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Thursday, July 3, 2014

Heinz Update: Who's Next?

So it's been about a year since BRK and 3G Capital acquired Heinz (HNZ).  This is old news to most of you as the 10-Q for the first quarter was posted more than a month ago.  It is pretty amazing to read and you will see how incredible the 3G folks really are.  To find it you have to search Hawk Acquisition Intermediate II at the SEC website.

The thing about the 3G book, even though it 's a great read, is that there aren't that many figures in there.  This is true with a lot of books and even newspaper/magazine articles in general, but I guess it's too much of a hassle for most non-financial people to talk numbers.  In journalism, there is some standard about "who what when where why and how".  Someone should come up with a similar standard for financial/business news.  I'm always baffled at how little information there is in articles in the U.S.  They never seem to ask, "at what valuation?".   They seem only to focus on notional size; like, "$28 billion, wow, that's like, huge!!".   But never mind.

Anyway, first of all, let's take a look at HNZ before the acquisition:

Heinz Margins 2008-2013


It looked pretty decent.  15% margins in the highly competitive food segment seemed reasonable.  SGA expenses in the 20%-ish range also looked pretty normal.   Most would wonder how you could possibly increase margins from here in this segment as we all know that with big customers like Walmart, Target and Costco, there isn't a whole lot of pricing power.

But of course, we all know what 3G Capital is capable of.   Let's see what these guys did with HNZ:

If you look at the headline figures, there is not much progress:

                          2013 1Q                        2014 1Q
Sales :                 $2,856                            $2,800
Gross profit:       $1,040                               $955
Gross mgn:          36.4%                             34.1%
SGA:                     $629                                $521
SGA%:                   22%                             18.6%
Op income:           $410                                $433
Op mgn:              14.4%                              15.5%

But of course this is not the whole story.  In these figures are a bunch of one time expenses to cut cost.

The one time charges and expenses from the 10-Q were:

(5)
Restructuring and Productivity Initiatives 

During the second half of 2013 and the first quarter of 2014, the Company invested in restructuring and productivity initiatives as part of its ongoing cost reduction efforts with the goal of driving efficiencies and creating fiscal resources that will be reinvested into the Company's business as well as to accelerate overall productivity on a global scale. As of March 30, 2014, these initiatives have resulted in the reduction of approximately 3,500 corporate and field positions across the Company's global business segments (excluding the factory closures noted below). Including charges incurred as of March 30, 2014, the Company currently estimates it will incur total charges of approximately $300.0 million related to severance benefits and other severance-related expenses related to the reduction in corporate and field positions, of which $279.6 million has been incurred from project inception through March 30, 2014.

In addition, the Company has announced the planned closure and consolidation of 5 factories across the U.S., Canada and Europe during 2014.  The number of employees expected to be impacted by these 5 plant closures and consolidation is approximately 1,650, of which 175 had left the Company as of March 30, 2014. The Company currently estimates it will incur charges of approximately $93.0 million related to severance benefits and other severance-related expenses related to these factory closures, of which $48.6 million has been incurred from project inception through March 30, 2014.  In addition the Company will recognize accelerated depreciation on assets it plans to dispose of but which are currently in use. The charges that the Company expects to incur in connection with these factory workforce reductions and factory closures are subject to a number of assumptions and may differ from actual results.  The Company may also incur other charges not currently contemplated due to events that may occur as a result of, or related to, these cost reductions.


11



The Company recorded pre-tax costs related to these initiatives of $140.8 million in the three months ended March 30, 2014, which were comprised of the following:

$53.7 million for severance and employee benefit costs relating to the reduction of corporate and field positions across the Company.
$13.7 million associated with other implementation costs, primarily for professional fees, and contract and lease termination costs.
$73.4 million relating to non-cash asset write-downs and accelerated depreciation for the planned closure and consolidation of 5 factories across the U.S., Canada and Europe.

