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

11.1x

1

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

11.3x

1

July 2007

Global Biscuit Business of Groupe Danone S.A.

Kraft Foods Global, Inc.

7,174

13.6x

1

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

9.9x

1

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

12.8x

1

Oct. 2001

The Pillsbury Company

General Mills, Inc.

10,396

10.1x

2

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		11.3x				13.7x
EV/LTM EBITDA		(transactions since 2009)
				10.9x		11.1x				13.7x

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!