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.