar brands, but those brands certainly aren't what they used to be. This is the challenge in the consumer products goods businesses. He talked a little bit about this before. The fickle consumer combines with a retailer, now, that is much more sophisticated than it used to be. Just look at what Amazon has done with the acquisition of Whole Foods. They are not price-givers anymore, they will be price-takers. That business, on the retail side, much like the airlines have gotten religion on profitability, I feel like the retailers have as well. That's also been a detriment to Kraft, and 3G missed that.
Hill: I think everyone expects there to be brands sold off from the Kraft Heinz universe. I saw one report that someone thinks that Maxwell House Coffee could fetch $3 billion. That struck me as a little high.
Cross: I was talking a little bit to some others about this -- not everyone buys Starbucks coffee. Not everyone buys Dunkin Donuts coffee. Maxwell House is a very large brand and it still takes them a lot of shelf space. If you go into certain grocery stores, it still takes up a lot of shelf space. It's a massive brand. Maybe it might be tied into some of the opportunities that the team is seeing, like you said, that 3G Capital might be divesting assets. They certainly have to, to help pay down some of the debt and get on the right footing. Whether it's Maxwell House or others, I'm pretty sure we will see over the next 18 months or so some big divestitures coming from Kraft.
Hill: Shares of General Electric up 10% this morning. I know! I'm incredulous to say that out loud! GE is selling its biopharma business to Danaher for $21 billion and change. Probably not a surprise that the stock would be up. GE says they're going to use the money to get their balance sheet in order, reduce their leverage. This seems like the obvious smart thing to do.
Cross: Yeah, they have to do that. A little more surprising is that Danaher's stock is up about 8% as well, too, Chris, as we're talking here. Clearly investors see this as a good sign for both companies. Danaher is a serially acquisitive company. It's local here in D.C. They've been enormously successful in rolling up operations over the years and building a life-sciences-focused business. They're going to take this on from GE as GE tries to separate its biotech businesses from its other operations and, like you said, get its balance sheet in order and bring a little life back into that business.
For Danaher investors, you're getting a pretty solid business. They're going to pay a premium for this. They're going to pay a nice penny for it at 17 times operating profits, but be able to now put it into a family that has real experience in managing life sciences operations. Good move that investors are seeing across the board.
Hill: In the same way that we expect brands to be sold off from Kraft Heinz, is it reasonable to expect that this is not the only selling that General Electric is going to be doing this year?
Cross: I think probably. Larry Culp, who took on the role at GE as CEO, used to be the CEO of Danaher. There's a connection there.
Hill: So he just called an old friend?
Cross: He probably called up an old friend, said, "Hey, what do you think? I have a business I want to sell, you got $21 billion to spare?" It won't be surprising if we see GE continue to focus and shed operations as they look to bounce off these lows. It's nice to see the stock has rebounded for shareholders of GE.
Hill: Stepping back and looking at, in the case of Berkshire Hathaway and General Electric, these two...I was going to say, "two enormous companies." General Electric, a lot smaller than it used to be. How do you think about mergers and acquisitions, given everything we've seen play out over the last few years?
Cross: Historically, if you go back decades, large acquisitions, large mergers, tend not to work out. Danaher and some other companies have had consistent small what are called tuck-in acquisitions at reasonable prices, to be able to put them into their marketing engine, put them into their sales pipeline, take some costs out of the operations, especially on the back-end, back-office operations. Those tend to work much better. Companies that can borrow at reasonable rates and make those acquisitions and get some higher returns from them can be a good use of capital.
The large ones, the large mergers, these big acquisitions, tend to make me a little bit less confident that this isn't just more empire-building from a CEO, from a board that just wants to be bigger. We saw a big merger with the bank world, BB&T and SunTrust earlier this year. We'll see how that plays out over time.
Hill: When you were talking about tuck-in acquisitions, it reminded me of a company that was in the news recently for a change at the top, Middleby (NASDAQ:MIDD). It's a company we've followed pretty closely here at The Motley Fool over the past decade. Middleby has done a phenomenal job of growing that business by making those type of tuck-in acquisitions that are very much in their wheelhouse.
Cross: That's exactly right, Chris. If you think about how Middleby has gone and made north of 40 acquisitions over the last couple of decades, they bring them into their sales pipelines, their sales force, help take some costs out. The Viking acquisition they made didn't go very smoothly. That was their largest. So, again, as these companies start to stretch a little bit, start to take on a little bit more challenges and turnaround stories, trying to get more costs out of there, especially on the consumer side -- where Viking plays -- that's a little bit more tricky. Certainly, we're seeing that with the Kraft and Heinz merger as well.
I think generally, there are some companies that have a history of doing this well. Selim Bassoul at Middleby is definitely one of them, and there are others, like Danaher, where these tuck-in acquisitions can add value for shareholders. But I would say, generally, they're more the exception than the rule.
Hill: Our email address is firstname.lastname@example.org. Great email from Nate Holdstein. Last week on MarketFoolery, Emily and I were talking about Boston Beer Company. You and I talked about it on Motley Fool Money, talking about the different brands. Nate dropped an email regarding the conversation Emily and I had about their 26.2 brand. Nate writes, "Lest you all think this was created just to be imbibed by marathoners, it's actually a limited release for which much of the proceeds go to a sports charity. For a number of years, it's supported medical and rehab costs incurred by the victims of the Boston Marathon bombing." I did a quick Google search, yeah, the Spaulding Rehabilitation Network. Thank you to Nate for the email. That makes me like it even more.
Cross: That's great! That has Jim Koch written all over it as a brand that so resonates with the Northeast, especially in the Boston area, as you know so well. I think that just speaks to the kind of leadership you want to see from founder-led organizations like Boston Beer.
Hill: Andy Cross, thanks for being here!
Cross: Thanks, Chris!
Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!