Kraft-Heinz

So 3G/BRK made their move and Kraft it is.   Buffett was on CNBC this morning and he said that BRK paid $4.25 billion for common stock in Heinz initially and will pay another $5.2 billion to get this deal done for a total common equity investment of around $9.5 billion.   After this deal closes, BRK will own around 320 million shares of the new Kraft-Heinz of a total 1.22 billion or so shares outstanding.   That puts BRK's cost per share at just under $30/share.    KRFT closed at $83.15/share yesterday.   Taking out the $16.50/share special dividend that will be paid out to the old KRFT shareholders (and BRK won't get), that puts the ex-dividend price of KRFT at $66.70/share, so that's roughly a double for BRK.  BRK also owns preferred shares and warrants.

$66.70/share and 320 million shares owned means that this stake is worth $21 billion, and this would be a listed stock holding.

This is great news for people who think BRK's equity portfolio is too financials-heavy.

As a refresher, check out BRK's equity portfolio at the end of 2014:

So this would be a gigantic position, second only to Wells Fargo.

What are They Paying for KRFT?
This is an unusual deal.  Usually, mergers/acquisitions are for cash, listed stock or some combination of them.  This one is a combination of cash and an unlisted stock.  So there is no fixed value (as in an all cash acquisition) or market value (price of acquirer's stock) to measure this deal against.

I wonder what merger arbs do in this case.  Usually, they buy the stock against a fixed price (in an all cash acquisition), or they buy the target and short the buyer against it (in a stock-for-stock merger).  Here, what do you do?

I guess you can view the $16.50/share special dividend as sort of the premium on the deal.  KRFT's pre-announcement price was around $62/share so this premium is around 27%.  KRFT shareholders receive $16.50/share in cash and one share of the new Kraft-Heinz for each KRFT share.

But let's say yesterday's closing price, $83.15/share is the acquisition price.   What is the valuation at this level?

P/E ratio
KRFT's EPS in 2014 and the estimates for 2015 and 2016 were:

                  EPS            P/E
2014a        $3.15          26.4x
2015e        $3.24          25.7x
2016e        $3.47          24.0x

So the current price implies an acquisition price of 26.4x P/E, pretty high.

EBITDA in 2014 was $3.6 billion (both the above EPS and EBITDA exclude a non-cash charge for post-retirement benefit expense), and EV is around $56 billion so that comes to 15.6x EV/EBITDA.

Price After Synergies
That seems high.  But they said there is $1.5 billion in synergies to be expected.   If we adjust the above figures, we can get $5.1 billion in EBITDA; that would bring the deal price down to 11x EV/EBITDA post-synergy.  For EPS, we can add $1.5 billion after, say, 30% tax and using 588 million shares.  That would add close to $1.80/share in after-tax earnings per share.  Add that to the $3.15/share and we get $5.00/share post-synergy EPS.  That brings the acquisition price down to around 17x P/E.    11x EV/EBITDA and 17x P/E is very reasonable.

What is the New KRFT Worth?
Well, this is the key issue.  The above acquisition price is sort of circular.  The more we think the post merger entity is worth, the higher the old KRFT price will go up, and the higher the acquisition price will look.  Even if the current KRFT stock price went up a lot, the cost to HNZ to acquire KRFT will not increase at all as the cash portion is fixed, and the stock portion will not increase. Regardless of how high the old KRFT goes, shareholders will still only receive one new share of the new KRFT.

Anyway, let's take a look at the post-merger valuation of KRFT.  First of all, we have to adjust the current price for the $16.50/share special dividend that will be paid once to the old KRFT shareholders.

Ex-dividend, the new KRFT would be trading at around $67/share.    There will be 1.22 billion shares outstanding, and net debt will be $28 billion.  This includes repaying the preferreds to BRK and replacing it with debt.   Therefore, post-merger, the EV would be around $110 billion.

Adjusted EBITDA at HNZ in 2014 was $2.8 billion, and the old KRFT had EBITDA of $3.6 billion (again, this excludes the post-retirement benefit adjustment so will differ from what you may see elsewhere).   That gives us total EBITDA of $6.4 billion.

On this basis, the new KRFT is already trading at 17.2x EV/EBITDA.

That seems a bit on the high side.  But wait.  There will be $1.5 billion in synergies, so we might have to put that in.  We can just add $1.5 billion to the $6.4 billion combined EBITDA and then we get a pro-forma combined EBITDA of $7.9 billion.   That gets us to EV/EBITDA of 13.9x EV/EBITDA.

