Question

5. Do you believe that Heinz is a good candidate for a leveraged buyout? Explain your answer.

In a departure from its traditional deal making strategy, Berkshire Hathaway (Berkshire), the giant conglomerate run by Warren Buffett, announced on February 14, 2013 that it would buy food giant H.J. Heinz (Heinz) for $23 billion or $72.50 per share in cash. Including assumed debt, the deal is valued at $28 billion. Traditionally, Berkshire had shown a preference for buying entire firms with established brands and then allowing then allowing them to operate as they had been. Investors greeted the news enthusiastically boosting Heinz’s stock price by nearly 20% to the offer price and Berkshire’s class A common stock price by nearly one percent to $148,691 a share. Unlike prior transactions, Berkshire teamed with 3G Capital Management (3G), a Brazilian-backed investment firm that owns a majority stake in Burger King, a company whose business is complementary to Heinz, and interests in other food and beverage companies. Heinz’s headquarters will remain in Pittsburgh, its home for more than 120 years. The major attraction to Berkshire is the extremely well-known Heinz brand and the opportunity to use Heinz as a platform for making additional acquisitions in the global food industry. Berkshire is adding another widely recognized brand to his portfolio which already contains Dairy Queen and Fruit of the Loom. The strong Heinz brand gives it the ability to raise prices. The deal is intended to assist Heinz in growing globally. By taking the firm private, Heinz will have greater flexibility in decision making not having to worry about quarterly earnings. Currently, about two thirds of the firm’s total annual revenue come from outside the U.S. Heinz earned $923 million on sales of $11.65 billion in fiscal 2013. At 20 times 2013 current earnings, the deal seems a bit pricey when compared to price to earnings ratios for comparable firms (See Table 1). The risks to the deal are significant. Heinz will have well over $10 billion in debt, compared to $5 billion now. Before the deal, Moody’s Investors Service rated Heinz just two notches beyond junk. If future operating performance falters, the firm could be subject to a credit rating downgrade. The need to pay a 9% preferred stock dividend will also erode cash flow. 3G will have operational responsibility for Heinz. Heinz may be used as a platform for making other acquisitions.

Risk to existing bondholders is that one day they own an investment grade firm with a modest amount of debt and the next day they own a highly leveraged firm facing a potential downgrade to junk bond status. On the announcement date, prices of existing Heinz triple B rated bonds fell by over two cents on the dollar, while the cost to ensure such debt (credit default swaps) soared by over 25% to a new high. The structure of the deal is described in Figure 1. H.J. Heinz Company, a Pennsylvania Corporation, entered into a definitive merger agreement with Hawk Acquisition Holding Corporation (Parent), a Delaware corporation, and Hawk Acquisition Sub (Merger Sub), Inc., a Pennsylvania corporation and wholly owned subsidiary of Parent. The agreement called for Merger Sub to merge with Heinz, with Heinz surviving as a wholly owned subsidiary of Parent. Berkshire and 3G acquired one-half of the common stock of Parent for $4.12 billion each, with Berkshire also purchasing $8 billion in 9% preferred stock issued by Parent, bringing the total cash injection to $18.24 billion. The preferred stock has an $8 billion liquidation preference (i.e., assurance that holders are paid before common shareholders), pays and accrues a 9% dividend, and is redeemable at the request of the Parent or Berkshire under certain circumstances. The use of preferred stock has been a hallmark of Berkshire deals and has often included warrants to buy common stock. Parent used the $18.24 billion cash injection from Berkshire and 3G (i.e., $14.12 from Berkshire + $4.12 from 3G) to acquire the common shares of Merger Sub. J.P. Morgan and Wells Fargo provided $14.1 billion of new debt financing to Merger Sub. The debt financing consisted of $8.5 billion in dollar-denominated senior secured term loans, $2.0 billion of Euro/British Pounds senior secured term loans, a $1.5 billion senior secured revolving loan facility, and a $2.1 billion second lien bridge loan facility. Total sources of funds equal $32.34 billion, consisting of $18.24 in equity plus $14.1 billion in debt financing. The deal does not contain a go shop provision, which allows the target to seek other bids once they have reached agreement with the initial bidder in exchange for a termination fee to be paid to the initial bidder if the target chooses to sell to another firm. Go shop provisions may be used since they provide a target’s board with the assurance that it got the best deal; for firms incorporated in Delaware, the go shop provision helps target argue that they satisfied the so-called Revlon Duties, which require a board to get the highest price reasonably available for the firm. While Heinz did not have such a go shop provision, if another bidder buys Heinz, it will have to pay a termination fee of $750 million, plus $25 million in expenses. If Berkshire and 3G cannot close the deal they must pay Heinz $1.4 billion before they can walk away.

Heinz may not have negotiated a go shop provision which is common in firms seeking to protect their shareholder interests because it is incorporated in Pennsylvania. Pennsylvania corporate law is intended to give complete latitude to boards in deciding whether to accept or reject takeover offers because it does not have to consider shareholders’ interests as the dominant determinant of the appropriateness of the deal (unlike Delaware). Instead, the directors can base their decision on interest of employees, suppliers, customers and creditors and communities. This may explain why Berkshire and 3G have agreed to have Heinz’s headquarters remain in Pittsburgh, keep the firm’s name, and preserve the firm’s charitable commitments. Firms incorporated in Delaware may be subject to greater pressure to negotiate go shop arrangements because Delaware corporate law requires the target’s board to get the highest price for its shareholders

Answer 1

Yes , I believe that Heinz is a good candidate for a leveraged buyout because of the following below reasons.

1. Heinz’s headquarters will remain in Pittsburgh, its home for more than 120 years. The major attraction to Berkshire is the extremely well-known Heinz brand and the opportunity to use Heinz as a platform for making additional acquisitions in the global food industry.so, It can help to grow globally.

2. The strong Heinz brand gives it the ability to raise prices.

3.The agreement called for Merger Sub to merge with Heinz, with Heinz surviving as a wholly owned subsidiary of Parent. So, It will result into an wholly owned subsidiary.

4. out flow of funds as if another bidder buys Heinz, it will have to pay a termination fee of $750 million, plus $25 million in expenses. If Berkshire and 3G cannot close the deal they must pay Heinz $1.4 billion before they can walk away.

5. Berkshire and 3G have agreed to have Heinz’s headquarters remain in Pittsburgh, keep the firm’s name, and preserve the firm’s charitable commitments.