Mergers and Acquisitions are an area of finance that attracts
attention from not only finance specialists but also the general public.
Announcements from high profile and well-known companies are reported in the
press with much speculation often arising before official statements are even released.
Reporters and analysts will follow the deal closely, offering their opinions on
the proposed benefits and whether they believe the deal to be fair to each
party involved. The recent announcement of the Heinz Kraft merger was no
exception. This case will be the focus of my blog, with the motives behind the
merger being discussed.
In late March, it was announced that the US food company
Heinz was set to merge with Kraft Foods Group, to create the third largest food
and beverage company in North America (BBC News, 2015). Heinz shareholders will
own 51% of the combined company, whilst Kraft’s shareholders will hold a 49%
stake (BBC News, 2015); therefore Heinz will hold the controlling interest. The
deal has been engineered by Heinz’s wealthy owners, Brazilian private equity
firm 3G and Warren Buffet’s Berkshire Hathaway (Armstrong & Roland, 2015). The
cash and stock transaction will see Kraft’s shareholders receiving a special
cash dividend of $16.50 per share, totalling $10bn which will be financed by Mr
Buffet and 3G (BBC News, 2015). This agreed price represents a premium of 27%
to Kraft’s closing share price on the day before the announcement (24th
March) which valued the business at $36bn (Armstrong & Roland, 2015),
suggesting a good deal for Kraft’s shareholders.
The deal is considered the largest of the year so far and the
biggest ever reported in the food industry (Armstrong & Roland, 2015). So
apart from creating the 5th largest food and beverage company in the
world (Fontanella-Khan, Massoudi & Daneshkhu, 2015), what benefits will
this merger bring? Watson and Head (2013) deem a merger only justifiable if the
wealth of the shareholders of each company is increased. Warren Buffet stated
“this is my kind of transaction, uniting two world-class organisations and
delivering shareholder value” (Fontanella-Khan et al., 2015). However, will
this be the case for the combined shareholders of the newly titled Kraft Heinz
Company?
Firstly, the deal represents a horizontal merger as it will merge two
companies in the same industry (Arnold, 2013) – the food sector. The normal rationales
behind this type of merger include economies of scale and scope and the
synergies that are created when operating as a combined entity (Watson &
Head, 2013). Again, the Heinz-Kraft deal is no exception. The combined company
expects to see annual cost savings of $1.5bn by the end of 2017 (BBC News,
2015) as they will benefit from economies of scale and operational synergies; however
this will inevitably result in redundancies. This is typical of mergers and
acquisitions as an obvious way of achieving scale economies is to streamline
business operations by cutting the number of employees in duplicated functions
(Watson & Head, 2013). Job losses in areas such as finance, marketing and
IT have been speculated after the merger (BBC News, 2015).
Furthermore, as well as delivering synergies, Heinz’s international
presence should help to expand Kraft’s portfolio of brands overseas allowing
them to access new markets. This was one of the reasons why Kraft’s CEO John
Cahill was open to the deal as Kraft are currently struggling due to slow
growth in US markets (Armstrong & Roland, 2015). The deal is predicted to
create a business with combined revenues of $29bn each year (Fontanella-Khan et
al., 2015). Additionally, Kraft can use Heinz’s expertise to revitalise their
outdated products. Kraft has failed to keep up to date with new consumer habits
(BBC News, 2015). Overall, it appears that Kraft will benefit considerably from
Heinz’s global presence and success in the food industry and enable them to
better meet consumer demands.
However, it is wise to consider whether these proposed benefits will
materialise. There has been much speculation as to whether mergers and
acquisitions actually create value for those involved. Studies suggest that there is no gain to
shareholders or even the economy after a merger or acquisition has taken place.
For example, Cowling, Stoneman, Cubbin, Cable, Hall & Dutton (1980) proposed
that at best acquisitions have a neutral effect on the economy and there are no
extreme efficiency benefits to be gained. Furthermore, they argue that most
takeovers of a horizontal nature, as in the case of Heinz and Kraft, are
neutralised by increased monopoly power (Cowling et al., 1980). The owners of
Kraft Heinz Company will no doubt be pleased with this increase in market power;
however consumers may suffer a decline in choice and also face increased
prices. Watson and Head (2013) highlight that subsequent research has echoed
the findings of Cowling et al (1980) and the effect of mergers and acquisitions
on the economy is deemed mostly neutral.
In contrast, scope does still exist for particular parties to benefit at
the expense of others. Singh (1971) suggests that acquisitions are unprofitable
from the acquiring company’s view point. Jenson and Ruback’s (1983) study
showed average abnormal returns to the acquiring company
shareholders of 4% for successful bids, whereas shareholders of the target
company on average experienced 30% for successful bids. This suggests that
substantial benefits arise for the target company shareholders. This was
demonstrated when the announcement of the Kraft Heinz merger was released (25th
March) as Kraft’s share price rose by 35% as shown on the graph I have
constructed below.
