Recently you may have seen the news that Warren Buffet, the multi-billionaire investor and his Berkshire Hathaway [NYSE: BRK-A] investment company had teamed up with a private equity firm to pay USD$28 billion for the HJ Heinz Company [NYSE: HNZ]. Now everybody knows that Warren Buffet is what is considered a “value investor” – he buys on the cheap and sells at the highs. That simply means he believes the market has undervalued a company’s current and future earnings potential and seeks to buy the stock at what he sees as a discount to the real value. So many investors and market commentators are intrigued at the latest offer, with Buffett agreeing to pay USD$72 per share for a company that had closed the previous day at USD$60.48.


Call it what you will – but that is certainly not value investing. So either Buffett has lost the plot, or there is more to the deal than meets the eye. Buffett and his team are no fools, so with a little digging, the following facts come to light…


Has Buffett lost the plot?

Don’t be fooled into thinking that Buffett’s swoop on Heinz means you should be piling into consumer goods shares at current prices. The deal is much more about clever financial engineering than any sort of great equity growth story. In fact, the way this deal is structured suggests that Buffett wants to ensure that he is exposed to less risk than normal shareholders.

Most of Buffett’s investment and return is coming in the form of preference shares ($9bn of them with another $4bn of equity on top). Preference share dividends get paid out before ordinary dividends.

So this means Buffett has first claim on the company’s post-tax profits. These preference shares are rumoured to be paying him a very juicy annual return of 9% or $810m. When you think that Heinz’s post-tax income is expected to be around $1.1bn in 2013, that’s a nice chunk of the profits for Buffett. But the thing is Heinz is being loaded up with debt – around $20bn of it (including the preference shares) compared with $5bn now.

This means that Heinz’s after-tax profits are likely to fall (as its interest payments shoot up). So Buffett could be taking virtually all of the income, with 3G getting next to nothing in the early years. Buffett, on the other hand, will get a virtually guaranteed $810m every year, and a chance of his equity stake going up in value if everything works out.

So, would that be considered value investing, or just plain smart investing? If the lay folk could get a guaranteed 9% return, in this market, who would not swoop at that chance. Also, the Berkshire Hathaway is sitting on a mass of funds, over $400 billion and it needs to ensure that is invests these funds appropriately. So we think the deal is actually a bit of masterful financial engineering, a potential deviation from the usual value investing (of which there are slim pickings around these days).

Categories: Business News, World News

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