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Author: Floorhead Two stars, 250 posts Old School Fool Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 212871  
Subject: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 3:20 AM
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Another interesting take from the FT (this time from the Opinion section):

By now the “Buffett deal” has become familiar: an investment by Berkshire Hathaway that includes high-yield preferred stock and very little risk. Berkshire’s purchase last week of Heinz fits the classic pattern. Before yawning, “he’s pulled off another one”, let us pause to consider some new shading that Heinz brings to the portrait of Warren Buffett as dealmaker and capitalist. Also worth noting are subtle signals that suggest where the US economy is heading. Mr Buffett has a history of being right about such things, so let us pay attention.
Through the deal, Berkshire and its partner 3G Capital, the Brazilian private equity firm, will each take half of Heinz in exchange for $4bn of equity. For another $8bn, Berkshire acquires redeemable preferred stock yielding 9 per cent and warrants (options that give investors the right to buy shares at an agreed price at some point in the future). The $72.50 per share cash transaction includes $12bn of new and assumed debt, valuing Heinz at $28bn.

What do these details tell us about Mr Buffett as a dealmaker? The most notable point concerns his tolerance for leverage. Heinz will sport $6 of debt for every dollar of equity – a ratio that has made bondholders and rating agencies uneasy. Mr Buffett bristles at applying the term “leveraged buyout” to the deal on the grounds that he does not intend to flip the company in a sale. That is a fair point. On the other hand, the deal does bark like an LBO – otherwise, the numbers would not work for the sellers. It may seem puzzling that Mr Buffett, who has criticised LBOs for decades, signed up to such a deal, but here is the twist. The leverage – which is very real for all the other parties – is largely illusory for Berkshire.

Even if Heinz loses money, Mr Buffett’s holding company is paid its preferred dividend. Only in the unlikely event of bankruptcy is Berkshire at risk. Should that happen, Berkshire would be in a position to wipe out other creditors. Its power to snag a cheaply restructured Heinz essentially eliminates Berkshire’s risk. No wonder bondholders are nervous.


continued:

http://www.ft.com/cms/s/0/5cd29ec0-79be-11e2-b377-00144feabd...
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Author: astore One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198829 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 3:51 AM
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Long ago that Ms Schroeder has been so positive!

I like the last sentence:

"In a world of near-zero interest rates, that 6 per cent looks pretty attractive. Mr Buffett, evidently, does not expect rates to rise sharply any time soon. A decade ago, he demanded a first-day return of 13 per cent before he would bother to consider a deal. Now the Oracle takes 6 per cent for his money. We should pay attention. There could hardly be a stronger signal that the investing tide has changed".

Thomas

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Author: Jtrau One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198830 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 4:39 AM
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"In a world of near-zero interest rates, that 6 per cent looks pretty attractive. Mr Buffett, evidently, does not expect rates to rise sharply any time soon. A decade ago, he demanded a first-day return of 13 per cent before he would bother to consider a deal. Now the Oracle takes 6 per cent for his money. We should pay attention. There could hardly be a stronger signal that the investing tide has changed".

I would be interested about the warrants - how many, strike price, expiry etc.
Without this information the deal cannot be qualified imho.

She also seems to imply that Berkshire's preferred stock would be senior to bonds - I wonder how this could be?
Lots of questions.

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198831 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 6:56 AM
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I would be interested about the warrants - how many, strike price, expiry etc.
Without this information the deal cannot be qualified imho.

She also seems to imply that Berkshire's preferred stock would be senior to bonds - I wonder how this could be?
Lots of questions.


Yes, and yes.

And there's this puzzler:

Heinz will sport $6 of debt for every dollar of equity – a ratio that has made bondholders and rating agencies uneasy.

Huh? According to her own summary, 3G and Berkshire will hold $8 billion in equity, there's $8 bn in preferreds for Berkshire, and $12 bn in debt. Even if you count the preferreds as debt, it's still $20 bn in debt against $12 bn in equity, or $2.50 of debt for every dollar of equity, no?

