The $28 billion purchase price at the time of the announcement was at 13.2 times FY13 Thomson consensus EPS. Other transactions of large cap packaged foods, most recently Cadbury, occurred at a similar valuation, further indicating that a higher offer is probably not in the works for Heinz.
Berkshire Hathaway Inc. (NYSE:BRK.B) and 3G Capital were interested in Heinz for its strong brands and growth in certain businesses. H.J. Heinz Company (NYSE:HNZ)’s growth in emerging markets, 21% of sales, was strong and the primary driver behind higher sales. Its developing market exposure is greater than its primary peers: Kellogg has 15%, and the remainder around are 10% or below.
One argument against Heinz prior to the deal was the quality of earnings versus its peers. Heinz received a steady contribution from a lower average tax rate. While the cash tax and book tax rates differ, the lower rate likely carried through to cash tax and led to higher free cash flow generation. Steady FCF has always attracted Buffet and private equity.
Berkshire Hathaway Inc. (NYSE:BRK.B) and 3G Capital will have to address the company’s performance in developed markets. First, developed market organic growth rates are below those of its peers like Campbell’s, General Mills, Kellogg, and Kraft. North American organic sales have been in the 0-1% range over the past six quarters, and the brands need some revitalization.
Impact on Industry
Although the deal is significant in size, it is not necessarily indicative of more looming large acquisitions by outside players. Multiples in the sector have likely had some positive impact, but packaged foods already traded at multi-year highs. The 20% premium, historically low as noted earlier, further supports the relatively high multiples the stocks already trade at.
Heinz’s portfolio will be evaluated and some divestures are probably on the horizon. Industry players looking to acquire brands, such as ConAgra and Kraft, could purchase some of Heinz’s assets. The frozen food portfolio is one likely candidate. Management of Heinz already announced plans to divest Shanghai LongFong Foods, an underperforming brand in China.
The valuation seems fair when looking at the group and comparing its valuation to Kellogg. Packaged food competitor Kellogg trades at about 11.4 times FY13 earnings and is negatively impacted from taxes versus the benefit that Heinz has had recently. It has lower, but still significant sales exposure (15%) to emerging markets. However, Kellogg does have a lower operating margin of 11% compared to 12.4% at Heinz. That said, the businesses are somewhat different since Kellogg has such a large presence in cereals, an area in which Heinz is not a player.
Conclusion
The shareholder vote to approve the deal is expected to go smoothly and the deal should close in 3Q13. The impact on the landscape of the industry is somewhat minor at this point. As noted earlier, it could result in more deals if Heinz divests certain business. Heinz may also start to add to its portfolio with strong financial backing from Berkshire Hathaway Inc. (NYSE:BRK.B). Also, the premium the industry trades at versus the S&P is not likely to expand due to further speculation on acquisitions. Berkshire Hathaway Inc. (NYSE:BRK.B) has participated in many transactions and investment opportunities, such as this example.
The article How Will This Brand Progress With The Buffett Backing? originally appeared on Fool.com and is written by Mike Thiessen.
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