Berkshire Hathaway Inc. (BRK.B): How Will This Brand Progress With The Buffett Backing?

Berkshire Hathaway Inc. (NYSE:BRK.A)As the world knows, H.J. Heinz Company (NYSE:HNZ) announced it agreed to be acquired by Berkshire Hathaway Inc. (NYSE:BRK.B) and 3G Capital, a private equity firm, on Feb. 14, 2013 for $72.50 per share, or about $28 billion. The offer is a 20% premium to the closing price the prior day, which is on the low end versus historic premium levels. Initially the stock traded up to $72.60 behind speculation of a higher offer. However, the shares now trade at $72.27, and there is no indication of a higher offer elsewhere. The transaction was already approved by the H.J. Heinz Company (NYSE:HNZ) board and is pending shareholder approval.

The $28 billion purchase price at the time of the announcement was at 13.2 times FY13 Thomson consensus EPS. Other transactions of large cap packaged foods, most recently Cadbury, occurred at a similar valuation, further indicating that a higher offer is probably not in the works for Heinz.

Berkshire Hathaway Inc. (NYSE:BRK.B) and 3G Capital were interested in Heinz for its strong brands and growth in certain businesses. H.J. Heinz Company (NYSE:HNZ)’s growth in emerging markets, 21% of sales, was strong and the primary driver behind higher sales. Its developing market exposure is greater than its primary peers: Kellogg has 15%, and the remainder around are 10% or below.

One argument against Heinz prior to the deal was the quality of earnings versus its peers. Heinz received a steady contribution from a lower average tax rate. While the cash tax and book tax rates differ, the lower rate likely carried through to cash tax and led to higher free cash flow generation. Steady FCF has always attracted Buffet and private equity.

Berkshire Hathaway Inc. (NYSE:BRK.B) and 3G Capital will have to address the company’s performance in developed markets. First, developed market organic growth rates are below those of its peers like Campbell’s, General Mills, Kellogg, and Kraft. North American organic sales have been in the 0-1% range over the past six quarters, and the brands need some revitalization.

Impact on Industry

Although the deal is significant in size, it is not necessarily indicative of more looming large acquisitions by outside players. Multiples in the sector have likely had some positive impact, but packaged foods already traded at multi-year highs. The 20% premium, historically low as noted earlier, further supports the relatively high multiples the stocks already trade at.

Heinz’s portfolio will be evaluated and some divestures are probably on the horizon. Industry players looking to acquire brands, such as ConAgra and Kraft, could purchase some of Heinz’s assets. The frozen food portfolio is one likely candidate. Management of Heinz already announced plans to divest Shanghai LongFong Foods, an underperforming brand in China.