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The $28-billion (U.S.) acquisition of Heinz shows the value of ultra-long investment. Berkshire Hathaway and buyout firm 3G Capital are pouring on the sort of financial sauce that many would find unpalatable. Some $1.4-billion of interest costs and payments on Berkshire's preferred stock will eat up much of Heinz's cash. That means it may take a decade to cook up a decent return.
The financing costs will leave less than $200-million in profit for the next financial year, ending in April, 2014. That's far less than the $1.2-billion Wall Street analysts expect a publicly listed Heinz to generate, which becomes $600-million after paying its regular dividend. That's not much wiggle room for any owner hoping to restructure and sell the company in the typical five-year private equity window. The lack of extra cash and already-high debt load also probably rule out any leveraged recapitalization.
Heinz's new owners have more time on their hands. Warren Buffett and his Berkshire conglomerate are well-established long-term investors. 3G, meanwhile, which will run Heinz, is the firm that spent some 20 years building AB InBev. Assume it takes 3G a decade to increase Heinz's operating margin to 22 per cent from its current 15 per cent at the same time as expanding the top line by an average 4.5 per cent a year – emulating the past 10 years. That would produce profit of about $1.1-billion by 2024.
That might not sound great – it's less than Heinz could earn in its next financial year. Apply a multiple of 14 to those earnings, however, a tad less than Heinz fetched in the public market before the deal was announced, and the $8.2-billion equity investment from 3G and Buffett would be worth almost $16-billion, a near doubling.
If 3G could improve revenue by 5 per cent a year, reach an admittedly impressive 26 per cent operating margin and refinance all of Berkshire's preferred shares with cheaper debt, the investment would quadruple. Of course, there are risks. Too much debt can hurt in a downturn, overaggressive cost cutting could harm the business and revenue may simply not grow as it once did. As the old ketchup jingle goes, however, anticipation could make Heinz well worth the wait.