Business Briefing | Company News: Berkshire Reports 29% Jump in Quarterly Profit

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Deal Professor: With His Magic Touch, Buffett May Be Irreplaceable for Berkshire

Harry Campbell

Acquisitions usually come with a nice premium for the seller. But when Warren E. Buffett is the buyer, there is typically something of a discount.

The ability to make acquisitions on favorable terms is a testament to Mr. Buffett’s personality and skills as a deal maker. It also highlights an almost unsolvable problem for his company, Berkshire Hathaway, and its shareholders. When its 82-year-old chief executive is gone, who will negotiate such sweet deals?

A case in point is the $28 billion buyout of the H.J. Heinz Company by Berkshire Hathaway and a partner, the investment firm 3G Capital. The deal, announced in February, is expected to be completed by the end of the summer.

Heinz had three investment bankers to advise it: Centerview Partners, Bank of America Merrill Lynch and Moelis & Company. Going through Heinz’s disclosure of the bankers’ analysis, it is pretty clear that Berkshire and 3G did not pay top dollar.

Berkshire Hathaway and 3G are paying a 19.1 percent premium over the closing price of Heinz shares the day before the acquisition was announced. This is below the average premium of 31 percent in the industry that Heinz’s own investment banking firm Centerview Partners used to determine the fairness of the transaction.

The two buyers are also paying a multiple of 11.9 times the last 12 months of Heinz’s earnings before interest, taxes, depreciation and amortization, or Ebitda. This compares with a range of 8.8 to 15.6 times, the ratio paid in comparable acquisitions of food companies disclosed by Bank of America Merrill Lynch.

The bottom line is that the bankers’ disclosure shows that the amount that 3G and Berkshire paid was below that of many other deals in the food industry.

The two buyers did not pay top dollar, but they did pay a fair price for Heinz and are certainly not paying as low a multiple as in other deals, like Kohlberg Kravis Roberts’s $5.3 billion acquisition of Del Monte Foods in 2010, which had a multiple of almost nine times.

Where it gets really tasty, though, are the terms that Berkshire negotiated for its own investment. In addition to putting up half the equity with 3G, or $4.12 billion each, Berkshire made an $8 billion investment for preferred stock.

And boy, is that preferred stock investment on good terms. It pays 9 percent interest, and has a redemption feature at “at a significant premium price,” according to Mr. Buffett.

This gives real downside protection to Berkshire for the investment. Not only that, but in exchange for the preferred investment, Berkshire was also issued warrants to buy 5 percent of Heinz for a “nominal” price, or in other words, pennies.

Mr. Buffett is getting 55 percent of Heinz plus an interest payment of $700 million a year. This is an extraordinarily good deal.

To see why, you need only to look at the terms of the rest of the financing. Heinz is taking on $14.1 billion in additional debt to help finance this deal. The debt takes several forms, and one part of it is $3.1 billion of high-yield notes at a 4.25 percent interest rate.

This yield is extraordinarily low, given that high-yield debt is ordinarily in the double digits. But this is no ordinary time, and despite the low yield, the issue was more than three times oversubscribed.

In this light, the relatively high 9 percent payment on the preferred stock investment plus its bonus features seem out of whack. 3G could have found cheaper financing by a few percentage points lower than it will pay on the preferred investment, even though Heinz will be laden with debt. The higher rate on the preferred investment will translate into a couple hundred million dollars more each year for Berkshire Hathaway.

As for Berkshire, it just sold five-year debt yielding a measly 1.3 percent. Basically, Berkshire’s financing costs for its preferred investment are most likely around 1 percent, meaning that it is earning in the double digits on the preferred investment. Then there is the upside on the $4 billion equity investment.

The Heinz deal aptly illustrates the huge issue looming for Berkshire shareholders. Simply put, Mr. Buffett negotiated a deal almost no one else on the planet could have received.

If this deal was better for Berkshire than 3G, you may ask why 3G would agree to it. I suspect that it is really paying to be associated with the Oracle of Omaha and his magic. Mr. Buffett has a unique ability to not only score a low acquisition price, but he can scare off competitors and attract other investors. Boards of target companies also appear to run into his grasp.

Heinz is again a good example. According to Heinz, 3G and Berkshire Hathaway made a first bid at $70 a share and then after one round of bargaining raised their bid to a best and final offer of $72.50 a share. That was it. Heinz accepted the bid without speaking to any other parties.

The reason that Heinz gave for failing to look for other bidders was that its investment bankers informed the Heinz board that “strategic acquirers” were unlikely.

Moreover, these bankers also told the board that if Heinz did solicit “alternative acquisition proposals,” 3G and Berkshire Hathaway were likely to withdraw their proposal.

In other words, Heinz’s board decided to deal only with Berkshire. And when Heinz requested the chance to solicit other bidders after announcement of the deal, through a so-called go-shop period, Berkshire and 3G said no.

