Berkshire Hathaway has launched what it appears will be a successful bid for Heinz in conjunction with 3G Capital, a Brazilian private equity firm. But does it fall within Buffett’s normal investment criteria?
- 1 Is this a typical Buffett deal?
- 2 A quick look at the Heinz buy-out from a Buffett perspective
- 2.1 Does the company sell brand name products that are likely to endure?
- 2.2 Is the business of the company easily understood?
- 2.3 Does the company invest in and operate businesses within its area of expertise?
- 2.4 Does the company have the ability to maintain or increase profitability by raising prices?
- 2.5 Is the company, looking at both long-term debt and the current position, conservatively financed?
- 3 Update
- 3.1 Does the company show consistently high returns on equity and capital?
- 3.2 Have the earnings per share and sales per share of the company shown consistent growth above market averages over a period of at least five years?
- 3.3 Has the company been buying back its shares, and if so, has it bought them responsibly?
- 3.4 Has management wisely used retained earnings to increase the rate of return to shareholders?
- 3.5 Is the company likely to require large capital sums to ensure continuing profitability?
- 4 Putting it all together
Is this a typical Buffett deal?
On the surface, it appears that this is outside Warren Buffett’s usual investment parameters. The buyers are borrowing some of the purchase monies, the price is well in excess of the price to earnings ratio that Buffett normally pays, and Buffett has said in the past that he does not like private equity firms all that much. In addition, private equity firms generally buy a company, restructure it by selling surplus assets and/or downsizing the work force, and then on-selling the new entity as soon as possible. Buffett, on the other hand, is generally a long term investor.
A quick look at the Heinz buy-out from a Buffett perspective
We might take a preliminary look at the buy out, the full details of which are not yet available, in the light of the things Buffett is known to care about.
Does the company sell brand name products that are likely to endure?
Heinz and its brands - Heinz, Lea and Perrins, Greenseas - are known all over the world and have been for many years. The answer here is yes.
Is the business of the company easily understood?
We would think that it is. The company is in the food business with an easy to understand business plan: it makes and wholesales ready-made, or easy to prepare, food products.
Does the company invest in and operate businesses within its area of expertise?
As far as we can make out, the company sticks to what it knows - making and selling foods. It does not appear to dabble in exotic businesses.
Does the company have the ability to maintain or increase profitability by raising prices?
The businesses that it is in are highly competitive but within its industry segment, it has pretty close to what Charlie Munger calls a moat; that is, a competitive edge. Sure - you can buy lots of brands of soup, baked beans or ketchup but some people will only buy Heinz, and when they use up a can or bottle will replace it. This is the repeat, cash producing business that Buffett loves. And it allows the company to edge up its prices to cover inflation and increased labor costs. Anyone who likes Heinz tomato soup is not going to stop buying it just because it goes up a cent or two.
And the size and market dominance of Heinz means that it is unlikely to be held hostage by big supermarket chains. Can you imagine a supermarket refusing to stock Heinz?
Is the company, looking at both long-term debt and the current position, conservatively financed?
The last balance sheet suggests that the company has long term debts of $4.78 billion and annual profits of $939 million. If we work on Buffett’s theory that a company should be able to pay its long term debt off out of current profits within 5 years, dividing the debt by the profit gives us just over 5 years, a little high and just outside the margin.
The current ratio of 1.46 is also higher than Buffett generally likes.
In addition, the joint buyers are funding part of the purchase price through borrowings, which will flow through to the company’s overall debt position. Although Berkshire is providing part of the purchase monies through taking preferred shares, why did Berkshire not put up all the loan capital, particularly when it is sitting on surplus cash? There could be a couple of reasons for this. First, interest rates in America are historically very low. Second, perhaps part of the deal with the private equity partner is to turn around any surplus assets in the company quickly.
The details of the purchase are becoming clearer. As we understand it, at the offer price, the deal will cost about $23 something billion. Of this amount, Berkshire and 3G Capital will each put in about $4 billion, Berkshire will put in another $9 billion in exchange for preferred shares, and the balance will be by way of loans. Two comments: First, the preferred shares will pay 9 per cent, a good rate of return for Berkshire at a time of low interest rates. Secondly, the loan proportion is quite low , compared to the usual private equity buyout model.
Does the company show consistently high returns on equity and capital?
Return on equity over the last five years has been in percentage terms 44.8, 75.7, 46.7, 32,4, 34.1. Buffett would love this. Even though the rate is coming down, it is still a ROE that most companies would die for. The return on capital is much less, probably reflecting borrowings, but is still acceptable: 12.8, 14.7, 13.7, 16.3, 12.5.
Earnings per share over five years has been 2.67, 2.94, 2.89, 3.09, 2.87. Steady but would not past the usual Buffett test. Sales tell a similar story.
We have not had time to research this.
We have not had time to make this calculation.
Is the company likely to require large capital sums to ensure continuing profitability?
Probably not, although the increased borrowings to finance the purchase may be a limitation on what the company can do.
Putting it all together
We figure that Buffett and Munger know better than we do what they see in Heinz but, apart from its competitive edge, brand name, and huge capacity to earn money per share, this looks to us as an investment outside Buffett’s usual parameters. Or perhaps he knows something that we don’t. Another curious thing is that Berkshire is handing the management of the deal over to its private equity partner. So Buffett must have a lot of faith in their capacity and their integrity, two traits that he values highly. He has said of the deal that:
Heinz is our kind of company with fantastic brands … Its my kind of deal and my kind of partner.
The owners of 3G seem to be somewhat different to other private equity tycoons insofar as they engage in active management of the bought out company. This may be what Buffett sees in them but still they remain private equity operators.
It remains to be seen what happens at Heinz but it would not surprise us if, after the deal goes through, there is some kind of redistribution of assets with Berkshire being left with a sized-down food company with the famous brands and the repeat consumer business that Buffett so loves.