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Archive for February 21st, 2013

Heinz Follow-up

Thursday, February 21st, 2013

I’ll keep trying until I get it right.  Aside from the terms of the warrants, most of the deal terms are known in terms of quantities, if not prices.  What I present benefits considerably from a comment I received.  Here it is:

Good analysis, though I think we know a bit more about how the debt portion will work than you imply. It appears to be very standard LBO mechanics: The sponsors (BRK and 3G) set up an acquisition vehicle, which drops down a shell subsidiary (Merger Sub), which, at closing, merges with Heinz, leaving Heinz behind as the surviving entity. This allows BRK and 3G to own and control the acquisition vehicle (referred to in the Merger Agreement as “Parent”), which will be a passive holding company, and Heinz will be below it.

The new debt raised by WFC and JPM will be primarily at this holding company level, though presumably the bank loans and revolving loan will be fully secured by Heinz’s subsidiaries and their assets, while new high-yield notes would be unsecured. From the 8-K with the Merger Agreement:

“J.P. Morgan and Wells Fargo have committed to provide $14.1 billion of new debt financing for the transaction, consisting of $8.5 billion of USD senior secured term loan B-1 and B-2 facilities, $2.0 billion of Euro/ British Pounds senior secured term loan B-1 and B-2 facilities, a $1.5 billion senior secured revolving facility and a $2.1 billion second lien bridge loan facility. The obligation of J.P. Morgan and Wells Fargo to provide this debt financing is subject to a number of customary conditions, including, without limitation, execution and delivery of certain definitive documentation. The final termination date for the debt commitment is November 13, 2013. Additionally, Parent also intends to roll over certain of the Company’s current outstanding indebtedness that is not subject to acceleration upon a change of control and that either does not contain change of control repurchase obligations or where the holders do not elect to have such indebtedness repurchased in a change of control offer. ”

http://www.sec.gov/Archives/edgar/data/46640/000095010313001110/dp36304_8k.htm

Note that the reference to a bridge loan is common in these deals, but my expectation — consistent with past practice — is that while there is a committed bridge there is no actual intention to fund a bridge loan to the acquisition vehicle (Parent), and instead the idea is to market high-yield notes. But the committed bridge is there so BRK and 3G can close the acquisition, as in this agreement, consistent with market practice, there is no condition that the financing from the banks actually be in hand (a “financing out”), and, according to the disclosure, the banks’ conditions have been tied to the acquisition conditions — there won’t (or shouldn’t be) be situations where they can refuse to fund but 3G and BRK are still obligated to close. You can see Section 7.13 of the Merger Agreement to see some of the obligations of Heinz to prepare financials and market the debt (very common in LBO deals). So I think we can fairly safely say that the new debt belongs to Heinz, not 3G and BRK. There won’t be any support from the investors.

Note also that the above is why I am unsure about your calculations above about the “new debt” are slightly off — though I could be wrong and I welcome any correction. At least some portion of the new debt will be used to simply refinance the old debt (see Section 7.13(b)(ix) of the Merger Agreement, which requires Heinz to obtain payoff letters of its existing bank debt), though some Heinz debt will roll. But this would still mean that new debt would be more in line with $14bn, not $7bn.

That said, maybe the best way to think of this would be a pro forma cap table for the acquired company, showing what the total debt of the acquired Heinz would be.

In that case I still think you come out with an even more leveraged picture than you have above, though I think all of your points about BRK’s upside remain. And it also highlights to me another benefit BRK got from this, which was 3G’s expertise in packaging and structuring this deal, which is designed as essentially a regular way LBO. The only unique aspect is the 50/50 common equity ownership of the acquired entity (though PE shops do “club” sometimes) and BRK’s “mezzanine” financing of preferred and warrants, though I’ve seen sponsors do “sponsor loans” to fund acquisitions when they have extra cash and charge even more than 9%.

