The Changing Food Landscape is Just Beginning

With this note we are announcing the addition of Shayne Laidlaw to the Hedgeye Consumer Staples team.  Shayne has spent the past three years working at General Mills and brings a differentiated view of the food industry to the Hedgeye team. 

 

Deal Overview

  • H.J. Heinz and Kraft Foods announced that they have entered into a definitive merger agreement to create the Kraft Heinz Company, forming the third largest food and beverage company in North America
  • Kraft shareholders to own 49% and Heinz shareholders to own 51% of the combined entity
  • Kraft shareholders to receive a one-time cash payment of $16.50 per share ($10 billion aggregate value), fully funded by $10 billion of new common equity contributed by Berkshire Hathaway and 3G Capital
  • The cash dividend represents 27% of Kraft’s closing price on 3/24/2015
  • Board of Directors to be composed of 5 members of current Kraft Board and 6 members of current Heinz Board (3 from 3G and 3 from Berkshire Hathaway)

 

Strategic Rationale

  • With combined sales of $29.1 billion, of which $22.2 billion are generated in North America, the Kraft Heinz Company will be the third largest food company in North America and the fifth largest in the world
  • Improved scale in key North America retail and foodservice markets
    • Foodservice platform raises brand awareness with iconic portfolio of center-of-store brands
    • Significant cost efficiency and synergy opportunities
      • Expected to achieve $1.5 billion in run-rate annual cost savings across COGS and SG&A by 2017
        • Implement zero-based budgeting
        • Integrate distribution networks and rationalize manufacturing footprints
        • Improve productivity and optimize procurement expenditures
        • Streamline organizational structure
        • Optimize advertising and marketing spending
  • Significant revenue synergy opportunity, with strong platform for international growth
  • International expansion from Kraft brands through Heinz platform
    • Heinz currently generates 61% of sales internationally
    • It is anticipated that the new company will use this manufacturing footprint to expand Kraft brands globally (currently only 2% of sales outside North America)
    • Kraft has many international brands currently licensed to Mondelēz that are due to revert back to Kraft in the near future
    • Investment grade company with sustainable capital structure built for long-term growth

 

Industry Implications

  • The food industry has seen a steady amount of M&A over the recent years involving acquisitions of small to mid-sized companies by larger food manufactures
  • But now, with this merger it will leave the big players; General Mills, Kellogg’s, Mondelēz, Campbell’s and J.M. Smuckers thinking, could we be next?
  • With this merger and Berkshire Hathaway’s backing we expect increased competitive pressure forcing other industry players to respond before their hand is forced
  • Kraft has had lackluster performance lately leading management to really think, can we return to growth? Or would it maximize shareholder value to sell now?
    • Obviously they chose to sell, most likely led by their newly appoint CEO John Cahill, known as a deal maker
    • When you look across the major competitors listed above, it will be interesting to see if current management is willing to rock-the-boat and make a move, or will an ousting or “retirement” be required for change to occur
    • Either way, I believe we will begin to see large transformational acquisitions or mergers in the space in order for companies to stay competitive. There is just no way all five of these companies will stand still, when starring down the barrel of Mr. Buffett’s elephant gun

 

Getting 3G’ed                 

  • 3G Capital has become synonymous across the Restaurant, food and beverage industries with cost cutting and creating efficiencies
  • Over the last two years since 3G and Berkshire Hathaway took Heinz private, they have turned it into a lean mean fighting machine and one of the most profitable food companies globally
    • In the process, realizing $1 billion in operating improvements by:
      • Implementing zero-based budgeting and management by objectives
      • Simplified corporate structure; and
      • Rationalization of the manufacturing footprint
  • Through these cost cutting efforts and operational improvements the new leadership has brought EBITDA margins from 18% to 26%

 

Words from an Insider

  • Warren Buffett when asked if he would continue to work on deals in this space, declined to comment, but said that Kraft Heinz will be a company with ‘ambitions for a long time’ and did imply that there is no ‘finish line’ with respect to the partnership with 3G

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