The billionaire investor has snapped up Heinz and taken it private. But he paid a 20% premium to the shares’ all-time highs. Has the value investor stained his reputation, asks Simon Wilson.
What’s happened?
Warren Buffett has struck again. His cash-rich Berkshire Hathaway company has teamed up with 3G capital, a private-equity firm backed by the Brazilian InBev brewing billionaire Jorge Paulo Lemann (see below), to take the foods giant Heinz private in a $28bn deal. It’s the biggest takeover of the year and the fourth-biggest food industry acquisition ever.
It has raised hopes among investment bankers that the recent uptick in mergers and acquisitions activity will prove sustainable. Berkshire, the conglomerate amassed by Buffett over four decades, has a cash pile of $46bn, and had made no secret of its appetite for big acquisitions. Indeed, even after the Heinz deal, Buffett told CNBC that he remains “ready for another elephant, so if you see one walking by, just tell me”.
Is it a typical Buffett deal?
In lots of ways, yes. Heinz is a well-run, easy-to-understand business of the kind long favoured by the ‘Sage of Omaha’. It has strong brands – not just Heinz, but Classico pasta sauces, ABC soy sauce and Ore-Ida potato chips and fries.
Its strong brand identity and dominant market positions, especially in ketchup, baked beans and baby foods, give Heinz what Buffett likes to call an ‘economic moat’ – ie, significant barriers to entry that in this case give it a good chance of standing up to competition from similar but cheaper products, including supermarkets’ own brands. Heinz also sits happily alongside Coca-Cola and consumer goods giant Procter & Gamble, two of the biggest holdings of Berkshire Hathaway.
Has he got a good price?
Not remotely. The $72.50-a-share price represents a breathtaking 20% premium to Heinz’s recent all-time high. It is also a massive 21 times this year’s earnings. That compares to an average price/earnings (p/e) for Heinz over the past decade of 16. One of Buffett’s famous old saws is that he’d rather pay a fair price for a wonderful company than pay a wonderful price for a fair company.
In other words, it pays to remember that value investing is about value, not price. But even allowing for all Heinz’s “wonderful” qualities, and the fact that anyone wanting to take such a big public company private is necessarily going to have to pay a full price, this deal does look expensive. So expensive, in fact, that the Financial Times’s Lex comment team kicked off their analysis of the deal with the line “let us all now give Warren Buffett a stern lecture about overpaying”.
Should investors follow his lead?
Heinz is now taken. But firms they might want to consider include Unilever and Reckitt Benckiser, PepsiCo and Kimberly-Clark. Before rushing to copy Buffett, they need to look closely at the Heinz deal to see what he is getting.
As with his previous Goldman Sachs and Bank of America deals, he’s secured predictable, fixed returns while taking on less risk than an ordinary shareholder. As MoneyWeek’s Phil Oakley put it when he explored this in a recent Money Morning email: “the fact is that, for all his professed faith in the US economy, Buffett doesn’t like these companies enough to be last in the queue to get paid, despite describing them as great businesses”.
That’s why a good slug of the money invested has gone into preference shares, which pay out before ordinary shares and offer Buffett an estimated coupon of as much as 9% and contribute to an estimated overall return on investment of 6%.
That’s not a spectacular return is it?
That’s because there are no real synergies here. Management’s argument that it will have more flexibility as a private company looks disingenuous, given that this is a mature packaged foods business with little obvious scope for pursuing radical investment or divestment strategies.
And as for the preference share dividend, Lex in the FT argues that “it is one thing to extract a good preferred dividend from a company in which you own a slice (Goldman Sachs, say). When you own a company outright, you are paying yourself. That is not a ketchup stain on your reputation, Mr Buffett. It looks more like blood.”
So what is he really up to?
Buffett may no longer be focused on ‘value’ as an investment driver, but on quality and safety – apparently at any price. An immense cash pile gives him access to opportunities denied to ordinary investors. Heinz offers steady growth, typically one or two points above inflation, and a great cash generator. It has made respectable inroads into emerging markets, upping its revenues from 5% to 25% of the total over the past decade. In short, it’s unexciting.
But then Buffett believes the investment environment has fundamentally changed and with one eye on succession planning his priority is capital preservation. This may be the right deal for a man who has one eye on hanging up his working clogs.
Who is Buffett’s new pal?
While Warren Buffett has long enjoyed the quiet pleasures of hometown comforts, his new best friend Jorge Paulo Lemann – the pair met on the board of Gillette – has had a rather more colourful life. Lemann is known as Brazil’s most famous banker and fiercest dealmaker, though he has lived mostly in Switzerland (his father’s home country) since 1999.
He graduated in economics from Harvard in 1961, and in between careers as a business journalist and building up a powerhouse brokerage firm, Garantia, he found time to become a professional tennis player, winning Brazil’s national championship five times, and playing at Wimbledon. Last year, he overtook Eike Batista to become Brazil’s richest man.