April 20, 2014

The H.J. Heinz Buyout Is a Windfall for Berkshire Hathaway Shareholders

As is now widely known, the H.J. Heinz company is being acquired by hedge fund 3G Capital and Berkshire Hathaway, in an interesting joint-venture deal that will take the world’s largest ketchup manufacturer private.  

The terms are fantastic for shareholders of Berkshire Hathaway, which makes me happy as the conglomerate represents my largest public securities market holding as of this afternoon, representing 36% of the net asset value of all common stockholdings across the personal portfolios with an aggregate average cost basis comfortably below book value.  

Berkshire Hathaway Heinz Aquisition

The short version from what has been made available about the Heinz buyout thus far:

  • $4.12 billion will be funded by 3G Capital writing a check for common equity
  • $4.12 billion will be funded by Berkshire Hathaway writing a check for common equity
  • $8.00 billion will be funded by Berkshire Hathaway writing a check for preferred stock, which will pay 9% dividends each year
  • $7.10 billion will be funded by bank debt provided through Wells Fargo and JP Morgan
  • $100 million will be funded by warrants issued to Berkshire Hathaway

This is a beautiful deal structure for Berkshire Hathaway stockholders.  3G Capital will provide all of the management for the private Heinz company so Berkshire Hathaway doesn’t have to think about how to run the business.  As it waits for the ketchup maker to spin-off or sell its frozen food division, cut expenses, and restructure, Berkshire Hathaway will receive $720 million per year in cash dividends on its preferred stock.  If Berkshire Hathaway decides to exercise the warrants, it could write another large check and become the majority owner of H.J. Heinz, taking control.

As of 3rd quarter of last year, Berkshire Hathaway had the equivalent of 2,478,739,631 Class B shares outstanding.  The H.J. Heinz preferred dividend income alone just added 29¢ of pre-tax investment income to each of those shares.  With the holding company generating so much cash that is earning an effective 0% parked in short-term Treasury bills, it’s a nice addition to the bottom line.

Under almost all scenarios, it is very difficult to see how the entire H.J. Heinz deal hasn’t paid for itself within 10 years.  By 2023 or 2024, Berkshire Hathaway should have gotten all of its money back, plus it will still own the storied Pittsburg-based saucier.

The Past Twenty Years, Berkshire Hathaway Has Put Together Some Amazing Deals

Honestly, I can’t get over how much Berkshire Hathaway has changed since I bought my first share.  It’s so much better now than it was even 10 years ago.  On top of the recent H.J. Heinz deal, you have Lubrizol and Burlington Northern Santa Fe.  You have Marmon Holdings and Iscar Metalworking.  I mean, when I was first reading about the business, it didn’t even own 100% of GEICO, yet.  Its buyout of General Re when I was in high school was a huge deal at the time and now it’s ancient history.  The Berkshire Hathaway of 2013 is a powerhouse compared to the Berkshire Hathaway of 1993.  The past twenty years have been unreal.

I imagine my family will continue to hold Berkshire Hathaway shares long after Warren and Charlie have passed away and the firm has begun paying out most of its earnings as cash dividends, using the stream of money to fund other investments.  I’ve been buying them practically my entire adult life, and studying them since I first read Peter Lynch’s famous book in 1992.

Heinz VinegarAs weird as it sounds, I feel the same way about my shares in the corporation as I do about my parents’ manufacturing business or my sporting goods businesses.  I love the firm, and not just because my childhood heroes built it.  I love the strategy – the sourcing of low cost capital through insurance float.  I love the economics – take a look at the tangible return on capital earned by some of the subsidiaries.  I love the history – how it was built by compounding good decision after good decision until you suddenly have this incalculably large behemoth.  I love getting the annual report each year and calculating just how much of that net worth, and those profits, belong to me.

That doesn’t mean I’ll lose my objectivity.  If we suddenly found ourselves in a world where it was selling at 5x book value or future management is starting to trade in all sorts of crazy derivatives while levering up the balance sheet, I’d probably liquidate the holdings.  I’d hate it, but I’d be rational about it.  Still, I am optimistic that it can someday transform itself into a system – like Procter & Gamble, General Electric, or Johnson & Johnson.  That way, I have a good shot at passing on the shares to my own children and grandchildren.  That thought brings me a lot of joy.

And now, H.J. Heinz is part of the story.  Can you imagine if, 25 years in the future, Berkshire Hathaway pulls a Ma Bell and splits itself up in a series of massive spinoffs?  It would be one of the biggest events in Wall Street history.  That would be crazy … you’d have the furniture group, the jewelry group, the insurance group, the homebuilders, the power plants, the railroad, the candy and food group … I can’t even imagine.  That would exciting to witness.  I’m not saying I’d want it to happen – I’m perfectly content to sit back and collect dividends for the next few decades once Messrs Buffett and Munger have given up on trying to put the surplus capital to work; a day that will inevitably come.  But it would be exciting.

  • Jason

    Interesting story that ol’ men’s suit lining company Berkshire Hathawy turned out to be :) I am reading through Lowenstein’s “Buffett” biography and I’m just to the part where Warren is shutting down his partnership in 1969.

    I’m very interested to read what’s coming up in his story and find out how his investing partnership, which closed into Berkshire Hathaway stock, became the business conglamorate that it is today.

    Forbes just came out with the 40 highest hedge fund earners from 2012. Some of these guys made hundreds of millions of dollars last year. But as their money grows year after year the hundreds of millions still just adds up to money in the form of stocks. Their style of compounding is an interesting contrast to Buffett’s style in terms of it’s manifestation.

    I’d be interested to hear you thoughts on why we don’t see more of these successful hedge fund investors turn their wealth into holding companies and business conglamorates like Buffett and Munger have. Why did it work out this way in Buffett and Munger’s case? Why don’t we hear about more hedge fund investors buying up compete businesses with their hundreds of millions? Strengths and drawbacks of each strategy?

    • http://twitter.com/SMcTwelve Scott McCarthy

      We do hear about “investors buying up complete businesses with their hundreds of millions” – we just call them “Private Equity Groups” rather than “Hedge Funds.”

      A PE fund could certainly go public as a holding company, if that’s what the investors wanted to do. But because of the annual performance fee, and the way that carry is computed (using IRR against an annualized hurdle rate), fund managers have an incentive to liquidate the companies they buy as soon as they can get full value for them.

      The first example of an actual hedge fund taking a controlling stake in a public company, and then appointing the fund manager as CEO is a company that’s probably too small to talk about under Joshua’s “mega-cap only” guidelines (the company has a current market cap of less than $500 million). I happen to love that company, and think it’s tremendously undervalued compared to break-up value. But the CEO/fund manager is currently loading debt on the operating companies, and “investing” that cash in his own hedge fund (where he personally takes 25% of the profits, in addition to annual management fees based on AUM) – not to mention he takes a salary from the public holding company that’s about 4-5x what you could really call “reasonable.”

      That’s not how you maximize investor wealth – so why would investors want to agitate for a structure like that?