Of the $140.8 million total pre-tax charges for the three months ended March 30, 2014$118.8 million was recorded in Cost of products sold and $22.0 million in Selling, general and administrative expenses ("SG&A"). 


So adjusting for these one timers, the actual results are:

Results Excluding Special Items
  
Management believes that this measure provides useful information to investors because it is the profitability measure used to evaluate earnings performance on a comparable year-over-year basis.

2014 Results Excluding Charges for Productivity Initiatives and Other Special Items

The adjustments were charges for productivity initiatives, amortization of deferred debt issuance costs related to new borrowings under our current Senior Credit Facilities and the Notes, incremental depreciation and amortization as a result of preliminary purchase accounting adjustments and stock based compensation expense that, in management's judgment, significantly affect the assessment of operating results. See “Restructuring and Productivity Initiatives” sections for further explanation of certain of these charges and the following reconciliation of the Company's first quarter of 2014 results excluding charges for productivity initiatives and other special items to the relevant GAAP measure.

Successor
First Quarter Ending March 30, 2014
(Continuing Operations)
Sales
Gross Profit
SG&A
Operating Income
Pre-Tax Income
Net Income attributable to Hawk Acquisition Intermediate Corporation II
(In thousands)
Reported results
$
2,800,159

$
954,599

$
521,175

$
433,424

$
249,099

$
195,202

Charges for productivity initiatives

118,793

22,014

140,807

140,807

104,560

2014 special items(a)

4,153

4,318

8,471

8,471

6,029

Amortization of deferred debt issuance costs




12,200

$
7,534

Incremental depreciation and amortization from preliminary purchase accounting adjustments

18,453


18,453

18,453

12,917

Stock based compensation


1,418

1,418

1,418

876

Results excluding charges for productivity initiatives and 2014 special items
$
2,800,159

$
1,095,998

$
493,425

$
602,573

$
430,448

$
327,118

(a)
Includes incremental costs primarily for additional warehousing and other logistics costs incurred related to the acceleration of sales ahead of the U.S. SAP go-live, which was launched in the second quarter of 2014, along with equipment relocation charges and consulting and advisory charges not specifically related to restructuring activities.


Redoing my above table, we get these figures:

                                                                                                Adjusted
                          2013 1Q                        2014 1Q                  2014 1Q
Sales :                 $2,856                            $2,800                    $2,800
Gross profit:       $1,040                               $955                    $1,096
Gross mgn:          36.4%                             34.1%                    39.1%
SGA:                     $629                                $521                       $493
SGA%:                   22%                             18.6%                    17.6%
Op income:           $410                                $433                       $603
Op mgn:              14.4%                              15.5%                    21.5%

HNZ averaged an operating margin of 14.9% for six years.  And then comes 3G and boosts that to 21.5% in less than a year.  In a single year, they took out 7.1% of revenues in costs;  4.4% out of SGA and 2.7% from COGS.

They increased operating earnings +47% in less than a year.

At BUD, I think they also took out around 6% of combined sales from expenses.  Since there wasn't a lot of overlap, this was probably mostly costs taken out of the old BUD, so as a percent of old BUD revenues, the cost savings were probably much higher than that.

It is still a little early so we have to see how things go going forward, of course.  But things look pretty good so far.

Heinz as a Platform
OK, so you may be rolling your eyes.  First, this guy (me) trips over himself seeing "outsider" CEO's everywhere; every acquisitive company is an outsider CEO company.  And then when a great CEO takes over a company, it suddenly becomes a "platform" for more acquisitions.

So yes, maybe I get a little caught up in these things and maybe it's the fad of the moment.  But as long as what I am looking at makes sense and are operated by competent people with track records of success (and we don't go out and overpay), I suppose there is nothing wrong with that.

I thought I'd just mention that since I too sometimes wonder if I take things too far.

Anyway, having said all of that, I do actually think that HNZ is a platform for further acquisitions.   Why not?  This has been the M.O. of 3G from the beginning.  The current BUD is a perfect example.

