• 14 Feb 2013 at 6:42 PM

Warren Buffett Levers His Own LBO

The new hotness appears to be large cash-rich companies directly providing subordinated financing for big LBOs. Microsoft bound itself to Dell via sub debt in its LBO, and now Warren Buffett’s Berkshire Hathaway is doing a very odd LBO of H.J. Heinz with Brazilian private equity firm 3G Capital. Heinz’s announcement of the merger is brief and dull, but Buffett has filed his commitment letter and disclosed that he will “invest $12.12 billion to acquire a package of equity securities consisting of preferred and common stock and warrants issued by Holding. The preferred stock will have a liquidation preference of $8 billion, will pay or accrue a 9% dividend, and will be redeemable at the request of Holding or Berkshire in certain circumstances.” So he’s providing $4bn of common equity and $8bn of preferred leverage. The remaining $11-ish billion of the $23-ish billion purchase price will come from 3G (equity) and from a JPM/WFC-led debt financing.

There’s a basic tactical explanation for the structure, which is that it solves for this equation:

  • Berkshire is an unlevered1 equity investor,
  • 3G is an LBO shop,
  • it’s 3G’s deal – they sourced it, they’ll operate it, they did the press conference – so 3G needs to own more than 50% of the equity,2
  • but they’re not gonna put up, like, $12 billion in equity.

So basically Buffett brings half the money and 3G brings half the money; their money is some equity and some traditional LBO debt, while Buffett’s is some equity and some traditional Buffetty high-coupon preferred. And warrants. Always warrants.

The result is that this ends up a pretty heavily levered buyout; LTM EBITDA is just over $2bn, there’s $5bn of debt now, and DealBook says that could rise to $10bn. Add $8bn of pref and you’re 9x levered through the pref, versus under 6x for the average 2012 LBO.3 I see Heinz 5-year CDS moving from low 40s yesterday to high 170s today, with the 10-year at like 255.4

The theme of companies with piles of cash deciding to play in subordinated high-yield fixed-income securities is odd on the surface, but makes a lot of sense. If you’re managing Microsoft’s or Berkshire’s cash, what can you do? Banks are terrifying, and in the capital markets yields are low covenants are lite. Subordinated fixed-income investments in companies you know well – and, in the case of Heinz, where you’re also investing in the common – provide yield and let you monitor your investment closely. Which in turn might let you stretch a bit more on the leverage you’re willing to provide – and might make the buyers of the senior debt a bit more comfortable that it’ll get paid back. Why wouldn’t you want to disintermediate banks and bond markets this way?5

Berkshire and 3G Capital to Buy Heinz for $23 Billion [DealBook]
Weighing Down Heinz With Debt [DealBook]
H.J. Heinz Company Enters Into Agreement to Be Acquired by Berkshire Hathaway and 3G Capital [EDGAR]
Berkshire Hathaway 8-K [EDGAR]

1. Except insurance float ha ha ha whatever.

2. When I say “equity,” in my life, I mean common equity. Pref is fixed income; it’s, like, very junior debt. Thus when DealBook says:

After the deal, Heinz could have well over $10 billion of debt, compared to $5 billion now. … In addition to common equity, Berkshire is getting $8 billion of preferred shares.

It sounds weird to me, though it’s perfectly correct. Like, that’s in your fixed charge coverage, man.

3. Also the pref pays $720mm a year, which is, like, half of your operating cash flow? That seems like a lot? It will “pay or accrue” a 9% dividend, which sounds pretty PIK-y? But it’s Warren Buffett, doesn’t he like cash? On balance I’m guessing that it’s not paying cash for a couple of years.

4. Which makes the 9% pref rate still seem pretty high? But, I dunno, it’s Warren Buffett. And who else is gonna lever you 9x on a $28 billion company? (And let you PIK it for a while?)

5. I suspect that the investment banking fees on Buffett’s $8bn of pref will be a lot less – i.e. zero-ish – than the fees on the ~$5bn of senior debt that the Heinz buyers will have to raise, which is also nice. Not for the banks.

7 comments (hidden to protect delicate sensibilities)
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Comments (7)

  1. Posted by CheeseHungryRat | February 14, 2013 at 7:47 PM

    In other words, investment bankers who used to take cheese out of every burger are not even getting a sachet of ketchup?

  2. Posted by Wire | February 15, 2013 at 3:37 AM

    "It will 'pay or accrue' a 9% dividend, which sounds pretty PIK-y?"

    I just read this as Buffett's getting cumulative preferred. I don't think it's PIK.

  3. Posted by Not the middle man | February 15, 2013 at 4:03 PM

    Points for using "disintermediate."

  4. Posted by 17 y/o stockbroker | February 15, 2013 at 8:04 PM

    pay or accrue = cumulative pref stock, not PIK toggle

    series 79 ftw

  5. Posted by Doug | February 15, 2013 at 9:13 PM

    It's not exactly like Heinz is a cheap stock, that value investors like Warren Buffett should love. Even when you back out its cash and generously half its receivables its still trading at 17 P/E and 7.7 P/B. It had some growth last year, around 8%, but before that not much.

    Why buy this, when you can get Apple, which has a hell of a lot more growth, at a 10 P/E with a decent dividend. It's not like capacity is an issue, Berkshire could dump $12 billion into AAPL over a few months and hardly budge the stock.

  6. Posted by Wire | February 16, 2013 at 8:34 AM

    Thanks, but you could have just given me a thumbs up instead of writing it all out.

  7. Posted by Guest | April 5, 2013 at 5:41 AM

    The $720? Yea, its a lot.

    The way I see it — Buffett puts up 1/2 the cash for 'equity' — a special equity — that gets ALL the dividends. Plus another $60. HNZ is paying $660 in dividends now.

    The $5 billion in senior debt should be refied @ less than the current rate.

    The remaining $8 billion? I dunno, but there will never be better market conditions to raise it than right now.

    Meanwhile, 3G will be their usual aggressive selves and cut some big $'s out of costs. Plus sell off non core stuff. &c.

    The entire deal is to get 1.5 billion Chinese into a heavy Ketchup habit.

    Per Gladwell — http://www.gladwell.com/2004/2004_09_06_a_ketchup

    Otherwise it is just another big food company.

    The margins are better in Ketchup.

    Soup? Not so much.

    So …. Buffett gets 1/2 the equity. All the dividends. And warrants.

    Sounds about right.