And where is she getting her 6% return?

Berkshire never bit on Heinz until now, when a deal arrived with terms that guarantee it a 6 per cent return.
In a world of near-zero interest rates, that 6 per cent looks pretty attractive.


9% (pre-tax; say 8%) on $8bn, X% on private equity probably held for a very long time, plus the value of the warrants on an undisclosed number of shares, at an undisclosed price. That looks a fair bit higher than 6%, whatever the details are.

I pretty much agree with her conclusions, but she should show her math, especially when she starts off with such a blooper.

Regards, DTM

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Author: Jtrau One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198832 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 7:28 AM
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And where is she getting her 6% return?

Berkshire never bit on Heinz until now, when a deal arrived with terms that guarantee it a 6 per cent return.
In a world of near-zero interest rates, that 6 per cent looks pretty attractive.


I assume she means

8bn preferred p+ 4 bn common = 12bn total investment.

9% of 8bn equal 720m

720m of 12bn total investment = 6%

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198834 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 9:04 AM
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I assume she means

8bn preferred p+ 4 bn common = 12bn total investment.

9% of 8bn equal 720m

720m of 12bn total investment = 6%



A reasonable hypothesis, but 6% pre-tax is neither a floor nor a ceiling, it is just the part that comes from the preferreds. The X% that comes from the equity could be fairly high, if the company can be operated more profitably, and even if it can't, if they can continue getting high rates of return on invested capital, especially with the increased leverage. On the other hand, that return could be negative if the company does not do well and if it has a hard time covering the interest costs. And then there is the value of the warrants, which must be worth something greater than zero, and which are included as part of the $12.12 bn investment.

Regards, DTM

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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198835 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:06 AM
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There is obviously some conjecture in the article and it would be better if that was explicitly stated. The full terms of the deal are yet to be disclosed as far as I know. And I doubt that she has any special information being cut off from Buffett for several years.

At the same time some humility is in order ... Schroeder's insights on Sokol's character (as documented on her blog in 2010 with respect to NetJets) were absolutely correct and I was dead wrong.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198836 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:19 AM
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As someone has pointed out that the 9% interest from the preferred is at least half self-paying. The actual interest rate should be considered as 4.5%. I think the main reason Buffett took the deal is his believe that HNZ will grow significantly faster in the international market, just like his believe in intermodal traffic grow for BNSF. The chance is good that he will be proven right again in a few years.

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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198838 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:26 AM
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Regarding growth for Heinz, I have been paying unusual attention to ketchup recently. At a recent visit to Chick-fil-a (a natural future Berkshire subsidiary), I noticed that Heinz ketchup is now packed in larger containers where you can either squeeze it out or use it for dipping. Presumably the unit cost of such containers is higher than the smaller packets that used to be the normal fast food packaging. The idea is probably that customers will take fewer containers. But habits die hard and I took the same number of containers that I usually take and I think I consumed more of it. Packaging tricks are sometimes effective at increasing consumption in an otherwise mature/static market.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198839 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:50 AM
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I recently happened to buy another brand of ketchup with bigger size and cheaper price. It didn't taste as good and last as long as Heinz's. I would never buy other brand again simply because it's not worth it. That's the moat.

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198840 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:59 AM
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And where is she getting her 6% return?
...
I assume she means
8bn preferred p+ 4 bn common = 12bn total investment.
9% of 8bn equal 720m
720m of 12bn total investment = 6%


I know. This drives me crazy.
I've seen the same math elsewhere.

It's true that 720m/12.1bn is only 5.95% (5.54% after tax), but that
assumes that the common shares for half of Heinz are worth nothing (!).
Which seems unlikely, as even before leverage somebody else just put
up $4.1bn for the same size stake in the same firm.
The preferred dividends and interest might consume most of this
month's earnings power but it seems unlikely to be like that forever.

