The first report I read, which was published on Tuesday evening, bore the headline "3G Capital Said to Be in Advanced Talks to Acquire Kraft" (NASDAQ:KRFT.DL). That was enough for me to suspect Warren Buffett's Berkshire Hathaway (NYSE:BRK.B) (NYSE:BRK.A) was involved in some capacity. The deal is now official. Sure enough, H.J. Heinz -- which is jointly controlled by 3G Capital and Berkshire Hathaway -- will merge with Kraft to create the world's fifth-largest food and beverage group (third-largest in North America), with estimated combined revenues of $28 billion. This isn't Buffett's first collaboration with 3G Capital – and it won't be his last.
Why was I so sure that Berkshire Hathaway was involved? At the end of February, in his golden anniversary shareholder letter, Warren Buffett alluded to the prospect of doing more deals with 3G Capital, as he praised the Brazilian investment group in the highest terms [my emphasis]:
Two years ago my friend, Jorge Paulo Lemann, asked Berkshire to join his 3G Capital group in the acquisition of Heinz. My affirmative response was a no-brainer: I knew immediately that this partnership would work well from both a personal and financial standpoint. And it most definitely has.
I'm not embarrassed to admit that Heinz is run far better under [3G Managing Partner] Alex Behring, Chairman, and Bernardo Hees, CEO, than would be the case if I were in charge ...
We expect to partner with 3G in more activities. Sometimes our participation will only involve a financing role, as was the case in the recent acquisition of Tim Hortons by Burger King. Our favored arrangement, however, will usually be to link up as a permanent equity partner (who, in some cases, contributes to the financing of the deal as well). Whatever the structure, we feel good when working with Jorge Paulo.
Indeed, to see just how well this partnership has worked from a financial standpoint, let's take a look at some of the number from this deal. First, here is how the transaction is structured:
- Kraft shareholders will receive shares in the combined company, named The Kraft Heinz Company, on a one-for-one basis (i.e. each share of Kraft is converted into a one Kraft Heinz share).
- In addition, Kraft shareholders will receive a $16.50 per share special dividend funded by a $10 billion equity investment by Berkshire Hathaway and 3G Capital.
- All told, existing Heinz shareholders will own 51% of the combined company, and existing Kraft shareholders will have a 49% stake on a fully diluted basis.
What do these numbers imply for Berkshire Hathaway and its shareholders? Here is how Warren Buffett broke it down on CNBC on Wednesday:
We put in four-and-a-quarter billion to buy common stock of Heinz initially and then we're putting a little over $5.2 billion [to fund the special dividend], because we have about 53% of Heinz, counting our warrants, so we're putting in another $5.2-something billion, so we'll have $9.5 billion, roughly, in the common stock and we'll own 320-odd million shares of the new company.
But, of course, the stock you're looking at will go ex-dividend $16.50, at some point, before we receive our new shares in the company. So we'll have 320-plus million shares, roughly, in the new Kraft Heinz and that will be the present Kraft stock less a $16.50 special distribution to the present Kraft shareholder. If we own 320 million-plus shares in the new company and we paid $9.5 billion, we will have paid a little less than $30 a share for our stock in the new Heinz company.
So Berkshire will have paid roughly $30 per share of Kraft Heinz -- what are those shares worth? Well, Kraft shares closed Wednesday at $83.17, (a 35% premium to the previous day's closing price) and each of those shares give right to one share of Kraft Heinz plus a $16.50 special dividend. Subtracting the special dividend, we find that Kraft Heinz shares are currently valued at $66.67. Compare that $66.67 to Berkshire's ~$30 cost basis and it becomes clear just how successful the original Heinz investment has already been (it was completed less than two years ago!)
3G Capital continue to prove themselves as extremely capable operators, who do the heavy lifting of overseeing the investments, while Buffett is content to contribute capital -- and then watch it compound. No wonder the Oracle of Omaha referred to them as a "perfect partner." You can take me at my word when I say this won't be the last deal he does with 3G Capital.