Earlier this week, Burger King (UNKNOWN:BKW.DL) announced it is acquiring Canadian coffee chain Tim Hortons (UNKNOWN:THI.DL) to create a fast food powerhouse with $23 billion in revenues. Behind the deal is Burger King's majority investor, Brazilian investment group 3G Capital, which will own approximately 51% of the combined company. Although it only commands a two-sentence paragraph in the press release, another savvy investor, Berkshire Hathaway (NYSE:BRK-B), is participating in financing the deal with a $3 billion preferred share investment. This is the second time in eighteen months that Berkshire Hathaway CEO Warren Buffett has joined forces with 3G Capital, but it won't be the last. Here's why Berkshire shareholders ought to rejoice at that prospect.
How much is Berkshire earning on this investment?
This has not been widely reported, but, in a conference call with investors earlier this week, Burger King CEO Daniel Schwartz revealed that Berkshire's $3 billion in preferred shares sport a 9% dividend. On the face of it, that figure is consistent with the two deals from Berkshire's recent transaction history that are most similar to this one:
- Last year, Berkshire acquired H.J. Heinz in concert with 3G Capital, putting up more than $4 billion common equity. As part of the financing of the deal, Berkshire also purchased $8 billion of Heinz preferred shares with a 9% annual dividend.
- In 2009, Berkshire bought $3 billion worth of Dow Chemical preferred shares in order to assist in the financing of Dow Chemical's acquisition of Rohm & Haas. The preferred shares paid an 8.5% annual dividend and were convertible into common shares under certain conditions.
However, this deal looks a bit less attractive than the two mentioned above, for two reasons:
First, as far as I can tell, the return on this deal is capped, as there is no "equity sweetener," such as equity warrants or a conversion feature attached to the preferred shares that would provide additional upside potential (I left a message for Berkshire Hathaway's chief financial officer Marc Hamburg to confirm this, but he had not returned my call at the time of publication).
Second, if Burger King transfers its headquarters to Canada (as it intends to), Berkshire will pay a 35% tax rate on the preferred dividends instead of the 14% it would have paid if it were to remain in the U.S. (in fact, the Financial Times reported that Buffett negotiated for a higher dividend in order to compensate for the difference in tax rates.)
Still, nine percent is not a bad return in an environment in which the forward earnings yield on the S&P 500 is just 6.4%.
Is this deal a template for future deals?
Berkshire Hathaway has a growing (if high-class) problem: A $49 billion cash mountain that Mr. Buffett is tasked with allocating in order that it may earn a return on behalf of shareholders. A $3 billion deal is always welcome – can shareholders expect to see more of the same?
As noted above, the Burger King-Tim Horton's tie-up is the second transaction in which Berkshire Hathaway has teamed up with 3G Capital. The reuniting of the two investment groups is not unexpected. At the Berkshire Hathaway annual meeting this year, Mr. Buffett didn't mince words in his assessment of 3G Capital, calling them "marvelous partners ... They're very smart, they're very focused. They're very determined. They're never satisfied. And as I said earlier, when you make a deal with them, you make a deal with them ... We welcome the chance to work with them again."
Furthermore, 3G Capital has a heavy focus on branded food and beverage companies; Buffett likes the same, seeing repeat demand, pricing power and low/zero risk of obsolescence as highly attractive investment characteristics.
But is this deal a template for future investments? While there is no question that Warren Buffett is open, even enthusiastic, to the notion of working with 3G Capital again, this transaction per se is not ideal from Berkshire's perspective in that it lacks the upside potential of a common equity investment. In addition, Mr. Buffett has stated his preference for control investments in which Berkshire acquires companies outright over passive minority investments.
Still, Mr. Buffett is sitting pretty: 3G Capital – an investment group for whom he has tremendous respect – is sourcing investments for him, they're the ones willing to get their hands dirty with day-to-day management and share the equity upside!
In fact, Mr. Buffett could have captured some of that upside with Burger King – he admitted to the Financial Times that 3G Capital offered to have him co-invest when it took the chain private in 2010, but he refused. "I didn't do it, I made a mistake," he concluded.
Mr. Buffett is nothing if not a quick study; as his confidence in and dealings with 3G Capital increase, I don't expect he will make the same mistake twice. Instead, Berkshire Hathaway investors can expect Mr. Buffett to get involved with 3G Capital at every future opportunity. Buffett-watchers will want to become Lemann-watchers, too (Jorge Paulo Lemann is the billionaire co-founder of 3G Capital).