As for the warrants, I will boldly make a guess as to what the terms are:
- for 30% of the firm, not for the entire other 50% of the firm
- strike price a fair bit higher than $72.50 ($100?) possibly rising after a few years
or possibly (more likely) tied to future financial performance, like Marmon.
- term at least 10 years.
- maybe also first right of refusal on the other 20% stake

This combo would satisfy several goals.
Higher strike means 3G could get out with a high ROI at some point,
and rising strike with earnings goals would do the same thing over a longer period.
30% higher ownership would allow enough to bring Berkshire's ownership
from 50% to 80% allowing zero-tax upstreaming of dividends some day in the future.
Not 50% as there are comments that 3G will/may stay partner long term.
First right of refusal might provide a path to eventual 100% ownership,
though that probably isn't a particularly important goal once you hit 80%.

Jim

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Author: carl777 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198843 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 12:01 PM
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Many of the comments in this thread point to the elements of this deal that seem to give additional benefit to BRK, over and above the obvious 9% and 50% common stake. Some of these are:
"The leverage – which is very real for all the other parties – is largely illusory for Berkshire."
The terms of the warrants.
First refusal rights.
Maybe more.

However, there is yet-to-be released information that precludes us from doing a reasonably accurate analysis of the deals upsides/downsides for BRK and 3G. I.e.,
The average interest rate of the new and rolled debt?
The conditions under which the Preferred can be called?
The terms of the warrants?

None-the-less, based on what we do know, it looks like this will turn out to be a very good deal for BRK as well as 3G. But not as quickly as the Railroad moved from "lemon" in the mind of some to obvious winner.
The knee-jerk reaction of some, including the first FT editorial, was that WEB paid too high a price for a solid but stodgy-looking company. After all, the argument goes, he is buying into a slow grower at a 20% percent premium to its all-time high--he has clearly lost it.

Not surprisingly, I come to a different conclusion on two counts.

1. Although there are important specifics we do not know about the deal, the points discussed on this board point to the not yet quantified deal attributes, but highly likely to be long-term positives for BRK and for 3G. Even assuming the conservative 6%/year earnings growth without any operational improvements or the above unquantified benefits, it looks like BRK and 3G will do nicely over the long term. I have to believe that many of the unspecified points are to BRK's benefit.

2. More interesting to me is that, unlike most classic BRK deals of buying value and growth on the cheap, the big win for BRK appears to come from the Deal Structure. This portends well for the future deployment of the growing cash pile in an era of pretty fully or richly valued companies. After all, the price results in a nice win for the current shareholders; the creativity in the structure seems to result in a big long-term(5-10 years) win for not only BRK, but of all people, a private-equity partner. This means that the basket of potential deals, and partnerships, that BRK can consider going forward has now grown, maybe considerably, if we assume WEB will continue to turn the "Deal Structure" knob in ways which will help compensate for growth and valuation limitations. This would be a continuation of a trend that started with the GE and GS deals, followed by Bank of America. This is good news for those of us worried about how BRK is going to deploy in a good way its cash piles when market valuations are not so attractive.
Carl

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198844 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 12:10 PM
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As someone has pointed out that the 9% interest from the preferred is at least half self-paying. The actual interest rate should be considered as 4.5%.


I see where this is coming from, but it is wrong - it would only work that way if Berkshire and 3G had symmetrical positions. Yes, Berkshire is a half owner of the equity, so the part of those interest costs that go to the preferred shares will come out of equity earnings, but not out of Berkshire's equity earnings, since they only get half of those. The fact that Berkshire owns all the preferred shares just means that that profit gets divvied up in an unequal way, to Berkshire's advantage.

So for instance if Heinz made $1.5 billion (a little less than their average operating income in the last 4 years), and has to pay, say, 6% on the $12 bn in debt, or $720 million, plus another 9% on the $8 bn in preferreds, or another $720 million, then they would only have about $100 million left to share equally between 3G and Berkshire, or, more likely, to be reinvested in the business.

