The collapse in the price of Kraft Heinz (NYSE:KHC) following its disastrous quarterly results brought down the wrath of the media on Warren Buffett and Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B).
But Buffett didn’t run Kraft Heinz off the rails. He just made a bad investment.
Buffett, who is a numbers man and not an operator, simply said he overpaid, thinking that using $7 billion in tangible assets to bring in $6 billion in pretax profit made for a bargain. In fact the tangible assets had cost various corporate buyers $100 billion, meaning they needed to bring in $107 billion.
Buffett also admitted he’s stuck. Berkshire’s stake in Kraft Heinz is so enormous, almost 27% of the common, that it can’t be easily disposed of without collapsing the shares entirely. When you owe the bank enough, you own the bank.
What Happened With KHC Stock
The people who deserve criticism here are 3G Capital. Specifically the villain is Bernardo Hees, the 3G partner who was put in charge of the company.
Hees blindsided Buffett and other shareholders with a $15.4 billion asset write down, a 36% cut in the dividend, and the announcement of an SEC investigation against the company. This resulted in a 27% one-day collapse for the stock, and Berkshire writing down its own investment by $3 billion. Berkshire common lost nearly 2% in the disaster.
The 3G way is simple. They buy known brand quantities, institute cost-cutting through “zero-based budgeting,” then secure the profits and either buy more brands or distribute them to shareholders.
This worked great with beer and 3G’s big win with AB InBev (NYSE:BUD). In beer, production is close to uniform, cutting distribution costs goes straight to the bottom line, and the marketing and back-office operations are synergistic.
It may even work well in fast food, where 3G’s Restaurant Brands International (NYSE:QSR) — which now owns Tim Horton’s, Burger King and Popeye’s — has become a dividend stalwart, raising the pay-out from 9 cents to 50 cents per quarter over five years, while rising 51%, in-line with the Nasdaq average.
But packaged food is different. You need to pay attention to changing consumer tastes, and invent new brands, not just extend old ones. Hees admitted that his strategy was based on cutting costs. The SEC investigation in KHC stock, meanwhile, covers how it accounts for costs in its supply chain. Specifically, the agency is looking at agreements, side-agreements and changes in agreements with its vendors.
Buffett was able to buy Heinz, and 3G was able to buy Kraft, then put the two together to make KHC stock, because brands like Oscar Meyer hot dogs, Kraft Macaroni and Cheese, Jell-O and Kool-Aid were already seen as stale and low growth.
Management’s first reaction is to consider selling one of those stale brands, Maxwell House coffee, which still brings in $400 million of earnings before interest, taxes, depreciation and amortization — the EBITDA so beloved of takeover artists. They think they can get $3 billion for it, based on the $8 billion KKR & Co. (NYSE:KKR) paid for I Can’t Believe It’s Not Butter and other spreads last year.
The Bottom Line for Kraft Heinz
Kraft Heinz’ problems are intrinsic and pre-date the entry of either Buffett or 3G Capital into the company. But they are the kinds of problems that demand new investment, not cost cutting.
Maybe, if the economy were collapsing instead of continuing to expand, low-priced mac and cheese with ketchup and baloney might look appetizing. But we, the consumers of America, want something else, something fresher than microwaved pasta, and we are willing to pay for it. That leaves KHC stock stuck.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in QSR.