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.