Earlier this week, it was announced that Berkshire Hathaway and 3G Capital who owned Heinz, would merge with the Kraft Food Group, in a stock and cash transaction which includes a one of cash dividend of $10bn to Kraft shareholders, who will then own 49% of the new company. It is estimated the combined entity, to be called ‘Kraft Heinz,’ and will be valued at roughly $100bn including debt. The new company will generate roughly $30bn of annual revenues making it the fifth largest food and beverage company in the world.
However, even though the driving force behind this deal, 3G Capital, itself is a private equity firm, this itself is not a traditional private equity deal. Private equity firms generally acquire companies using a great deal of leverage by heavily funding their acquisition with debt, in order to amplify their returns. However, in this case, this deal is essentially a stock-for-stock transaction, with the $10bn being paid out as one time cash dividend to Kraft shareholders is being financed through equity raised.
Instead the result of this is in fact a reduction in leverage of the combined entity, from 3G and Berkshire Hathaway’s perspective as well as the combined entity moving towards a more conservative capital structure. Prior to the transaction being announced, Heinz had a Net Debt/EBITDA multiple of around 8.0x, however the combined entity will have a Net Debt/EBITDA of around 5.0x, as the merger with Kraft adds no additional debt. This more conservative financial leverage ratio could help facilitate the further debt financing and refinancing in the future – something I will explore later on in this article.
One of the most intriguing aspects of this deal is that it appears to be beneficial for all parties involved despite the deal coming at a time where the US food and beverage industry has struggled with sluggish growth. Recent trends within the US food and beverage industry does suggest that consumers are becoming more health conscious, as they switch towards smaller, healthier brands, whilst the typically “unhealthier” frozen food business of companies like Heinz has shrunk. However, given the involvement of 3G alone and their pedigree for achieving operational efficiency it could ease these concerns.
Since 3G initially took Heinz private, their cost saving strategies have helped Heinz become more profitable, with profit margin increasing 8% over the last two years to 26%. In addition to this, a number of other investments by 3G within this sector have become huge successes; most notably 3G returned a $1.4bn profit whilst retaining 71% stake in Burger King just two years after taking it private. Furthermore, its operational strategies have led to successful mergers between several companies to create “AB InBev” in 2008, the worlds leading brewery. Thus the involvement of 3G and their relentless focus on achieving operational efficiency could suggest Kraft-Heinz may be well placed to overcome this challenge.
In addition to this, cost synergies, as well as increased access to global markets are other key features of this deal. In recent years, both Kraft and Heinz have been cutting costs and trying to become more efficient. As mentioned Heinz has managed to increase its profit margin over the last two years by a significant amount. In 2012, Kraft completed a demerger and successfully spun off several snack and food brands, including Cadbury’s, in an effort to refocus its core business and operational priorities. Since then, it has managed to achieve a 20% profit margin, as of last year. The cost saving synergies of this deal, roughly $1.5bn per year from 2017, would be welcomed by both parties given the sluggish nature of US food and beverage industry. In addition to this, there is also the potential for increased international access following the merger. Specifically, Kraft, whose brands are heavily focused on the US, would benefit most from the merger, as it would provide a better platform for international distribution. This could potentially see the resurgence of several of Kraft’s struggling brands like “Jell-O” and “Kool-Aid.”
Finally, the merger itself could open up greater options for debt financing, as mentioned previously. Not only does the combined entity have a lower Net Debt/EBITDA ratio, but also the credit rating of Kraft-Heinz is expected to be investment grade, based on Kraft’s current credit rating. As a result of this, it may be the case that the combined entity could possibly look towards refinancing some of Heinz’ existing debt obligation, thus saving on interest payments. Furthermore, the lower leverage and investment grade rating could open up possibilities for the company to access Debt Capital Markets to facilitate further growth and development of its business in the future.
In terms of what this merger could do for the Food and Beverage industry, I would expect the announcement of this deal to possibly trigger some consolidation within this industry. However, given that the Food and Beverage industry has struggled with growth, key competitors such as Kellogg’s are undergoing structural changes, so may not be willing to look towards M&A as a means of consolidation. Although, given macroeconomic conditions and the impending interest rate rise by the Federal Reserve, it may be the case that this deal could be the trigger for a restructuring of the industry as whole.