Opinion

Felix Salmon

Heinz: The headline-friendly LBO

By Felix Salmon
February 14, 2013

Brazilian multi-billionaire Jorge Paulo Lemann’s cunning plan seems to have worked. In 2008, when his InBev announced that it was buying Anheuser-Busch, there was an immediate uproar: sites like Drink American and SaveAB immediately appeared to protest the deal. (“With your help we can fight the foreign invasion of A-B. We will fight to protect this American treasure. We will take to the Internet, to the streets, to the marble halls of our capitals, whatever it takes to stop the invasion.”)

headlines.jpgThis time around, Lemann has decided that he wants to be the American — and he’s done it by teaming up with an American icon even more beloved than Budweiser or Heinz ketchup: Warren Buffett. This is a takeover of Heinz by 3G, make no mistake: Lemann approached Buffett with the idea in December. But look at how this is playing on, say, the NYT homepage: the headlines are all about Buffett and Berkshire, not about Brazil.  This is a leveraged buy-out, just like most other private equity deals, but it’s getting none of the bad press that LBOs often receive, and no one’s talking about “corporate raiders”. (The headline isn’t even accurate: Buffett is paying only half of the $23 billion, with the other half coming from Lemann and his partners in 3G. And it’s unclear what mergers are included in this “revival”.)

It’s easy to see why both 3G and Buffett love this deal. $23 billion is a lot of money, quite possibly more than 3G could comfortably stretch to on its own. So having a partner is attractive to them — especially when the partner is Warren Buffett. On the other side, Buffett gets to buy in to a storied franchise — one, what’s more, which will now be run by the best operators in the world. The 3G folks know the fast-moving consumer goods industry intimately, and can run companies in that industry more effectively and efficiently than anybody else in the world. Pair them up with brands as strong as Heinz’s, and it’s reasonable to assume that Buffett is going to see some gratifying profits from this deal.

This, then, is not a Buffett deal: it’s a 3G deal, with Buffett being brought in as a kind of guest GP. Neither is it, as Peter Lattman says, an indication of “the rise of Brazil as an economic power”, or of the strength of the Brazilian economy. 3G’s principals might be Brazilian nationals, but really they’re part of the global plutocracy, and are as happy with a Belgian brewery as they are with a Brazilian bank.

In a world where private-equity shops are desperate to put their money to work, and where stock-market investors are more conservative than aggressive financiers, we’re going to continue to see more of these high-profile LBOs. Which in turn is going to make the stock market even less relevant than it is today.

Comments
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“we’re going to continue to see more of these high-profile LBOs. Which in turn is going to make the stock market even less relevant than it is today.”

They’re leveraged, which means they rely on debt (a lot of cash floating around, so I guess it’s easy to make these giant purchases). But they eventually have to pay off those loans, and the usual way is by going public. So how is that going to make the stock market irrelevant?

While you might be right about an increase in LBOs, all that these buyers are doing is flipping. They will still need public muppets, I mean markets, to unload their debt-laden carcasses on.

Posted by KenG_CA | Report as abusive
 

Buffett’s MO is also to buy companies that throw off cash and allow them to keep throwing off cash. He doesn’t generally load them up with debt.

Posted by Zdneal | Report as abusive
 

Berkshire’s aversion to debt has always been somewhat overstated, and Buffett is happy to let that be the case for PR purposes. Most of Berkshire’s “debt” is just in the form of non-interest bearing insurance liabilities – i.e., premium float and reserves for future losses. It’s not a bad strategy, but the distinction versus an LBO capital structure is overstated.

One, admittedly imperfect, way to look at it is to compare Berkshire’s total balance sheet to a typical LBO. Berkshire has (per its latest 10Q) book equity of $189 million, book assets of $424 million, and therefore liabilities of $235 million. That’s an equity to total capitalization (equity + liabilities) of 45%. The average equity contribution to an LBO in 2012 (from S&P Leveraged Commentary & Data) was 38%. Over the past 10 years, that annual average has varied between 30% and 46%.

Posted by realist50 | Report as abusive
 

One other way to think about this same phenomenon – PE funds do not have fund-level leverage. The fund itself is 100% equity capital, with debt at the operating company level. When buying an operating company, Berkshire draws the capital from an already levered source – its holding company and insurance subsidiaries – but doesn’t use much debt at the operating company level.

Posted by realist50 | Report as abusive
 

@realist I would argue that the book value of Berkshire understates the value of their assets by at least half. Look at Sees Candy, an admittedly tiny but visible part of their empire.

http://www.gurufocus.com/news/108738/war ren-buffett-on-sees-candy

In 2006 they were carrying Sees at a book value of 72 million… the intrinsic or market value would probably be something higher than that for a business that ANNUALLY earns 80 million pre-tax. That’s an extreme example to be sure… but in that example the carrying value of the business is understated by 90% rather than the average of 50% that I’m estimating.

You’re absolutely right about their debt being understated though.

Posted by y2kurtus | Report as abusive
 

Felix, I think you’re being a bit harsh on Michael de la Merced here. Yes, the NYT headline (and the first three paragraphs of Michael’s story) ignore the arguably dominant party in the deal – but I don’t think it’s fair to criticize him for referring to a revival in mergers. Clearly he’s referring to M&A activity generally – and “mergers” is a common shorthand for that. You are apparently thinking of classic mergers of equals, or at least trade buyers acquiring each other. Neither one is technically correct, so it’s not clear why your conception of the word is more accurate or correct than his. But if you want to get technical about it, he is correct – both Heinz and Dell are being structured as statutory mergers.

Posted by bw210 | Report as abusive
 

@y2kurtus – fair point. BRK stock closed today at 1.33x of book value, which I should have used as superior measure to book value. Using the market value of equity puts Berkshire’s equity to total capitalization at 52%. I suspect that the implicit market valuation of the operating companies is greater than 1.33x book, but the insurance operations and marked to market investments lower the blended average.

My complaint, by the way, isn’t really with Buffett. He’s obviously a very successful and disciplined investor. His public comments paint himself and Berkshire in a favorable light, which is fair and not surprising. My issue is that most of the financial press reports his words as the views of a neutral observer, even when he has a vested interest. In certain cases it’s like reporting what the CEO of Ford thinks about GM.

* All the “millions” in my earlier post were, of course, typos that should be “billions”.

Posted by realist50 | Report as abusive
 

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