P/E
We'll start with the combined $6.4 billion EBITDA.   Take out D&A for both of $961 for an EBIT of $5.4 billion.   Take out $1.2 billion of interest expense and we get $4.2 billion in pretax income.   But this interest expense actually doesn't include $8 billion of preferreds, which will be refinanced with investment grade debt.   They say current HNZ debt and this preferred stock will be refinanced by investment grade debt, but let's just use 5% for now.   That's another $400 million of interest expense (for the preferreds that get refinanced at 5%).  So pretax income is actually $3.8 billion.   (It's a little complicated, but I think the preferreds don't show up in the Heinz 10-K because they are at the parent company level.  The 10-K only includes financials of the subsidiary and not the parent (that's why you don't see preferred stock on the balance sheet or preferred dividends in the income statement)).

Using a 30% tax rate (I used 24% for HNZ and 33% for the old KRFT for a 40/60 blended rate), that's net income of around $2.7 billion.   That's $2.20/share in EPS for a 30x P/E for the new combined entity at $67/share.    That's kind of expensive.

But then again, let's include the synergies.  Then we get $6.4 billion + $1.5 billion = $7.9 billion in EBITDA, take out D&A of $961 million for EBIT of $6.9 billion.  Take out $1.6 billion in interest expense (which includes preferreds converted into debt at 5%) for pretax income of $5.3 billion.  After tax, that comes to $3.7 billion in net income or $3.00/share in EPS.   That brings down the P/E to 22.3x. 

This doesn't take into account the refinancing of current HNZ high yield debt into investment grade debt.

Growth
By the way, even though they won't give us long term guidance on growth, one of the major factors in this deal is growth.  Most of KRFT's sales are in the U.S. while HNZ has 60% of sales outside the U.S.  The idea, like in the Burger King/Horton deal, is to use HNZ's global distribution platform to increase sales of KRFT products around the world.   This is probably too aggressive, but just imagine if KRFT's sales breakdown evolved to something simliar to HNZ's; a double in sales?

Margins
By the way, the old KRFT had these margins:

EBITDA margin:      17.6%
Operating margin:     20.0%

After 'synergies', their margins would be:

EBITDA margin:       28.0%
Operating margin:      25.8%

For the new entity, the margins would be:

EBITDA margin:       22.0%
Operating margin:      18.6%

After synergies, this would be:

EBITDA margin:        27.2%
Operating margin:       25.2%

For reference, here are some comps; their current valuations and margins:

	ttm	ttm	EBITDA	Operating
	P/E	EV/EBITDA	margin	margin
PEP	22.4	13.1	18.6%	15.0%
KO	25.3	15.3	27.9%	23.6%
GIS	23.2	13.1	17.9%	14.8%
K*	16.6	11.3	17.8%	14.7%
MDLZ	28.0	14.5	14.7%	11.6%
CPB	18.8	11.0	17.9%	14.2%
DPS	21.7	12.4	22.9%	19.3%
SJM	21.0	11.6	21.9%	16.8%
average	22.1	12.8	20.0%	16.3%

*For K, I used "comparable" figures, which exclude charges.

With the best margins out there (and similar to KO), there shouldn't be a problem with the new KRFT trading at 22x P/E and 14x EV/EBITDA.   Yes, we are assuming the $1.5 billion in synergies get realized, but when you look at what 3G has done in the past, I don't have any doubt it will be realized.

For reference, here are some figures from the HNZ merger proxy back in 2013:

This is what the comps were trading at back in 2013.  Maybe this is not so useful but it's good to look at everything so...

		Enterprise Value/EBITDA				P/E
Company		LTM		CY 2013E		LTM		CY 2013E
Campbell Soup Company		9.7x		9.8x		14.9x		14.7x
ConAgra Foods, Inc.		9.9x		9.8x		13.8x		13.9x
General Mills, Inc.		10.1x		10.0x		15.6x		15.3x
The Hershey Company		13.4x		12.5x		24.9x		22.2x
The Kellogg Company		11.6x		10.9x		17.3x		15.4x
Kraft Foods Group, Inc.		10.8x		10.4x		not meaningful		16.2x
Groupe Danone S.A		10.3x		9.7x		16.9x		16.1x
Mondelēz International, Inc.		13.9x		12.5x		not meaningful		17.6x
Nestlé S.A.		12.2x		11.1x		19.3x		17.7x
PepsiCo, Inc.		10.6x		10.2x		17.3x		16.4x
Unilever PLC		10.9x		10.2x		18.6x		17.1x

The results of the analysis were as follows:

		Enterprise Value/EBITDA				P/E
		LTM		CY 2013E		LTM		CY 2013E
Mean		11.2x		10.6x		17.6x		16.6x
Median		10.8x		10.2x		17.3x		16.2x
Heinz		11.9x		11.2x		17.3x		16.4x

And here is the precedent transactions of comps:

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

59

Company

EV

EV/EBITDA

($ in millions)

2013E

P/E 2013E

Nestlé S.A.

