Berkshire Hathaway (NYSE:BRK.B) and investment firm 3G Capital are paying $72.50 per share for ketchup king H.J. Heinz (NYSE:HNZ), 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.