I’m guessing that Berkshire has tried to reduce its risk with a buyback provision included with the preferred. However, that infers Heinz will be able to refinance the $8 billion in a timely manner when, as I expect, the company will also be undertaking a substantial restructuring under 3G Capital’s guidance. Given the history of 1980’s consumer product leveraged buyouts like RJR Nabisco and Beatrice Foods, it is hard to deny that deals comprised of a generous offer, meaningful leverage and a restructuring involve a significant amount of risk.
Berkshire’s increased partiality toward “sweetheart” preferred stock deals is also concerning. Besides the Heinz preferred, Berkshire has purchased $5 billion of Bank of America 6% preferreds that also included 700 million shares worth of around par warrants in 2011. In 2008, $3 billion in General Electric 10% preferred shares were purchased that included a 10% buyout premium. These were later redeemed in 2011. Berkshire also undertook attractive preferred share deals with Goldman Sachs 10% paper (that was also redeemed in 2011) and $3 billion of Dow Chemical 8.5% stock.
These purchases are not necessarily a negative in themselves. But in assessing Berkshire’s future operations their continued availability cannot be counted on without a concurrent assumption that these deals will also involve increased risk. I think the Heinz transaction is an example.
However, Berkshire being un-investable is not related to these factors specifically but more to their influence on calculating the company’s “discount factor.” Conglomerates, of which Berkshire Hathaway may be the most varied ever, usually have their intrinsic business value discounted. This discount is justified by the additional administrative control necessary to oversee the disparate businesses held. The potential for further acquisitions to spur growth and the possible internal unease at future divestitures of lagging subsidiaries are additional concerns that usually warrant a discount.
As Berkshire brought some large dissimilar businesses into its fold, such as the BNSF railroad and chemical company Lubrizol, the discount factor appraisal was made more difficult but not unmanageable. Though, as the Heinz deal might suggest, if Berkshire is pushing out on the risk spectrum and relying more on unconventional preferred share deals, ascertaining a reasonable discount is getting close to being impossible. Without being able to discount Berkshire intrinsic value adequately, its stock is just about uninvestable.
I’m sure investors will flock to Berkshire Hathaway for a variety of reasons but the Heinz deal might make the stock far less attractive. Shareholders and potential stock buyers might want to consider my concern and satisfy for themselves that they are truly getting the value they believe they are paying for.
The article Surprising Concern About Berkshire’s Heinz Deal originally appeared on Fool.com and is written by Bob Chandler.
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