MASTER STROKE BY WARREN BUFFET

Recently, Warren Buffet hit the headlines again due to his acquisition of an ‘elephant’ along-with an investment partner. We are referring to Warren Buffet's acquisition of Heinz. However, the deal smacked something unlike of Warren Buffet. Why? Warren Buffet is known to be value investor or a bargain hunter. Well he was till late 1980s- however thereafter Warren Buffet changed his investing style. He began to ardently follow the advice of his business associate Charles Munger that it is better to buy a good company at a fair price than a fair company at a cheap price. This slight change in the investment philosophy has done wonders to the investment career of Warren Buffet.

Acquisition of Heinz was done at USD 28 billion. Warren Buffet and his Brazlian investment partner had paid 20% more than the market. There were criticisms that they overpaid for this acquisition. Did Warren Buffet overpay? Has Warren Buffet moved away from his investment principles? Financial Views will examine a few points below as to why did warren buffer pay 20% more than the market?

1.       Warren Buffet knows its trackrecord. Warren Buffett’s file on Heinz goes back to 1980. Heinz has been incredibly consistent over that time. During the last 5 years, the company have recorded strongest performance to date, with a ROE (return-on-equity) of 32%. Heinz has a nearly 60% market share in the U.S. ketchup market, but only 25-26% international market share. So, Warren Buffet has identified a company with potential to grow further in international market.

2.      Strong dividends: Warren Buffet may not pay dividends to his shareholders; however Warrant Buffet’s fancy for dividend paying companies is well documented (Recently Warren Buffet came out with a clarification whey he is not paying dividends to shareholders) Heinz’ dividend growth rate has increased over the last 5 years. This trend will accelerate after the company is taken private.

3.      Growth opportunity : Since late 1980s, Warren Buffet penchant for growth companies is well known. Warren Buffet likes increasing strength of Heinz’s in China, India, Brazil and other “emerging” markets. In this way, this investment by Warren Buffet has some similarities to his investment in Coco Cola Warren Buffet might also have noticed the Heinz strategy of buying local brands in these markets to speed up the access to introduce its own global brands.

4.      Paying for him first: Even if someone argue that there is overpayment, Warren Buffet has played the game in his favour. Warren Buffet (through Berkshire Hathaway) gets preferred shares (with warrants). The structure of the deal is favourable to Warren Buffet. Warren Buffet invested $4.12 billion in Heinz common equity, another $8 billion in preferred shares, (and gets warrants). 3G Capital contributed $4.12 billion of equity, the rest financed by $7.1 billion in acquisition finance, by Warren Buffett’s darling banks, Wells Fargo & Company (WFC) and JPMorgan Chase & Co. (JPM)).

5.      Future Cash Inflows: Warren Buffet obsession with cash is also well-known. So what does Warren Buffet will receive in return for his massive investment in Heinz? Assured $720 million (pre-tax) a year on his $8 billion worth of preferred shares with a 9% yield, and dividends on equity shares of $4.12 billion, which could fetch a dividend yield of 10%-15%. Hence, Warren Buffet could enjoy  a billion dollars inflow from this deal + capital appreciation possibilities.

 

At a time when US treasury offers just 0.25%, this deal has all features of a master stroke by Warren Buffet.

Discussion on rate hikes that killed Growth

Recently RBI Governor (RBI-G) D Subbarao addressed IIT-Kanpur Alumni and made some observations. http://www.moneycontrol.com/news/economy/5-6-growth-not-sufficient-says-rbi-governor_833324.html In fact RBI-G is admitting that his own policies since 2011 were wrong! Financial Thoughts(FT) have taken the key sections of the speech and provides some comments, which are captured below:

RBI-G:  “Growth rate of 5-6 percent is not sufficient for the economy, which has the potential to grow at double-digit rate provided some issues are addressed”

FT Comments: To achieve growth, proper monetary policy is needed. The interest rates have to reduced - which RBI had increased during 2^nd half of 2011. Since then the growth rate was on the downward trend. Correlation between rate hike and slowdown is well established.

RBI-G: “Pointing out some of the long-term challenges for the growth, Subbarao said there was a need for stable and predictable macroeconomic environment, removal of infrastructure deficit, skill improvement and job creation. He said there is also need for raising agriculture productivity, and improvement of social sector outcome.”

FT Comments: RBI clearly failed in this. Whilst RBI is supposed to be a guardian of foreign currency exchange rate, they have failed abjectly. Once $: INR was stable around Rs45/- now it has touched Rs55/- and it may fall further resulting in higher cost of fuel, which drives the economy. See the link http://www.financialstrategyonline.com/2011/12/rbis-smart-moves-taking-india-down.html On another blog post dated 21 Oct 2011 Financial Thoughts had screamed as follows:

“Those who support further indiscriminate rate hikes must go back to US in 2006 when US Fed was blindly hiking the rates in pursuit of a mirage, which achieved nothing but a fantastic economic collapse in 2008”

RBI-G: "We are quite happy that India is growing at 5-6 percent, but I must tell you that is not sufficient. That is much less than our potential ... unless we grow at 9-10 percent year on year for about 10 years we cannot pull hundreds of millions of people out of poverty," 

FT Comments: Totally wrong! In fact many Indians are unhappy in way things are mismanaged and brought to this level. 

RBI-G: "India consists of the largest number of poor people in the world. India has more poor people than the entire economy of South Africa," Subbarao, who is also an alumnus of IIT Kanpur, added.

FT Comments: For the sake of poor, put the economy back on track on 9% growth rate. Studies have proven that since liberalisation in 1991, the Indian Poverty has dropped because of the growth in the economy. Even slums in India have a TV set and two wheelers which during 1980s was the luxury of middle class. Post liberalisation, middle class migrated to four wheeler, however it becomes unbearable now due to the hike in fuel costs, thanks to RBI whose foreign currency management has exacerbated the issue. 

RBI-G: “Inflation is still high and stubborn. Balance of payments is under stress. Decline in investments is a worry. Investments not taking place today, that's a worry," 

FT Comments: Very sad to hear this as the interest rates were hiked in the first place to curb inflation!! Secondly investments will not take place if the debt finance is costly.  Thirdly with the slowing growth in India, there are other countries with better profitable opportunities as far as FII and FDI are concerned. FII and FDI deploy their capital not for charity; but for profit. Right now, India is not the second fastest growing economy but the third or fourth!

RBI G: "So people worry whether we have got derailed from the high growth trajectory. My short answer to all those questions is that the India story is still intact and India's growth story is still credible," he said.

FT Comments: Whilst Indian Growth story is still credible, we wait for a radical change in RBI policy or a new RBI Governor similar to Bimal Jalan to rekindle growth in the economy.

Financial Thoughts also believe that Narendra Modi, who has an excellent track record in ruling Gujarat must be given a chance to rule from New Delhi. Whilst many will point out to 2002, Financial Thoughts would like to point out to the role of congress leaders during 1984 massacre in New Delhi.  Financial Thoughts do not support any type of massacre or violence (as it reminds the chimpanzee past of humans!? Real humans are more evolved and sophisticated and do not indulge in violence – learn from Mahatma Gandhi or Martin Luther King)

With Modi at helm, the probability of India growing at 10% and becoming an attractive investment destination of the world would be a reality.