$

233,969

11.3x

17.6x

PepsiCo, Inc.

135,550

10.3x

16.5x

Unilever plc

123,112

10.5x

17.8x

Mondelēz International, Inc.

75,436

12.6x

17.6x

Groupe Danone S.A.

50,478

10.0x

16.0x

Kraft Foods Group, Inc.

37,387

11.1x

17.4x

General Mills, Inc.

37,561

10.4x

15.2x

Kellogg Company

29,064

10.8x

15.4x

The Hershey Company

19,605

12.5x

22.1x

ConAgra Foods, Inc.1

24,429

9.5x

12.8x

Campbell Soup Company

16,281

9.9x

14.6x

The J.M. Smucker Company

11,639

9.3x

16.2x

McCormick & Company, Incorporated

9,614

13.0x

19.6x

Hormel Foods Corporation

8,990

9.9x

18.0x

1Financial data were pro forma for the Ralcorp acquisition.

This analysis indicated the following mean and median multiples for the selected companies and for Heinz:

Selected Public Companies

Heinz – Management

Heinz – Street

Mean

Median

EV/EBITDA

2013E

10.8x

10.5x

11.1x

11.2x

P/E

2013E

16.9x

16.9x

16.4x

16.4x

Moelis then used its professional judgment and experience to apply ranges of selected multiples derived from the selected companies of (i) 9.5x to 11.5x, in the case of the EV/EBITDA multiple for calendar year 2013, and (ii) 16.0x to 18.0x, in the case of the P/E multiple for calendar year 2013

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. This analysis indicated the following implied per share reference range for Heinz (rounded to the nearest $0.25), as compared to the per share merger consideration:

Moelis determined that a fair value range for HNZ, based on previous food company deals, was 11.0x - 14.0x LTM EBITDA.

So according to this, KRFT is currently trading within range.  Keep in mind that the new KRFT is going to have tremendous margins and some real growth opportunities.

Conclusion
So this deal looks really interesting.  Some people are skeptical of these cost-cutting deals but I think the 3G guys are really good.  Sales is not growing at HNZ currently because they were rationalizing their SKU line-up, cutting unprofitable lines etc.

The right way to look at this is that the special dividend itself is the acquisition premium.  Something around 30% is typical in takeovers.

Other than the special dividend, old KRFT shareholders end up with one new Kraft-Heinz share.  What does that mean?  At the pre-deal price of $62/share, old KRFT shareholders owned a company trading at around 20x ttm P/E and 12.4x EV/EBITDA.   This company had an operating margin of 18% and EBITDA margin of 20%.

Post deal, before an increase in the stock price (other than the amount of the special dividend), on a pro-forma basis at $62/share, the old KRFT shareholder would own the new Kraft-Heinz that trades, on a pro-forma basis at 21x P/E and 13x  EV/EBITDA, a pretty similar valuation.  But the pro-forma operating margin would be 27% and EBITDA margin would be 25%.

That sounds like a good deal to me.  You get a nice premium, and you end up with a better stock than you owned previously.  You were stuck with sort of a no-growth situation and suddenly there is hope.

The new Kraft-Heinz (synergies are already priced into the above metrics) would not only have better margins, but also a much more interesting and promising growth profile than the current KRFT.

The post-announcement rally in the stock price has pushed up the valuation of KRFT to $67/share on an ex-dividend basis, so the current pro-forma valuation is more like 22x P/E and 14x EV/EBITDA. This is at the high end of food companies, but they will also have margins at the high end and greater growth prospects.

This is a first pass look at this deal, sort of a back-of-the-napkin look so I am probably missing a few things here and there.  There are a lot of moving parts here and others will make different adjustments than I made so may come up with different figures.

And there are things that we don't know yet.  The merger proxy should be very enlightening in that sense.

Anyway, this is kind of an exciting deal; it will be fun to follow.