Heinz and 3G declined to comment on the deal. Berkshire did not respond to a request for comment.

The Heinz board’s quick acquiescence is not unusual for Buffett deals. In Berkshire’s $9 billion acquisition of Lubrizol and $26.5 billion acquisition of Burlington Northern, neither board appeared to negotiate particularly hard. In Lubrizol’s case, its board accepted Mr. Buffett’s first bid of $135 a share. In Burlington Northern’s case, the board accepted Mr. Buffett’s first bid of $100 a share after he said that was all he could pay. The Heinz shareholders are lucky their board held out for at least one raise.

When it comes to Mr. Buffett, boards roll over. According to a draft paper by Shane Corwin, Matt Cain and myself, the median number of bidding rounds in public deals from 2006 to 2011 was four, and only 16 percent of bidders made a best and final offer.

Mr. Buffett is thus an outlier in that he will not raise a bid significantly from his first or contemplate target companies speaking to other possible buyers. But unlike other bidders, boards do not push back with Mr. Buffett.

Only someone with his magic touch could do this. Boards, buyers and everyone else want to be associated with Mr. Buffett. This is perhaps why he was also able to work his magic on 3G, getting a financing co-partner deal that others couldn’t.

As for competing bidders, they too appear to be unwilling to challenge him. In Heinz’s case, Mr. Buffett not only got a better deal with his partner, he may have saved a few dollars a share in the total price paid. It all adds up over time.

Heinz’s shareholders don’t appear to be complaining about the possible loss of a few dollars a share. Happy to get a premium, they approved the deal, a transaction recommended by the proxy advisory services.

The question really is what happens once Mr. Buffett isn’t around. Berkshire will still be a gigantic company with a lot of cash, but there are other companies out there of the same ilk. It all means that unless Berkshire can find another Warren Buffett, it may find its returns just aren’t as good.

Even though Mr. Buffett has hired and groomed other executives, he is a true star, and he cannot just create or transmit those qualities, which are the very ones that get those great deals. Unfortunately, there is only one Oracle of Omaha.

DealBook: Berkshire Hathaway’s 2013 Shareholder Meeting

We’re back from lunch, and Mr. Kass leads off with a question about whether Mr. Buffett’s intensity has waned over the years. He specifically cites the weeks of work that Berkshire put into research American Express at the time of its first investment, versus the quick decision-making that went into its move into Bank of America. (Mr. Buffett famously hit upon the latter idea while in the bathtub.)

“Are you at the point now where the game interests you more than the score?” Mr. Kass asks.

Mr. Buffett responds that he still finds running Berkshire the most interesting thing he could possibly do.

“I have every bit of the intensity, though it’s not manifested in the same way,” he says. “I love thinking about Berkshire, about its investments, about its businesses. It’s a part of me.”

Mr. Munger interjects that Berkshire needed to do an enormous amount of analysis for its first investment in American Express, since the company was unfamiliar at the time. When it made a subsequent investment, Mr. Buffett had already amassed a wealth of knowledge.

“It was all cumulative,” Mr. Munger said.

Responding to a later question, Mr. Buffett comes back to the Bank of America decision. “The bathtub wasn’t the most important part,” he jokes.

Berkshire Hathaway Profit Rises 51%

Results beat expectations, and were released after Berkshire shares earlier in the day closed at a record high. On Saturday, Warren E. Buffett, the company’s chairman, and Charlie Munger, the vice chairman, will field shareholder questions at the company’s annual meeting in its hometown, Omaha.

Net income increased to $4.89 billion, or $2,977 per Class A share, from $3.25 billion, or $1,966 a share, a year earlier. Operating profit increased 42 percent to $3.78 billion, or $2,302 a share, from $2.67 billion, or $1,615 a share.

Revenue rose 15 percent from a year ago to $43.87 billion.

Analysts on average expected profit of $1,996 a share, according to Thomson Reuters.

Book value a share, Mr. Buffett’s preferred measure of growth, increased 5.5 percent from year end to $120,525 per Class A share, and Berkshire’s cash stake grew over that period to $49.09 billion from $46.99 billion.

About $12 billion of cash is being used to finance a purchase by Berkshire and Brazil’s 3G Capital of the ketchup maker H. J. Heinz.

Operating profit from insurance operations, including the Geico car insurance and General Re reinsurance businesses, doubled to $1.7 billion from $845 million.

Nearly all of the improvement came from underwriting, where profit rose to $901 million from $54 million, in part because of a $255 million pretax gain in its reinsurance business.

Operating profit from noninsurance business rose 12 percent to $2.25 billion from $2 billion.

Berkshire owns more than 80 business units that sell things like athletic apparel, chemicals, furniture and ice cream. It also owns tens of billions of dollars of common stocks like Coca-Cola, International Business Machines and Wells Fargo.

