Lessons from the Kraft-Heinz cul-de-sac | USAEMALL.com

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Kraft-Heinz

What begins with financial engineering ends with it, too. Kraft-Heinz, the packaged food conglomerate put together by 3G Capital and Berkshire Hathaway, is considering a break up. From the FT: 

The decision comes after the company . . . in May said it was considering several options to reverse its persistent underperformance…

One of the plans being considered includes spinning off much of its traditional grocery portfolio . . . The remaining part of the business, which would include Heinz condiments, Grey Poupon mustard and a broader slate of sauces

Maybe I’m missing some subtleties, but this looks like breaking up the two companies on exactly their original lines. What are the lessons from this twelve-year round trip?

When Berkshire and 3G bought Heinz in 2013, I wrote the following in the Lex column:

Let us all give Warren Buffett a stern lecture about overpaying. The Sage of Omaha needs a good talking-to after Berkshire Hathaway and 3G Capital agreed to pay $72.50 a share, or $28bn including debt, for Heinz. That is almost a 20 per cent premium to the all-time high the packaged food company’s stock recently hit and amounts to 21 times this year’s earnings . . .  

Heinz is an excellent, high returning, cash generating, if slow growing company, I argued. But that was reflected in the price before the 20 per cent premium was tacked on. And the room for restructuring and reinvention at a packaged food company is limited. “That is not a ketchup stain on your reputation, Mr Buffett,” my note concluded. “It looks more like blood.”

Boy oh boy did I get some salty emails about that one. No one likes it when you criticise the patron saint of American capitalism. And for a while, it looked like Buffett was once again right while I was spectacularly wrong. Just after the all-stock Heinz-Kraft merger in 2015 (Kraft shareholders got a 30 per cent premium in that one) Lex had this to say: 

It was easy to be sceptical: Warren Buffett and 3G paid a super-premium price to buy Heinz two years ago. It was hardly growing, and how much scope for change is there at a well run packaged foods company? 

Well, the sceptics can open their family-sized can of Heinz humble pie and dig in. Kraft’s shares traded for $83 on Thursday, implying that the Buffett/3G stake in Heinz-Kraft is worth $41bn. They invested $8bn in Heinz originally, and then contributed a further $10bn to the Kraft deal. 

The key trick was sacking a fifth of Heinz staff. Profits rose by a third. That plus a lot of financial leverage worked well, and the share price of the combined company suggested the same trick would work again with Kraft. It did not.

That $83 price turned out to be a high point, and the shares trade at a third of that now. Berkshire took a $3bn impairment charge on their investment in 2019 and Buffett admitted overpaying for Kraft; 3G sold the last of their stake in 2023.  

What went wrong? Part of the story is that consumers moved away from many Kraft-Heinz products (ketchup giving way to salsa, and so on) and away from big established food brands to niche brands. Another part is big retailers wrestling pricing power away from food brands (it is worth noting that sales growth was stalling at both companies even before the deal was closed). But the performance of other big packaged food groups has not been as poor as Kraft-Heinz’s.

When Kraft was riding high, the consensus was that the Kraft-Heinz tie up was a mere proof of concept (or rather further proof of concept, after 3G’s success rolling up beer companies). The expectation that more brands would be absorbed and improved was built into the price. A failed 2017 bid for the much larger Unilever let much of the air out of that idea; a 2019 writedown and SEC investigation into cost accounting let out the rest.

Less clear is the degree to which 3G’s relentless focus on costs killed revenue growth. Nominal sales have been flat since 2016 — a remarkable feat given sharp post-pandemic inflation in food prices. And the wild expansion in margins that caused such excitement in 2017 has faded considerably:

I don’t know to what extent cost cutting hurt growth while creating a margin boost that was unsustainable, and to what extent the trouble was caused by other factors internal or external to Kraft-Heinz. Perhaps readers who know the food industry better than I do will have thoughts. But I am confident that mergers, break-ups, and cost-cutting campaigns are secondary sources of shareholder value at best. They can, of course, cause share prices to burst upward in the short term. Over the long-term, though, they can only serve as complements to primary sources of value, such as innovation and high barriers to entry. In the absence of the sales growth that those things create, restructuring and cost control are largely inert. 

Of course, dealmaking in particular has great appeal to the people in charge of it. This includes not just the investment bankers who, as with Kraft-Heinz, charge fees for both the putting together and the taking apart. CEOs and private equity managers, too, can get rich by timing their entries and exits. Bosses and financial engineers have almost always come and gone before the lifecycle of a product or strategy has played out (Buffett is an honourable exception here). 

The lesson from Kraft-Heinz is that, when it comes to the purely financial management of a company, long-term investors should not hope for too much. 

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