Think about it.  They got 6% of revenues worth of costs out of BUD and that was probably with very little synergies as operations didn't overlap too much.  At HNZ, they took out 7% of revenues in cost and this wasn't even a merger so there were no synergies or scale advantages.  It was just pure cost cutting and increased efficiency.

Can you imagine what they can do if they did a merger?  If HNZ bought another food company, they can probably take out 6-7% or more in cost savings, but then they can probably get more value from scale advantage and cost synergies (one human resources department instead of two, one legal department instead of two, consolidating manufacturing/distrubution/sales organizations etc...).

Now that would be incredibly value-creating.

HNZ Buying Power
Obviously, since HNZ is loaded up on debt, the question is whether HNZ can do anything in the near term.  They have $14.6 billion in long term debt on the balance sheet as of March 2014.  Annualizing the 1Q EBITDA, we get $2.8 billion.  So HNZ has leverage of 5.2x, but excluding cash and using net debt we get a leverage ratio of 4.2x.  4.2x is lower than the typical 5.0x or so in LBO's, but on it's own it doesn't look like HNZ has a lot of room to take on too much debt to do any huge deals right away.  With free cash to increase substantially going forward, maybe the gun gets loaded more quickly than we think.

But then again, there is Buffett sitting there with a lot of cash he wants to put to work.  Maybe he buys HNZ stock to help fund a deal (and more bonds/preferreds as needed); he would no doubt love to buy more HNZ and see a big value creating deal.

Recap of HNZ Deal
Before we look at who might be next, here are some figures from the HNZ deal last year (valuation).
The deal was a 20% premium at $72.50/share and a total deal value of $28 billion.

The EPS and EBITDA estimates for the year ending April 2013 and 2014 and respective valuations at the time (at $72.50/share) were:

                             EPS       P/E        EBITDA                 EV/EBITDA
April 2013e          $3.58     20.3x     $2,057 million         13.6x
April 2014e          $3.78     19.2x     $2,195 million         12.8x

Not cheap, right?

Shopping List? 
Here's a list of some of the big food companies. K and CPB are often mentioned as potential BRK/3G candidates and that does sort of make sense.  The companies with an asterisk on them have one time things that impact the figures.  For example, K is not trading at a 12.7x p/e and 8.1x EV/EBITDA, and KRFT is not as cheap as it looks there either.  They had one times gains and CPB is not as expensive as it looks in the table.


Anyway, GM is gross margin, SGA% is sales, general and administrative expense as percent of revenues, OM is operating margin, MC is market capitalization, EV is enterprise value, and p/e cye is current year estimate p/e.  I put that there due to some of the abnormal figures in the ttm p/e; I think the current year estimate reflects a more normalized p/e.

For K, it looks cheap on a ttm basis, but it is trading at 17.6x 2013 EPS and 11.8x 2013 EV/EBITDA (actually, current EV to 2013 EBITDA).

For CPB, it is trading at 17.3x July 2013 year end EPS and 18.0x July 2014 estimate EPS.  It is also trading at 12x 2013 EV/EBITDA.

KRFT is trading at 13.8x 2013 EV/EBITDA.


Precedent Transcactions for Food Companies
And just for reference, here are some valuation analyses from past deals.  This is from the HNZ merger proxy.  A valuation analysis was done by Centerview, BOFA Merrill Lynch and Moelis.



Centerview Analysis
Selected Precedent Transactions Analysis
Centerview analyzed certain information relating to selected transactions since 2000 in the food industry with transaction values over $3.5 billion that Centerview, based on its experience and judgment as a financial advisor, deemed relevant to consider in relation to Heinz and the merger. These transactions were:

Date of Transaction
Announcement
  Target  Acquiror  Transaction
Value
($billion)
  Enterprise
Value /
LTM
Sales
  Enterprise
Value /
LTM
EBITDA
November 2012
  Ralcorp Holdings Inc.  ConAgra Foods, Inc.