In trading on Friday, Berkshire Class A shares closed up $2,047, or 1.2 percent, at $162,904. Its Class B shares closed up $1.34, or 1.2 percent, at $108.64.

DealBook: Berkshire Hathaway to Acquire the Rest of IMC for $2 Billion

Kim Kyung-Hoon/ReutersWarren Buffett, left, with Eitan Wertheimer, the chairman of IMC, in 2011.

Berkshire Hathaway has agreed to buy the 20 percent of the IMC International Metalworking Companies that it does not already own for $2.05 billion, giving it full control of the company.

The deal was announced on Wednesday, just days before Berkshire holds its annual shareholder meeting, where Warren E. Buffett is expected to tell investors that he remains on the hunt for big deals.

It is the second big acquisition by Mr. Buffett’s company this year, following the blockbuster $23 billion takeover of H.J. Heinz by Berkshire and 3G Capital.

By buying the rest of IMC, an Israeli tool maker, from its founding Wertheimer family, Mr. Buffett is completing an acquisition that he began seven years ago. Berkshire’s initial purchase of an 80 percent stake for $5 billion was one of the largest takeovers of an Israeli company in that country’s history.

In a statement, Mr. Buffett attributed the 64 percent rise in IMC’s valuation over the seven years to the tool maker’s enormous growth.

“Since the time IMC entered our lives, my partner, Charlie Munger, and I have enjoyed Berkshire’s association with the company, the Wertheimer family, and the company’s management team,” Mr. Buffett said in a statement. “We look forward to continuing our stewardship of this unique company founded by the Wertheimer family in Israel 60 years ago and nurtured into a truly global enterprise.”

Berkshire was advised by its usual law firm, Munger, Tolles & Olson. The Wertheimers were counseled by Wachtell, Lipton, Rosen & Katz.

DealBook: Berkshire to Buy Oriental Trading Company

8:10 p.m. | Updated

With the holidays approaching, Warren E. Buffett has found a way to stock up on elf hats and reindeer paper plates: by buying an 80-year-old retailer overflowing with them.

On Friday, Mr. Buffett’s company, Berkshire Hathaway, agreed to buy the Oriental Trading Company, acquiring a catalog-based arts-and-crafts company whose wares include Santa doorknob kits and a color-your-own Christmas photo holder. Berkshire paid about $500 million, according to people briefed on the matter.

“Oriental Trading is a leader in its industry, has a strong management team and delivers exceptional customer value and service,” Mr. Buffett said in a statement. “We are delighted to have them join the Berkshire Hathaway family and continue their quest to make the world more fun.”

The deal signals the end to a series of ownership changes for Oriental Trading, which has been passed among private equity firms and retooled under bankruptcy protection. Its current owners include Kohlberg Kravis Roberts, which took a big stake in it during the Chapter 11 process.

Oriental Trading was founded in 1932 by Harry Watanabe, a Japanese immigrant in Omaha who found a profitable niche in selling Kewpie dolls and other trinkets through local stores and carnivals.

His son, Terry, expanded the business enormously by bolstering a catalog business that drew in direct sales to churches and schools. Terry Watanabe sold Oriental Trading to Brentwood Associates in 2000. Six years later, Brentwood sold it to the Carlyle Group for $1 billion. K.K.R. had also looked at buying the company through its private equity unit, but was outbid.

Soon afterward, however, Oriental Trading struggled with both rising mailing costs and the recession, as well as the enormous amount of debt that was placed on the company. The company filed for bankruptcy in 2010, prompting K.K.R.’s special situations team to consider expanding upon a small investment in the retailer’s debt. The division specializes in investing in distressed companies, usually by buying debt or providing rescue financing. It currently oversees about $2 billion.

Early in 2011, the unit bought up what eventually became one-third of Oriental Trading’s first-lien debt, putting K.K.R. in line to take control by converting its holdings into equity. Using knowledge gleaned by the leveraged buyout side years earlier, the team decided that the retailer appeared headed for a recovery and would make an attractive investment.

“In our view the business was stabilizing and starting to turn positive,” Jamie Weinstein, a co-head of the special situations group, said in an interview. “That was a different view from a lot of distressed investors at the time.”

In recent months, K.K.R. and the company’s other owners, Par IV Capital Management and the Crescent Capital Group, decided to look for a potential exit, according to people briefed on the process. Oriental Trading hired Lazard as an adviser to reach out to potential buyers, including Berkshire.

Given Mr. Buffett’s aversion to bidding in auctions, bankers showed Berkshire a number for a potential deal, one of these people said. He accepted.

The deal has been a good one for K.K.R., which should earn twice its initial investment, according to the people briefed on the process.

Jeremiah Lane, another member of the K.K.R. team, said in a statement: “Over the past two years the company has transitioned to steady growth, both top and bottom line, and there is no question the company has a bright future as part of the Berkshire Hathaway enterprise.”