Although it could also be argued that wealth is not
necessarily created but rather redistributed, i.e. transferring wealth from the
acquiring company’s shareholders to the target company’s shareholders (Watson
& Head, 2013), the benefits cannot really be quantified until after the
merger has been approved and put into place. The deal between Heinz and Kraft
has only been approved by the boards of each company; agreement is still waiting
from regulators and also the shareholders of Kraft (BBC News, 2015). Only time
will tell if Kraft’s shareholders considerably benefit from the merger.
However, if there is not much to gain in practice, why have
3G and Warren Buffet masterminded this merge between Heinz and Kraft? Is this
more a case of managerial greed? Arnold (2013) suggests that managerial motives
behind mergers and acquisitions are not always concerned with maximising
shareholder wealth. Instead it is
proposed that some managers simply enjoy creating an empire as it gives them a
sense of achievement and purpose. Both 3G and Warren Buffet are no strangers to
mergers and acquisitions. During the past seven years 3G have acquired Heinz,
Burger King and the brewer Anheuser-Busch, with Warren Buffet teaming up with
them on their last three food deals (Fontanella-Khan et al., 2015). Have they
become transfixed with pulling off these high profile mergers?
Furthermore, the deal has been structured to keep Berkshire
Hathaway and 3G in control of the new company. The special dividend of $16.50 a
share allows them to keep their combined ownership at 51% (Solomon, 2015). This
again highlights Lemann and Buffet’s desire for power. Reports have suggested that both Buffet and
3G will appoint three directors each with five other directors being appointed
by Kraft (Solomon, 2015). This means 3G and Buffet will remain in control as
they can simply act together and replace Kraft directors if they wish.
Therefore, Solomon (2015) proposes that the company will be predominantly run
by 3G and Berkshire Hathaway, with very little input from Kraft’s shareholders.
Moreover, when considering what Lemann and Buffet may plan
to do with the merged Heinz Kraft Company, it must be highlighted that 3G is a
Brazilian private equity firm. Private equity investors have recently become
dominant players in the merger and acquisition market (Watson & Head,
2013). Many private equity firms have made headlines as high profile listed
companies have been purchased and taken private with the aim of re-floating the
company at a later date (Watson & Head, 2013). In 2013, 3G and Buffet
bought and privatised Heinz (BBC News, 2015). Therefore, it is natural to
question whether this is the intended path for their latest merger. Buffet
assured investors that “3G is unlike other private equity firms, they don’t
just buy to sell, they buy to keep” (Armstrong & Roland, 2015). However,
only time will tell what 3G and Warren Buffet really have planned for Kraft.
To conclude, I believe the motives behind this merger may be
more to do with establishing power and status within the food industry rather
than creating wealth for shareholders. Although it must be noted that Kraft
should gain considerably from Heinz’s global presence, what is certain is that
Warren Buffet and Jorge Lemann won’t be sparing a thought for those who will be
rendered jobless because of the merger. I believe it won’t be long before they
will be planning their next purchase to satisfy their “insatiable appetite for
acquisitions” (Armstrong & Roland, 2015).
References
Arnold, G. (2013). Corporate Financial Management. (5th
ed.), Harlow: Pearson.
Armstrong, A. & Roland, D. (2015, March 25). Heinz to
merge with Kraft to create US food
giant. The Telegraph. Retrieved
from http://www.telegraph.co.uk
BBC News. (2015, March 25). Kraft shares soar in Heinz
merger. BBC News. Retrieved from http://www.bbc.co.uk/news/
Cowling, K., Stoneman, P., Cubbin, J., Cable, J., Hall, G.
& Dutton, P. (1980). Mergers and
Economic Performance. Cambridge University Press .
Fontanella-khan, J., Massoudi, Arash. & Daneshkhu, S.
(2015, March 25). Heinz swallows Kraft in deal engineered by Warren Buffet and
3G. Financial Times. Retrieved from http://www.ft.com
Jensen, M. &
Ruback, R. (1983). The market for corporate control: the scientific evidence. Journal of Financial Economics, 11 (1),
5-50. Doi: 10.1016/0304-405X(83)90004-1
Singh, A. (1971). Takeovers:
Their Relevance to the Stock Market and the Theory of the Firm. Cambridge
University Press.
Solomon, S.D. (2015, March 26). Reading the fine print in
the Heinz-Kraft deal. The New York Times.
Retrieved from http://www.nytimes.com
Watson, D. & Head, A. (2013).
Corporate Finance: Principles and
Practice. (6TH ed.), Harlow: Pearson.
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