Sunday, February 17, 2013

Unusual Heinz Acquisition May Have Reaped $2 Million in Illegal Profits

Heinz Ketchup Dress Costume
Warren Buffett is in the news again; this time with plans to acquire H.J. Heinz Company, maker of Heinz ketchup as well as a number of other well-known food products. This acquisition, however, is unlike many of Buffett's past purchases. This time Buffett's Berkshire Hathaway is not going it alone. In acquiring Heinz, Berkshire is teaming up with 3G Capital. Berkshire and 3G will each put in $4 billion in cash. Berkshire will put in another $8 billion for 9% preferred stock. The remainder of the deal will be finance with debt, bringing the total value (including Heinz's existing debt) to $28 billion.

The preferred stock portion of the deal is typical Berkshire. The company often uses this security to give it a generous and stable return. However, the fact that Berkshire is not going it alone suggests that Buffett was more interested in establishing a relationship with 3G than he was in acquiring the target itself. Buffett was even quoted as saying that "Heinz will be 3G's baby," implying that Berkshire will take a hands-off approach to managing Heinz.

While Heinz has great brand names and the kind of "mote" Buffett loves, the company's balance sheet is not as healthy as one might expect. For example, it has $5 billion of debt. It also has $4.6 billion of goodwill and other intangible assets and only $2.9 billion of total equity. In other words, tangible book value is negative. Frankly, it is difficult to argue that Berkshire and 3G are getting a bargain. In fact, Heinz shareholders, who must vote to approve the deal, should be thanking their lucky stars that this offer came through.

Apparently, Heinz, Berkshire, and 3G all took great pains to keep the deal secret. They used a code word for Heinz and their executives refrained from meeting with one another in Pittsburgh where Heinz's headquarters are located. However, that did not prevent word from leaking out. The SEC noticed a surge in the purchase of out-of-the money call options on Heinz shortly before the deal was announced. The trade, which appears to have been executed out of Switzerland, reaped a profit of close to $2 million. The SEC has sued to freeze that Zurich account, which appears to belong to a client of Goldman Sachs. When all is said and done, the insider trading angle of the Heinz acquisition may be more interesting than the acquisition itself.

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