That would mean that the return to the equity holders would be minimal, unless 3G manages to find some new operating efficiencies (I expect the people in Pittsburgh will be a little worried about all this), or to reinvest that $100 million in profitable ways. But if they did pay out that last $100 mn, the pre-tax returns would be:

*for 3G: $50 million on a $4.12 billion equity investment (about 1% pre-tax, say 0.7% after tax.)

*for Berkshire: $50 million on a $4.12 billion equity investment , plus $720 million on the $8 bn preferred shares, so $770 mn on a total investment of $12.12 bn (6.35% pre-tax). Taxes might be $35 mn on the preferreds (based on 80% exemption as an owner of more than 20%), and $17 mn less on the equity (at 35%), so 5.9%.

What Berkshire gets in interest from the preferred is taken from equity holders, but that just means that HALF of the preferred interest comes at the expense of Berkshire's equity stake, not all of it; the other half comes at the expense of 3G, giving them a powerful incentive to increase profits if they want to get anything decent in the way of return.

I haven't checked all my calculations, and I have ignored the warrants, but the point is that it is better to get special treatment than to be an equal partner, although 3G will still do fine if they can operate Heinz more profitably, getting half of all the earnings beyond interest costs with a much smaller investment of capital. Munger must love the way the incentives are set up, and Buffett must love it that it's not him sending out the pink slips.

Regards, DTM

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198850 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 1:57 PM
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<<I see where this is coming from, but it is wrong >>

The 4.5% interest comes from 3G's earning for its share of HNZ. That's from someone else and it's meaningful. The other 4.5% comes from BRK's own equaty earning and shouldn't count. BRK and 3G certainly don't have equal deal.

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198851 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 2:30 PM
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<<I see where this is coming from, but it is wrong >>

The 4.5% interest comes from 3G's earning for its share of HNZ. That's from someone else and it's meaningful. The other 4.5% comes from BRK's own equaty earning and shouldn't count. BRK and 3G certainly don't have equal deal.



You can do it your way and it still comes out the same.

So if Heinz makes $1.5 bn operating earnings as it has recently, then you could say that 3G and BRK each get $750 mn of that. Now there is also the $720 mn in interest on the debt that has to be paid, so 3G and BRK each cough up $360 mn (Jim cogently argues that this number would be substantially lower, since the debt may end up costing only 3.5-4%, and I may not have the amount right, I said $12 bn and it might be $14bn, but just to keep the same numbers for the sake of comparison...)

So now, 3G and BRK each has $390 mn in operating earnings left. But then, there's the $8 bn in preferred shares, all owned by Berkshire, that need to get another $720 mn. So each side coughs up another $360 mn, TO BERKSHIRE, leaving 3G with $30 mn, but now Berkshire is just paying itself that $360 mn (minus some which we will ignore for the moment, being pre-tax), so that means BRK has $390 mn PLUS 3G's $360 mn, making $750 mn, as before.

I think it is simplest to think of that as being $720 mn for the preferreds (9%), and $30 mn for Berkshire's equity, and $30 mn for 3G's equity. This follows the usual process of working down the capital structure, distributing to each its due.

But if you insist on dividing the preferred interest into two piles, pile A taken from 3G's share of the earnings, and pile B taken from BRK's share, OK, we can do that, but it means going down in a slightly different order, 1-3-2, and we have to start over.

So, this time, we still have $1.5 bn in operating earnings, less $720 mn in interest to other debt-holders (step 1), that leaves $780 mn available for the next tier of capital, the preferreds (step 2), and then the equity (step 3). Ignoring the preferreds for the moment (step 2), if it were not for the preferreds, each side (3G and BRK, i.e. step 3) would get $390. But that $720 mn in interest on the preferreds has to be paid (backing up from step 3 to step 2), and so both equity partners will have to pay it. So 3G will cough up $360 mn to go to pile A of preferreds, while Berkshire will PAY ITSELF $360 mn of its $390 mn by sending it to pile B.

