At first sight, Warren Buffett’s deal with the Brazilian-led private equity firm 3G Capital to purchase H.J. Heinz Company (NYSE:HNZ) looks strange.
At $28 billion the famed ketchup maker is valued at a rich 23 times earnings, and Buffett won’t even control the management, which is to be left to 3G. Given Warren’s long and storied history, something doesn’t make sense.
But maybe he’s become a doomsday prepper.
In the age of Ben Bernanke, canned baked beans and the like seem to make as the ideal investment. Or maybe Buffett feels that the dollar is about to be wiped out by hyperinflation.
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Of course, in those circumstances, you would normally buy gold, but maybe Buffett believes that the crash will be so severe that the economy as a whole will break down.
In that case, you’d want guns and ammunition. Buffett’s holding company Berkshire Hathaway (NYSE:BRK-A and BRK-B) does not own a gun manufacturer, but a subsidiary manufactures shoes under license from Browning Arms Company, so no doubt a deal could be done.
However, an even more strategic asset in such an event would be imperishable canned food, and you can certainly imagine a gigantic stockpile of Heinz 57 varieties being accumulated in warehouses around Omaha, maybe accompanied by a lake of ketchup, allowing Buffett to corner the market in baked beans and condiments.
Warren Buffett’s Sudden Interest in Ketchup
Apart from the possibilities of Armageddon, there are only a few things that would seem to make the Heinz deal attractive.
As well as paying $4.5 billion for 50% of the equity, Buffett gets $8 billion in preferred stock paying a 9% dividend, similar to his successful investments in Salomon Brothers in the 1990s and Goldman Sachs in 2008.
However, his preferred stock will be junior to $12 billion in debt in the transaction, including Heinz’s existing debt of $4.5 billion. That means Buffett is putting a great deal of confidence in Heinz’s cash flow.
If the company’s total value (including debt) reverts to its late 2009 level of around $15 billion, Buffett’s $12.5 billion investment will be nominally worth only $3 billion, presumably resulting in a write-down of $9 billion in Berkshire Hathaway’s accounts. In those circumstances, Buffett’s fancy preferred stock dividend might find itself in difficulty.
Presumably, Buffett hopes that Heinz’s operations can be sweated in the usual private equity fashion, to produce higher cash flows to service debt and increase the company’s value.
That’s why it makes sense to have 3G Capital run the company, so Buffett’s own operation is not forced to do anything so politically incorrect as firing tens of thousands of honest, noble but impotent U.S. food workers and relocating the entire operation to Vietnam, Bangladesh, Nigeria or to wherever the best deal can be found.
To me, the deal really only makes sense if Buffett feels that Berkshire Hathaway’s $48 billion cash pile is in serious danger of being eroded by low interest rates and inflation.
If that’s the case and cash is trash, then beans by default are queens.
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As the inflation kicked in, Heinz’s $12 billion of debt disappears as quickly as Berkshire Hathaway’s cash would. So would Buffett’s preferred stock, though the dividend would still be useful while it’s disappearing. But in the end, Buffett would still own 50% of a company whose products are almost all inflation-proof, with prices that rise as they did during the inflation of the late 1970s.
Buffett’s public pronouncements may be foolish, but I have to believe that deep down he still has the best instincts for value in the business. So if he thinks Heinz is worth the huge price he is willing to pay for it, investors would be wise to pay attention.
Manufacturers of staple non-perishable foods, however overpriced, may be worth more than they seem.
And if Buffett thinks it’s politically incorrect to buy gold, that’s his own misguided hang-up.
Personally, I’d rather own a few gold bars than a case or two of ketchup.
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