  $6.8    1.5x    11.9x  
November 2010
  Del Monte Foods Co.  Funds affiliated with Kohlberg Kravis Roberts & Co. L.P.,
Vestar Capital Partners and Centerview Partners
  $5.3    1.4x    8.8x  
January 2010
  Kraft Foods’ North America frozen pizza business  Nestlé S.A.  $3.7    1.8x    12.5x  
July 2007
  Group Danone S.A.’s biscuits division  Kraft Foods Group, Inc.  $7.2    2.6x    13.2x  
December 2000
  Quaker Oats Co.  PepsiCo, Inc.  $14.0    2.8x    15.6x  
October 2000
  The Keebler Company  The Kellogg Company  $4.4    1.6x    11.1x  
July 2000
  Pillsbury  General Mills, Inc.  $10.5    1.7x    11.0x  
June 2000
  Nabisco Holdings Corp.  Philip Morris Companies Inc.  $18.9    2.1x    13.2x  
June 2000
  Bestfoods  Unilever PLC  $24.3    2.6x    13.9x  
No company or transaction used in this analysis is identical or directly comparable to Heinz or the merger. The companies included in the selected transactions are companies with certain characteristics that, for the purposes of this analysis, may be considered similar to certain of Heinz’s results, business mix or product profile. Accordingly, an evaluation of the results of this analysis is not entirely mathematical. Rather, this analysis involves complex considerations and judgments concerning differences in financial and operating characteristics and other factors that could affect the public trading or other values of the companies to which Heinz was compared.
For each of the selected transactions, based on information it obtained from SEC filings, FactSet, Wall Street research and Capital IQ, Centerview calculated and compared transaction value as a multiple of LTM sales and LTM EBITDA, with LTM EBITDA excluding one-time expenses and non-recurring charges. This analysis indicated the following multiples:

    
Implied Enterprise Value
as a Multiple of:
    LTM Sales  LTM EBITDA
Mean
  2.0x    12.4x  
Median
  1.8x    12.5x  

Centerview then drew from this analysis and other considerations that Centerview deemed relevant in its judgment and experience an illustrative range of multiples of implied enterprise value / LTM EBITDA of 11x-14x. Centerview then applied the illustrative ranges of multiples to Heinz’s LTM EBITDA for the period ended October 28, 2012. The results of this analysis implied a value per share range for shares of Heinz common stock of approximately $55.75 to $74.00, based on the outstanding number of shares of Heinz common stock on a diluted basis. This range of $55.75 to $74.00 per share was compared to the $72.50 per share merger consideration to be paid pursuant to the merger agreement. 

BofA Merrill Lynch Analysis

Selected Precedent Transactions Analysis. BofA Merrill Lynch reviewed, to the extent publicly available, financial information relating to the following nine selected transactions valued over $3.5 billion involving companies in food industry, which, based on its professional experience and judgment, BofA Merrill Lynch deemed relevant to consider in relation to Heinz and the merger:

Announcement Date
Acquiror
Target
Transaction
Value ($bn)
Multiple of LTM
Sales
EBITDA
November 2012
•    ConAgra Foods, Inc.
•    Ralcorp Holdings, Inc.
•    $6.8
•    1.5x
•    11.9x
November 2010
•    KKR & Co.
•    Del Monte Foods Co.
•    $5.3
•    1.4x
•    8.8x
January 2010
•    Nestlé S.A.
•    Kraft Foods’ Frozen Pizza Division
•    $3.7
•    1.8x
•    12.5x
July 2007
•    Kraft Foods Group, Inc.
•    Danone S.A.’s Biscuits Division
•    $7.2
•    2.6x
•    13.2x
December 2000
•    PepsiCo, Inc.
•    The Quaker Oats Company
•    $14.0
•    2.8x
•    15.6x
October 2000
•    Kellogg Company
•    Keebler Foods Company
•    $4.4
•    1.6x
•    11.1x
July 2000
•    General Mills, Inc.
•    Diageo PLC’s Pillsbury Division
•    $10.5
•    1.7x
•    11.0x
June 2000
•    Philip Morris Companies Inc.
•    Nabisco Holdings Corp.
•    $18.9
•    2.1x
•    13.2x
June 2000
•    Unilever plc
•    Bestfoods
•    $24.3
•    2.6x
•    13.9x
BofA Merrill Lynch reviewed transaction values, calculated as the enterprise value implied for the target company based on the consideration payable in the selected transaction, as a multiple of the target company’s latest 12 months EBITDA. The overall high to low latest 12 months EBITDA multiples observed for the selected transactions were 8.8x to 15.6x. Based on its professional judgment and after taking into consideration, among other things, the observed data for the selected transactions, BofA Merrill Lynch then applied a selected range of latest 12 months EBITDA multiples of 11.0x to 14.0x derived from the selected transactions to Heinz’s latest 12 months (as of October 28, 2012) EBITDA. Estimated financial data of the selected transactions were based on publicly available information at the time of announcement of the relevant transaction. Financial data of Heinz were based on Heinz’s public filings. This analysis indicated the following approximate implied per share equity value reference ranges for Heinz, as compared to the merger consideration:




Moelis Analysis
Selected Precedent Transactions Analysis. Moelis reviewed financial information of those transactions announced between 2000 and 2012 involving large target companies with significant food businesses that Moelis deemed generally comparable to Heinz in product mix and geographic scope. Moelis reviewed, among other things, transaction values of the selected transactions and the merger as a multiple of EBITDA for the most recently completed twelve-month period (“LTM”) for which financial information had been made public at the time of the announcement of each transaction, unless otherwise noted. Financial data for the selected transactions were based on publicly available information at the time of announcement of the relevant transaction. The list of selected transactions and the related multiples are set forth below:

Date
Announced
  Target  Acquiror  EV
($ in thousands)
  EV/LTM
EBITDA
Dec. 2012
  Morningstar Foods, LLC  Saputo Inc.  $1,450    9.3x  
Nov. 2012
  Ralcorp Holdings, Inc.  ConAgra Foods, Inc.  6,775    12.1x  
Feb. 2012
  Pringles Business of Procter & Gamble Company  Kellogg Company  2,695    11.1x1 
June. 2010
  American Italian Pasta Co.  Ralcorp Holdings, Inc.  1,256    8.3x  
Jan. 2010
  North American Frozen Pizza Business of Kraft Food Global, Inc.  Nestlé S.A.  3,700    12.5x  
Nov. 2009
  Birds Eye Foods, Inc.  Pinnacle Foods Group, Inc.  1,371    9.5x  
Sept. 2009
  Cadbury plc  Kraft Foods Inc.  21,395    13.3x  
June 2008
  The Folgers Coffee Company  The J.M. Smucker Company  3,398    8.8x  
Apr. 2008
  Wm. Wrigley Jr. Company  Mars, Incorporated  23,017    18.4x  
Nov. 2007
  Post Foods  Ralcorp Holdings, Inc.  2,642    11.3x1 
July 2007
  Global Biscuit Business of Groupe Danone S.A.  Kraft Foods Global, Inc.  7,174    13.6x1 
Feb. 2007
  Pinnacle Foods Group, Inc.  The Blackstone Group, L.P.  2,142    8.9x  
Aug. 2006
  European Frozen Foods Division of Unilever plc  Permira Advisors Ltd.  2,199    9.9x1 
Aug. 2006
  Chef America, Inc.  Nestlé S.A.  2,600    14.5x  
Dec. 2002
  Adams Confectionary Business of Pfizer Inc.  Cadbury Schweppes plc  3,750    12.8x1 
Oct. 2001
  The Pillsbury Company  General Mills, Inc.  10,396    10.1x2 
Dec. 2000
  The Quaker Oats Company  PepsiCo, Inc.  14,010    15.6x  
Oct. 2000
  Keebler Foods Company  Kellogg Company  4,469    10.7x  
June 2000
  Nabisco Holdings Corp.  Philip Morris Companies Inc.  19,017    13.7x  
June 2000
  International Home Foods  ConAgra Foods, Inc.  2,909    8.5x  
May 2000
  Bestfoods  Unilever plc  23,503    14.5x  
1 Financial data were based on latest available fiscal year end information; not latest quarter-end information.
2 Financial data reflected revised deal terms pursuant to a second amended merger agreement.