Since the second part of this is just paying from the left pocket to the right pocket, you want it to be considered differently, saying that the total return on the $8bn in preferreds is just $360 mn, or 4.5%. But then, if we are consolidating Berkshire's equity and preferreds, then the return on the Berkshire side doesn't have to be docked $360 mn! In other words, doing it this way, we end up with 3 returns:

*3G equity: still 1% (all numbers pre-tax), since they only get $30 mn on their $4.12 bn investment.
*BRK preferreds: 4.5% (not counting what BRK's equity would have paid them)
*BRK equity: $390 mn, i.e. 9.5% !

The error that you (in good company, with the people at the Financial Times' Lex column) are making, is correctly identifying the one-pocket-to-another aspect of the transaction, but then docking that $360 mn in preferred interest from both the equity side AND from the preferred side. Double counting is bad, but zero counting is also bad.

Regards, DTM

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198852 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 2:57 PM
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<<So if Heinz makes $1.5 bn operating earnings as it has recently, then you could say that 3G and BRK each get $750 mn of that. Now there is also the $720 mn in interest on the debt that has to be paid, so 3G and BRK each cough up $360 mn (Jim cogently argues that this number would be substantially lower, since the debt may end up costing only 3.5-4%, and I may not have the amount right, I said $12 bn and it might be $14bn, but just to keep the same numbers for the sake of comparison...)

So now, 3G and BRK each has $390 mn in operating earnings left. But then, there's the $8 bn in preferred shares, all owned by Berkshire, that need to get another $720 mn. So each side coughs up another $360 mn, TO BERKSHIRE, leaving 3G with $30 mn, but now Berkshire is just paying itself that $360 mn (minus some which we will ignore for the moment, being pre-tax), so that means BRK has $390 mn PLUS 3G's $360 mn, making $750 mn, as before.
>>

Without the $8B preferred, BRK would earn $750m. Now with the $8b preferred, BRK would earn $390+$720m=$1.11b. The difference is $1.11b-$750=$360m. SO BRK receives 0.36/8 = 4.5% interest on the extra $8b preferred it invested.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198853 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 3:03 PM
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<<*3G equity: still 1% (all numbers pre-tax), since they only get $30 mn on their $4.12 bn investment.
*BRK preferreds: 4.5% (not counting what BRK's equity would have paid them)
*BRK equity: $390 mn, i.e. 9.5% !
>>

Actually, we seems to agree that the $8b preferred earns only 4.5% interest. That's my point. The BRK equity earning rate is a different story, because of the LBO, the rate is higher, which would be even more spectacular without the preferred assuming HNZ could borrow $8b more from banks at lower rate than 9%.

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198854 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 3:30 PM
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Without the $8B preferred, BRK would earn $750m. Now with the $8b preferred, BRK would earn $390+$720m=$1.11b. The difference is $1.11b-$750=$360m. SO BRK receives 0.36/8 = 4.5% interest on the extra $8b preferred it invested.


You are doing a better job of stating your case succinctly than me, but I still think my logic is correct. Using the same numbers as above, there are 2 things to say:

(i) Without the $8B preferred, BRK would NOT earn $750m; it would have to replace that $8B by some other kind of capital, either more interest-bearing debt, reducing the $750m, or more equity which diluting BRK's stake.

(ii) With the $8B preferred, BRK earns $720m on its preferred, we agree thus far. But BRK does not get $390m from its equity stake (either you are double counting, or you have not accounted for the interest on the $12B in debt; I can't tell, both numbers are the same). In fact, after paying interest on the debt and interest on the preferred, there is only $1500m - $720m interest - $720m preferred interest = $60 mn left, so $30 mn for 3G and $30 mn for BRK.

