Warren Buffett's Tasty Food Deal

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Warren Buffett, the most successful and respected investor in the world, has recently pulled the trigger on H. J. Heinz (NYSE: HNZ), one of the largest global makers of ketchup and baby food. His firm Berkshire Hathaway partnered with 3G, a Brazilian private-equity firm, to purchase Heinz at around $72.50 per share, with a total transaction value of $28 billion. The purchase price represented a 20% premium to its Wednesday’s closing price of $60.48 per share. Some might argue that Warren Buffett has overpaid this time, but Buffett said that it was his kind of deal and kind of partner.

Heinz is a Wide Moat Business

Heinz is considered the global leader in the ketchup and baby food businesses, with a global brand portfolio and world-class iconic brands. Over the last 10 years, Heinz has reduced the number of business categories from 6 in 2002 to only 3 in 2012. The three main business categories are Ketchup & Sauces, Meals & Snacks, and Infant/Nutrition. Around 47% of the total sales were generated from the Ketchup & Sauces business, including one of its key brands, Heinz Ketchup. Heinz Ketchup is considered a market leader in several markets, with a 60% market share in the US, 70% in Canada, and around 80% in the UK. For the last 10 years, Heinz has been increasing its global mix successfully. The sales from emerging markets have grown significantly, from 7% in 2002 to nearly 25% in 2012. In the first quarter of fiscal year 2013, Heinz derived two-thirds of its revenue from the international market.

Tasty Deal for Buffett

The Heinz acquisition is not a common buyout deal that Warren Buffett often does. Looking closely into the deal structure, I find that the majority of his investment goes into preferred stocks. Berkshire Hathaway will invest more than $4.5 billion for a 50% stake in the company, and 3G will invest an equal amount for another 50% stake. In addition, Berkshire Hathaway will invest an additional $8 billion in preferred stocks in the company. Thus, out of the $12.5 billion that Buffett invests in the deal, around 64% goes into preferred stock investment. Interestingly, the preferred stocks carry a juicy dividend yield at 9%. Thus, the $8 billion preferred stock will pay Buffett a yearly stable preferred dividend of $720 million.

Is it an Expensive Deal?

At a purchase price of $72.50 per share, the deal values Heinz at nearly 14x trailing EBITDA, a 30% premium to Heinz’s 10-year EBITDA average. It seems to be quite pricey compared to its listed peers, including ConAgra Foods (NYSE: CAG) and Nestle (NASDAQOTH: NSRGY). ConAgra Foods, with a trading price of $33.70 per share, is worth nearly $13.7 billion on the market. The market is valuing ConAgra at 11.45x EV/EBITDA. Among the three, Nestle is the biggest company with a $218.5 billion market cap. It is valued at around 13.5x EV/EBITDA. However, the Heinz deal is not as expensive as Nestle/Pfizer’s baby food deal.  In April 2012, Nestle purchased Pfizer Nutrition, a baby food business from Pfizer for around $11.85 billion, or as much as nearly 20 times EBITDA. In November 2012, ConAgra bought Ralcorp, a leader in the private brand food sector, for around $90 per share, with a total transaction value of $6.8 billion. The deal values Ralcorp at around 11x EV/EBITDA. Thus, the ConAgra/Ralcorp deal seems to be the cheapest. Among the three, ConAgra had the lowest LTM operating margin at 8%. Nestle’s operating margin is the highest at 16%, while the operating margin of Heinz is 14%. 

Foolish Bottom Line

With a 14x EBITDA, the Heinz buyout deal doesn’t seem to be quite expensive. Personally, I think it is a fair deal. As Warren Buffett put it: "It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.  With the market leading position, Heinz has quite a wide moat. It is really a great business that has been purchased at a fair price.

hoangquocanh has no position in any stocks mentioned. The Motley Fool recommends H.J. Heinz Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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