Final note on the warrants: It’s not clear that Berkshire would get control of the new entity even if they exercise the warrants. Buffett on CNBC repeated that 3G would have “day-to-day control,” despite the 50/50 equity ownership. This tells me that 3G has been given operational control regardless of the equity stake in the joint venture/LLC Agreement, and we simply don’t know if the exercise of warrants even given Berkshire greater than 50% equity ownership would change that. It might, but it might not. It’s very common in real estate deals for one party to put up 70-90% of the equity but cede day-to-day control to a minority partner, who, after satisfaction of a hurdle rate, takes a big commission or even splits the economics 50/50 for “finding and executing” a deal. Buffett undoubtedly has lots of experience in these kinds of structures and this one is tailored to this particular situation.

Hopefully these are helpful comments. I am a big fan of your blog.

PS — One correction to [what I said above]. I mistakenly said the bonds would likely be unsecured; given that the committed bridge loan is going to be second-lien secured, I’d expect the bonds to be second-lien secured bonds as well. This actually further supports the notion that this is a very leveraged transaction — the bond market is “hot” right now, so the idea that this deal needs secured bonds implies that the guys on JPM’s and WFC’s high yield desk already view this as a very leveraged deal.

I’m not sure how I could have missed that one filing at the SEC that listed the deal terms for debt.  As it is, I decided to sit down and calculate out what the balance sheet of Heinz might look like post-deal.  Here’s what it looks like as of the last 10Q:

Amount ($B)

Amount ($B)

Cash

                 1.01

ST Debt and LT Debt <1 yr

                    0.92

Other Current Assets

                 2.89

Other Current Liabilities

                    2.38

Long-term Debt

                    4.12

Total property, plant and equipment, net

                 2.44

Other non-current liabilities

                    1.55

 Intangibles & other noncurrent assets

                 5.57

Total Liabilities

                    8.97

Common Equity (mostly)

                    2.94

Total Assets

               11.91

Total Liabilities & Common Equity

                 11.91

 

That leaves a tangible net worth of negative $2.63B.  Given that they are paying $23.4B or so for Heinz, that means Intangibles & other noncurrent assets will be $26.1B.  Now here’s what the balance sheet would look like if none of the existing debt is refinanced:

 Amount ($B)

 Amount ($B)

 Cash

                 7.93

 ST Debt and LT Debt <1 yr

                    0.92

 Other Current Assets

                 2.89

 Other Current Liabilities

                    2.38

Senior Secured Bank Loans

                 10.50

Senior Secured Revolver

                    1.50

Second-lien bank bridge loan

                    2.10

 Long-term Debt (mostly usec’d)

                    4.12

 Other non-current liabilities

                    1.55

 Total property, plant and equipment, net

                 2.44

 Total Liabilities

                 23.07

 Intangibles & other noncurrent assets

               26.05

Preferred stock

                    8.00

 Common Equity

                    8.24

 Total Assets

               39.31

 Total Liabilities & Common Equity

                 39.31

 

And here is what it looks like if the debt is refinanced in entire:

 Amount ($B)

 Amount ($B)

 Cash

                 2.89

 ST Debt and LT Debt <1 yr

 Other Current Assets

                 2.89

 Other Current Liabilities

                    2.38

Senior Secured Bank Loans

                 10.50

Senior Secured Revolver

                    1.50

Second-lien bank bridge loan

                    2.10

 Long-term Debt (mostly usec’d)

 Other non-current liabilities

                    1.55

 Total property, plant and equipment, net

                 2.44

 Total Liabilities

                 18.03

 Intangibles & other noncurrent assets

               26.05

Preferred stock

                    8.00

 Common Equity

                    8.24

 Total Assets

               34.27

 Total Liabilities & Common Equity

                 34.27

 

In this latter scenario, I wonder what assets back the pledge for securing the bank debt.  There are not enough tangible assets to do so.  That said, I know that the real value of Heinz resides in its brands, not its tangible assets.

After the deal completes, Heinz will not produce a lot of profits for the common stockholders, because Buffett’s preferred stock and the additional debt will eat up most of the gross profits.  3G will have an incentive to increase the gross profits as a result, or else their $4B investment will not be worth much.

This is an aggressive deal.  Much as I think Buffett got the better deal vs 3G, it is by no means certain that increasing profits at Heinz will be easy.  10 years out, this will be a case study for many business schools.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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