So you can either say (simply) that BRK makes $720m on $8B preferred (9%), and $30m on $4.12B equity (1%), OR you could say BRK makes $360m on $8B preferred (4.5%), but then makes $30m + $360m = $390m on $4.12B equity (9.5%). Whether you put that $360m in the first part of the expression or the second, in either case, the total return is $360m + $360m + $30m = $750m, which makes $790m/$12120m = 6.2%. Hey, maybe that's Ms Schroeder's number?!

All these scenarios ignore the tax inefficiency of this arrangement, whereby that $720 mn in preferred interest flows through to BRK only after a tax hit; it is 'only' 20% of the usual 35% top rate because BRK owns more than 20% of the equity, but still. I like the structure of the deal, but sending that 7% ($50m a year) to the US Treasury is a bit galling.

Regards, DTM

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198855 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 3:50 PM
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Think in another way, assuming another entity (e.g., a bank) invested $8b preferred for 9% interest. BRK would lose $360m ($720m/2) in equity earning for the preferred interest. Further assume that BRK owned that third entity which then paid the $720m to BRK. BRK's net book value increase due to the preferred would be $720m-$360m=$360m.

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198857 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 4:26 PM
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Think in another way, assuming another entity (e.g., a bank) invested $8b preferred for 9% interest. BRK would lose $360m ($720m/2) in equity earning for the preferred interest. Further assume that BRK owned that third entity which then paid the $720m to BRK. BRK's net book value increase due to the preferred would be $720m-$360m=$360m.


750 = 30 + (360 + 360) = (30 + 360) + 360

In the first case (my way), $30m for equity (1%), $720m for preferreds (9%).

In the second case (your way), $390m for equity (9.5%), $360m for preferreds not financed by Berkshire itself (4.5%).

In either case, total return (ignoring taxes) is $750m on $12.12B

OR (special extra section for the 1.25 board readers who are not already bored to tears)

If you want to add a third party, the bank that invests $8b for 9% interest, what is their return? Is it not 9%? Isn't it simpler to say that Berkshire, with the same number of the same preferred shares at the same rate, would also get that 9%, but at the expense of its (and 3G's) equity?

Whereas if you do it your way, OK, BRK's preferreds get $360m (4.5%), but now BRK's $4.12b equity gets $390m, whereas 3G's $4.12b equity gets only $30m, although it is the same amount of capital invested in the same kind of equity.

DTM

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Author: EliasFardo Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198862 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 5:10 PM
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As someone has pointed out that the 9% interest from the preferred is at least half self-paying. The actual interest rate should be considered as 4.5%.

I see where this is coming from, but it is wrong


You are correct, Sir. It is wrong.

Below are various ways the deal could have been structured. The first one is the one actually used.

Assume for all calculations: $780 million operating earnings after interest paid. Total return on $16 billion: 4.875%. The preferred receives a $720 million dividend on an $8 billion investment for a return of 9%. The common receives $60 million look through earnings on an $8 billion investment for a return of .0075%.

As you can see, Berkshire’s return in all cases exceeds 4.5%.

(1) Assume $8 billion, 9% dividend preferred owned all by Berkshire and $4 billion of equity from each partner.

Berkshire share of earnings: $720 dividend plus $30 million look through earnings, or $750 million, on total investment of $12 billion. Berkshire return: 6.25%

(2) Assume $8 billion, 9% dividend preferred owned half by each partner and $4 billion of equity from each partner.

Berkshire share of earnings: $360 dividend plus $30 million look through earnings, or $390 million, on total investment of $8 billion. Berkshire return: 4.875%

(3) Assume no preferred and $8 billion of equity from each partner.

Berkshire share of earnings: $390 million look through earnings on total investment of $8 billion. Berkshire return: 4.875%

(4) Assume $4 billion of 9% preferred for Berkshire and $6 billion common equity from each partner.