This analysis indicated the following mean and median multiples for the selected transactions and the merger were as follows:

Selected Transactions

The Merger

      Mean  Median
EV/LTM
EBITDA
  (all
transactions)
    
    11.8x  11.3x13.7x
EV/LTM
EBITDA
  (transactions
since 2009)
    
    10.9x  11.1x13.7x
Moelis then used its professional judgment and experience to apply a range of selected multiples derived from the selected transactions of 11.0x to 14.0x LTM EBITDA to Heinz’s LTM EBITDA as of the announcement date of the merger.


So, it seems like all three advisors came up with a fair value range of 11-14x LTM EBITDA.  They are all looking at similar past deals, so I suppose that's to be expected.

Conclusion
BRK/3G paid 20x p/e and 14x EV/EBITDA for HNZ which at the time didn't look cheap at all, but we see how much value they created already in one year.  And this was done in a deal as a 'financial' deal, meaning no operating synergies from a merger or anything like that.

This, to me, would suggest that they would have some room to pay more if there were going to be operating synergies / scale benefits from a real merger instead of pure LBO.

For KO and PEP, I am thinking about BUD, of course.  But for other food companies, it might make sense for HNZ to combine with them.  Thinking about the fact that they can get 7% of revenues in cost out in the first year, imagine what they could do to an undermanaged food company if they can get the synergies too.

There seems to be plenty to do!












23 comments:

  1. They could split PEP with the beverage business going to BUD and the snack business going to HNZ.

    ReplyDelete
  2. This isn't specific to this post but just want to say thanks for all you do, it's truly appreciated.

    ReplyDelete
  3. Hi KK - Great look at Heinz. Interesting to see if they can use Heinz as a platform in the way that they used BUD given that they can't offer public stock to make acquisitions. For example, if Heinz were publicly traded, they could bid for CPB and offer stock to deleverage the company. This is what Valeant is doing in the Allergan case.

    Speaking of Valeant/Allergan, I see you've alluded to that situation in the past, but would be great to get your take on that situation.

    Thanks again!

    ReplyDelete
    Replies
    1. Good point about HNZ being unlisted. People worry about the leverage at HNZ, but they forget that it is backed by Buffett, so it's no ordinary LBO. For other LBO's, there are a variety of problems. They need an exit plan, for example. And the lenders aren't as forgiving and flexible as Buffett would be. In bad times, banks may not be able to roll LBO debt etc... but in bad times, Buffett would be more than happy to buy more HNZ stock, preferred or whatever else.

      So think about it this way. If BRK and 3G eyes something and looks to do a similar deal to HNZ, then they may feel it's just more efficient to do it via HNZ and both 3G and BRK can put up more capital to HNZ to get it done. This way, it's the same thing in terms of putting up capital, but maybe they get an added boost in value creation from using the HNZ platform (to eliminate overlapping corporate functions, which would not be possible if they just did another HNZ type deal).

      Of course, this would work fine for BRK, I'm sure. But for 3G it might be more complicated as they have fund investors and they may need separate deals. But I don't know anything about that aspect of all of this.

      And yes, VRX/AGN should be a post here; it's an Ackman deal, VRX is owned by some great value investors, it's an outsider type situation (or not depending on who you ask) and it's a big merger etc...

