Kraft – Heinz and the Buffett Return

We looked carefully at the Kraft and Heinz merger deal and we were blown away by the numbers. Let us look at it two separate ways to see whether it holds water:

Berkshire and 3G bought Heinz by investing $4.25B of equity each and Buffett topped it with $8B of preferred stock in Heinz. Berkshire has already received $1,440M of dividends from the preferred stock in two years. Chances are by the time the stock gets called, he would have received another $720M of the dividends.

Berkshire and 3G are adding $5B each to pay the $10B dividend @ $16.5/share. At today’s closing price of $88.95/share, ex-dividend, the share is worth $72.45/share. Buffett on CNBC said that post the $5B investment, he would own 320 million shares of the combined company. That is worth $28.3B. $5B of that is yet to be invested, so, $4.25B turned into $23.45B in 2 years. This is a mind-boggling return of 450% in 2 years. What an elephant he has bagged on such a big investment…..

To top it all, Berkshire will also get $8B back next year that he has to deploy elsewhere from the calling of the preferred stock. In addition, 3G has indicated that they will maintain the current 3% dividend, that is $2.2/share dividend on 320 million shares, about $700M/year will flow into Omaha starting this year.

The other way to calculate it is, Kraft’s market cap today is $52B; Kraft’s shareholders will get $10B dividends; 49% of the combined company that Kraft’s current shareholders will own, will be worth $42B; 51% of the rest will be worth $43B; initial equity investment was $8.5B equally by 3G and Berkshire; Implied value for the original $8.5B is $43B; (not taken into account the $10B dividend as it will flow from Berkshire and 3G in the future to Kraft’s shareholders)

Either way, Warren Buffett’s elephant gun has fired a salvo that will bring cheers to his shareholders as a new equity position that will be his largest or second largest position once the transaction is closed depending on the stock price on any given day.


What are we thinking?

We are thinking quietly about the Kraft Heinz deal. What is the hidden margin of safety that Buffett is counting on?

When we look back on Berkshire’s acquisition of BNSF, the deal initially looked crazy. Here is Warren’s justification for it and here is what some of the value investors thought about it. Investors believed that Warren had gone loco. The deal turned out to be very good for Berkshire shareholders. Five years since the deal, BNSF has provided $15B dividends back to Berkshire on the purchase price of $26.5B that he paid to own the rest of the company. (Link) Part of that was luck due to oil being transported more on rails compared to five years ago that even Warren could not have anticipated. Nevertheless, when Warren has capital of tens of billions of dollars that needs to get allocated, he is still finding deals with the required margin of safety and returns proving that he is a continuous and an innovative learner. If one were to value the railroad at where the competitors are trading it, it looks like BNSF will be worth about $66B.

One has to sit back and think about what are the margins of safety is Warren counting on the Kraft-Heinz deal? One, of course is 3G’s focus on cost. But is there something beyond it? What does it mean for the Shareholders? It will be the second biggest security in the Berkshire’s portfolio soon.