Berkshire share of earnings: $360 million dividends and $210 million look through earnings, or $570 million, on total investment of $10 billion. Berkshire return: 5.7%

(5) Assume no preferred, $4 billion of equity from 3G and $12 billion of equity from Berkshire.

Berkshire share of earnings: $585 million of look through earnings on total investment of $12 billion. Berkshire return: 4.875%.

Let us take a different assumption. What if earnings after taxes and interest expense were $720 million? After payment of the dividends on the preferred, the common stock has no look through earnings. The Berkshire preferred stock still earns its 9%. How can you say that it is only earning 4.5% when it still receives $720 million on its $8 billion investment?

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198881 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 8:46 PM
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<<Let us take a different assumption. What if earnings after taxes and interest expense were $720 million? After payment of the dividends on the preferred, the common stock has no look through earnings. The Berkshire preferred stock still earns its 9%. How can you say that it is only earning 4.5% when it still receives $720 million on its $8 billion investment? >>

Without the $8b preferred investment, BRK would receive $360m from its equity share of HNZ. Now with the $8b preferred, BRK would receive $720m and nothing else. Tell me what is the difference the $8b earns, $360m or $720m? And if that $8b is invested in company-A's preferred with 4.5% interest rate, BRK would receive $360m from the preferred and $360m from HNZ's earning, total $720m, that's same result as if it's invested in HNZ's preferred. And do you think company-A's preferred retuns interest rate of 9%?

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198884 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 10:00 PM
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<<If you want to add a third party, the bank that invests $8b for 9% interest, what is their return? Is it not 9%? Isn't it simpler to say that Berkshire, with the same number of the same preferred shares at the same rate, would also get that 9%, but at the expense of its (and 3G's) equity?
>>

I see that your argument is conditioned on HNZ having to sell $8b of 9% preferred to somebody, if not BRK, it would be someone else. If a third party gets the 9% preferred, do you think WEB would still agree to the deal, borrowing money at 9% to pay for assets that earn 5%? and if the equity part of the deal is bad, wouldn't it be still bad no matter who owns the preferred? If BRK were to take over 3G's role and own 100% of HNZ, does the 9% preferred make the deal any better? Why don't pose interest rate of 20%? Who care?

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Author: DrtThrwingMonkey Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198887 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/19/2013 11:13 PM
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If a third party gets the 9% preferred, do you think WEB would still agree to the deal, borrowing money at 9% to pay for assets that earn 5%?

No, I am just saying the preferred get 9%, not 4.5%. I agree that they reduce the earnings on the equity, but the crucial point is that that is not all at the expense of Berkshire's equity, it is also at the expense of 3G's equity.


... and if the equity part of the deal is bad, wouldn't it be still bad no matter who owns the preferred?

The equity deal must be not so bad, because that is all 3G is getting, right? They must think it is good for them, perhaps because they think they can substantially increase the operating earnings. And if they are right, then it will also be good for Berkshire, since it is the same deal, on the equity side. In fact, Berkshire's deal is even a little better than that, because it includes warrants, although we don't know anything about them yet, AFAIK.


If BRK were to take over 3G's role and own 100% of HNZ, does the 9% preferred make the deal any better? Why don't pose interest rate of 20%? Who care?

That is correct. In that case, the rich preferred interest would be coming entirely out of Berkshire's equity, and we would be indifferent about the rate. In fact, it would be meaningless to even have preferred shares, in that case. It would be like inventing preferred shares in See's, and paying oneself interest out of one's own earnings. At least there would be no tax hit, though.

regards, DTM

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Author: knighttof3 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198891 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 3:19 AM
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This deal is too much in favor of Berkshire while 3G does all the real work. I wonder why Lemann accepted it on these terms at all, I wouldn't have. Would it really have been impossible without Buffett? Something stinks. It has to be riskier than it appears (not just financially as an LBO but operationally as well.)