      I listened to the long Ackman presentation and all that, and I find it fascinating. But I don't own either stock at the moment and even though I do lean towards VRX/Ackman here. It seems like a great idea and I totally get (and agree) with the idea that a lot of money is wasted in traditional R&D. (Ackman said that AGN pays people based on maintaining R&D, but that's just to prevent some CEO from coming on board, slashing R&D to boost profits, take a bonus and then go home).

      Maybe I will make a post about it at some point, but frankly, I don't know what I can add to the debate as I really don't have a strong view (or knowledge) of the industry etc... But that never stops me from posting, lol...

      Thanks for reading.

      Delete
  4. You might like this
    http://www.dynamo.com.br/uploads/2230819951154430630d132165a7fd6f035ffcef.pdf

    ReplyDelete
    Replies
    1. i dunnoe about kk, but i thank you for sharing this.

      Delete
    2. Thanks. That's a great report!

      Delete
    3. I am from Brazil and have been following the 3G guys for some time. KK do you any contacts or email?
      Best
      Gabriel

      Delete
    4. This video from Brito (ABI's CEO) is spectacular and shows the fundamentals of their culture: http://youtu.be/OSnWnqq23JU

      Delete
    5. Thanks for the video! I'll watch it later. If you leave a contact here, I will email you. I'll delete your contact info too so the bots don't grab it. Thanks.

      Delete
  5. I was reading some of your old articles. Wonder if you have any updates on HRG, for example. Since your article, hrg is up from $5+ to almost $13, which in turn is hugely dependent on SPB which is up from mid $20s to $85. And back then, you indicated you were not quite sure about SPB. And since then, SPB happens to be a favorite of Meryl Witmer, who recommended it end of 2012 when it was in the high $40s and then early this year again at high $60s.

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    1. Hi. Yes, HRG is pretty interesting. It is in fact now Falcone's primary investment vehicle (as his hedge fund is shut down), so it can be really interesting over the long term. LUK bought a big block (from the hedge fund).

      And yes, I missed SPB. I just saw a bunch of second rate brands / businesses, but I missed that they can still manage those businesses for cash flow and increase value. Someone did point out in the comment section that SPB really is the gem in HRG.

      Oh well...

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  6. I find it weird why would Falcone wants to sell a portion of the hedge fund stake to LUK at $8.5 back in Sep 2013. At that time, according to presentations given by HRG, the sum of parts valuation is worth $13.5 and to sell it at $8.5 is almost 40% discount.

    But LUK is smart to buy it at such wide discount to intrinsic value and now, the value has closed to less than 20% discount based on the latest presentation. As a result, LUK is up 50% since for this investment.

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    1. Hi, I don't think he had much choice. Also, HRG was trading at a discount at the time and there's nothing Falcone could've done about that. He sold the shares to meet redemptions. I think he is continuing to wind down his hedge fund.

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  7. Have you ever looked at Steel Partners? If so, any thoughts on Warren Lichtenstein? Steel looks like a version of LUK with the NOL's etc but questions over 2008/9 actions in rolling fund money into a publicly listed company.. If you are familiar, love to hear your thoughts.. thanks!

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    1. I've looked at it before. I think it's been discussed extensively at VIC and I couldn't make up my mind. I haven't looked at it in a while, maybe I'll take another look. Thanks for reminding me.

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  8. If you are ever able to post about Buffett's formula for long-term stock market returns (earnings growth, dividends, GNP, interest rates, etc.) and maybe explain his 1999 article in Fortune, I think many readers would find it helpful. Although the 1999 period isn't the same as where we find ourselves today, I wonder if there are some similarities. Also Buffett's 1999 shareholder's letter may have some use today when thinking about stock market returns over the next 10 or 20 years. A good blog post on this subject is an idea if you are looking for topics. Thanks.

