Heinz – Mazor'sEdge

(BRK.A), (BRK.B)

Questions about Brazil-based 3G Capital were much on the minds of Berkshire Hathaway shareholders at Berkshire’s annual meeting on May 2. Warren Buffett defended 3G’s cost-cutting methods as necessary to bring complacent century-old companies into the modern age.

“3G has been buying businesses that have too many people,” Buffett explained.

Over the past year, Berkshire and 3G went in together on two major deals.

On December 14, 2014, Berkshire provided key financing for the combining of Burger King International with the Tim Horton’s chain. The move was a merger that created a new company, Restaurant Brands International (QSR), one of the world’s largest quick service restaurant companies with more than $23 billion in system sales and over 19,000 restaurants in nearly 100 countries and U.S. territories.

3G Capital ended up owning 51% of the combined company and quickly installed 3G’s partner Daniel Schwartz as the Chief Executive Officer and a Director of the company.

Berkshire came out of the deal owning 68,530,939 Class A 9.00% Cumulative Compounding Perpetual Preferred Shares, and warrants to purchase 8,438,225 shares of Common Stock for a penny a piece. Berkshire later exercised those warrants for a modest 354,000% paper profit on its money.

On March 25, 2015, 3G and Berkshire announced the merger of their jointly-owned H.J. Heinz Company with Kraft Foods Group. The combined Kraft Heinz will be 51 percent owned by 3G Capital and Berkshire Hathaway. Kraft shareholders will own the remaining 49 percent. 3G partner Alex Behring will become the Chairman of Kraft Heinz. Berkshire will be the largest shareholder in Kraft Heinz.

In its growing partnership with 3G Capital, Berkshire Hathaway has found an aggressive partner that is looking to own major brands, and most importantly, to “right-size” them in the words of Charlie Munger.

Right-sizing refers to ruthless cost-cutting that cuts expenses in all areas, including laying off employees.

It’s the laying off of employees that drew questions at this year’s Berkshire annual meeting.

Counter to the Berkshire Ethos?

While some may mistakenly think Warren Buffett’s folksy persona might make him a softie when it comes to the management of companies, cost-cutting clearly is not just on the minds of 3G’s partners.

“You will have never found a statement from Charlie or me saying that a business should have more people than needed,” Buffett said at the meeting.

Charlie Munger compared the employment of excess personnel to the full employment guarantees in the former Soviet Union, where, as he quoted the old Russian saying, “We pretended to work, they pretended to pay us.”

Buffett went on to point out that Berkshire’s own strategy is to make sure its companies do not have excess employees, and as he joked about companies in general, “Any company that employs an economist has one employee too many!”

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

(BRK.A), (BRK.B)

Berkshire Hathaway and 3G Capital have upped their bet on the tastes of American consumers. H.J. Heinz, which is wholly owned by 3G Capital and Berkshire Hathaway, will acquire Kraft Foods Group in a mega-merger that creates a $37 billion food company that will be the number five food and beverage purveyor in the world, and North America’s number three food company.

The combined company will be known as The Kraft Heinz Company.

Kraft Heinz will be 51 percent owned by 3G Capital and Berkshire Hathaway. Kraft shareholders will own the remaining 49 percent. The deal is expected to close in the second half of 2015.

The combined company will have a portfolio of packaged food brands that includes Heinz ketchup, Philadelphia cream cheese, and Oscar Mayer meats.

Kraft has $18 billion in annual sales, employs 22,500 workers, and boasts that 98 percent of U.S. and Canadian households have Kraft products in their kitchens. Nine of Kraft’s brands have more than $500 million in annual sales, and 80 percent of sales are in categories where they hold the #1 or #2 market position.

Kraft Heinz will have $28 billion in sales with eight $1+ billion brands and five brands between $500 million-$1 billion.

Under the terms of the merger, Kraft shareholders will receive one share of the combined company and a special cash dividend of $16.50 per share. The special cash dividend will be funded by 3G Capital and Berkshire Hathaway. While Berkshire is putting in cash, it is not swapping any Berkshire stock, which is Warren Buffett’s preferred method of acquisition.

3G Capital and Berkshire acquired Heinz in 2013 for $23.2 billion. The day to day management of the company has been handled by 3G Capital, with 3G’s managing partner, Alex Behring, serving as Heinz chairman. Behring will assume the reins of the new company as chairman, and current Kraft chief executive John Cahill will be appointed vice chairman.

Kraft has struggled in recent years as its packaged foods such as Velveeta, Miracle Whip, Planters, Jell-O and Kool-Aid have lost ground in the era of natural foods, however Heinz’s strength internationally is seen as a plus for the combined company. Kraft’s current markets are the U.S., Canada and Puerto Rico.

On the investor side, Kraft was a reliable dividend stock for investors as it’s brands brought steady earnings, even amidst lackluster growth. Its goal has been to “deliver steady, reliable growth with a strong focus on cash flow to fund a highly competitive dividend…” At the time of the merger announcement its annual dividend yielded 3.59 percent.

For Berkshire and 3G the deal is already a winner. Barron’s states “By our calculation, 3G and Berkshire have tripled their original $8.5 billion ($4.25 billion for each) equity investment in Heinz in less than two years, which amounts to a private-equity type score on a deal that originally looked like it was fully priced. Heinz was taken private at about 20 times forward earnings. We estimate that Berkshire and 3G are each sitting on more than $10 billion in profits from their investments in Heinz.”

The deal will also raise Heinz’s debt rating. In a press release, Kraft Heinz states that it is “fully committed to maintaining an investment grade rating; Company plans to maintain Kraft’s current dividend per share, which is expected to increase over time.”

Alex Behring’s management of Heinz has brought significant cost cutting, and a similar approach is expected at Kraft Heinz. The company expects to cut $1.5 billion in annual expenses by the end of 2017.

“This is my kind of transaction, uniting two world-class organizations and delivering shareholder value,” Warren Buffett said. “I’m excited by the opportunities for what this new combined organization will achieve.”

3G’s and Berkshire’s focus is on a long term investment. Kraft’s announcement of the merger states “Berkshire Hathaway and 3G Capital have a history of successful partnerships and are committed to long-term ownership of The Kraft Heinz Company as it strengthens its leadership position in the industry.”

The company notes that “As the cash consideration is fully funded by common equity from Berkshire Hathaway and 3G Capital, the merger is not expected to increase the debt levels of The Kraft Heinz Company. The Company is fully committed to deleveraging in a timely manner and to maintaining an investment grade rating going forward.”

Buffett, who drinks five cans of Coke a day, will now have lots of packaged foods to munch on all day long. He recently joked that the secret to his longevity was that “I eat like a six-year-old.”

Could his self-confessed love for munching on UTZ brand potato sticks make Utz Quality Foods, the largest independent privately held snack food brand in the U.S., a fit someday for Kraft Heinz?

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