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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198892 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 6:15 AM
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This deal is too much in favor of Berkshire while 3G does all the real work. I wonder why Lemann accepted it on these terms at all, I wouldn't have

In addition to benefitting from appreciation of their equity, I've assumed that 3G will draw management advisory fees for their "active role" in optimizing the business. But I cannot verify that this is the case.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198894 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 7:52 AM
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<<No, I am just saying the preferred get 9%, not 4.5%. I agree that they reduce the earnings on the equity, but the crucial point is that that is not all at the expense of Berkshire's equity, it is also at the expense of 3G's equity.
>>

That has been my point all along. Half of the 9% comes from BRK's own equity earning and shouldn't count. Only the other half of 9% is meaningful.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198895 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 8:05 AM
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<<This deal is too much in favor of Berkshire while 3G does all the real work. I wonder why Lemann accepted it on these terms at all, I wouldn't have. Would it really have been impossible without Buffett? Something stinks. It has to be riskier than it appears (not just financially as an LBO but operationally as well.)
>>

It doesn't look so great for BRK too, it's definitely worse for 3G. I think there're two main reasons they do it: 1. borrowing money from bank at historical low rate (less than HNZ's earning rate anyway and possibily some tax benefit because the interest payment is before tax) to lessen the cost; 2. belief that HNZ could grow much faster ahead in international market, especially now that it's private and can focus on long term. For 3G, there could be other reason: partnership with WEB boost their credibility and fames and attract more investments.

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Author: plusev8 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198897 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 10:37 AM
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[That has been my point all along. Half of the 9% comes from BRK's own equity earning and shouldn't count. Only the other half of 9% is meaningful.]

The return on preferred is still 9%.

The reason that might be still confusing to many people, me included initially, is because we first thought it is like shifting money from left pocket to right pocket.

But this thinking is wrong. There is no left pocket to begin with. The money to fill the 8B gap has to come from somewhere.

If we insist that WB and 3G add additional 4B each to avoid issuing preferred shares, then the "left pocket" is already changed, and can not be used to compare to right pocket on equal footing.

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Author: bigshan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198898 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 10:48 AM
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<<But this thinking is wrong. There is no left pocket to begin with. The money to fill the 8B gap has to come from somewhere.
>>

So what pocket do you think the 9% interest of the preferred come from? Does it all come from 3G' pocket?

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Author: plusev8 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198899 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 10:58 AM
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[So what pocket do you think the 9% interest of the preferred come from? Does it all come from 3G' pocket?]

No, it is from the 3rd party who would have provided the 8B in replace of WB.

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Author: plusev8 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198909 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/20/2013 12:59 PM
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[So what pocket do you think the 9% interest of the preferred come from? Does it all come from 3G' pocket?]

Perhaps you are right that since WB will own both equity and preferred, so it does cloud his preferred earning rate somewhat. Whether it is 9% or 4.5%, it is just looking at the same thing from different angles. To really compare apple to apple though, we need to compare the returns on same total amount invested.

Assuming 3G does not want to invest more than 4B, so the left pocket case is #5 from EliasFardo post, and right pocket case is current deal #1. In both cases, WB invests 12B. The return based on current earning is 4.875% of #5 to 6.25% of #1. Obviously #1 is better deal. We are still not sure what real return of 8B preferred should be, but it is not important any more.

Now, the interesting question is why 3G chose #1 instead of #5. My guess is that they have no choice because WB wants it. Another guess is 3G strongly believes that the private company will generate much higher earning rate in future, which will dwarf the 9% that WB gets.

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Author: susan400 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 199029 of 212871
Subject: Re: FT: Buffett brand has more beans than Heinz Date: 2/23/2013 3:25 PM
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A view, "3G" from Brazil, who? Even though respected, there is no what a HEINZ would hoist that on middle american shareholders, thus BW gets a superior deal for making it "legit.

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