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    1. Hi, thanks for the idea. I don't really know what to add to what Buffett said in the 1999 article or the shareholders' letter. The key, I think, is that he is just trying to temper people's expectations about future returns. Over time, the stock market can only grow with the economy, so if nominal GDP growth is 4%, and you get 1.5% in dividends, returns over time can only be 5.5%/year.

      So he was warning people that were expecting 15-20%/year returns (long term historical average returns up to 1999) that this is not possible without interest rates going down more or economic growth accelerating etc...

      As for valuation levels, I don't know that Buffett has ever articulated a specific model (as to what an appropriate p/e ratio is etc...), but when he wrote about overvalued markets in the late 60's and in 1999, he didn't specify what the market level should be, only that future returns would be anchored by economic growth, inflation and dividends.

      In 1999, he did say there would be a big correction as expectations for the market comes down. But he didn't say, for example, that the p/e should be 20x instead of 30x. He almost sounded like that would depend on interest rates (he said if interest rates went down by half, the market multiple would double or something like that).

      And as we all know he has no view on interest rates (even though since the financial crisis, he has been saying that rates are abnormally low), he would also have no view on appropriate p/e ratio. He did say things were not interesting enough to buy, but he didn't sell anything in 1999.

      Even if he thought a big correction was coming due to valuations, I don't think he would advocate selling stock now so you can get back in later. He may say if you are investing, you may want to spread it out over time so you don't buy everything at the tippy top.

      Also, many people see Buffett as sort of timing the market because he keeps a lot of cash on hand. They have been saying that throughout the crisis too, but we later learned that he wasn't really carrying excess cash as he had to sell some stocks to fund the BNI acquisition (I think it was that one), for example.

      Also, he is looking to bag an elephant and he wants to keep liquidity to get those kinds of deals done. I will continue in the next comment as it's getting long and I will be cut off by the blogger...

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    2. Buffett is looking for really big deals to put money to work. If he keeps taking the billions of cash coming in and buying WFC, IBM, XOM or whatever else he likes, he will then have to sell when the elephant comes along. So I think there are a lot of factors as to why he lets liquidity build up. We don't know what deals are in the pipeline or him... Maybe something looks doable and he builds up cash etc...

      So there is that aspect of it too.

      Buffett has been telling people to put their money in the S&P 500 index and that it is the best place (for most people) to be, and the market level hasn't really changed much since he has been saying that (including the 2013 letter to shareholders).

      Anyway, that's my take.

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  9. Great thread - Here is my take: I think Buffett's formula for return is along the lines of Earnings Growth + Dividends + or - P/E changes = Total Return. As you said I think he relates earnings growth to GNP growth (since society won't tolerate the private sector taking too much of GNP) and he relates P/E changes to interest rate changes.

    In Buffett's 1999 comments he said that if he had to guess at returns for the next 17 years, he'd go with 4% real but if he missed he'd have likely shot too high. Looking back I believe his guess has been very close but we got there by interest rates dropping (P/E ratios staying high) and not by a high earnings growth number. I suspect you are exactly correct in that Buffett was trying to help investors understand more realistic future returns.

    With earnings growth ahead of maybe 3% (if global economic growth is near 3%), dividends near 2% (although outside of the US they are higher), and the P/E at or above its long term average, I wonder if that projects future long term equity returns in aggregate near 5% or 6% assuming no or low inflation.

    - Stan

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    1. Hi,

      I think that sounds about right.

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  10. US$14.6 Billions in LT Debt + Buffett's US$8 Billions of preferred shares likely redeemable @t 110% à la Goldman Sachs and GE which are really like debt except at the bottom of the capital structure, you quickly arrive at the ludicrous sum of US$23.4 Billions in total debt...I mean, at some point they really have to increase sales or sale assets, your 21.5% margin figure is a GROSS margin, this mean you have to discount taxes & Buffett's special dividend($720millions/year for at least 2 more years) FCF will be negative for a couple of years according to Fitch before the cost savings kicks in

    This a big big challenge,even by 3G standards I'm surprised we haven't seen asset sales yet.

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