Published by Nick McCullum on September 4th, 2017
In March of 2013, 3G Capital and Berkshire Hathaway closed on the acquisition of Heinz, privatizing this foodmaker for a total acquisition price (including debt) of around $28 billion. 3G’s cash contribution (the acquisition made significant use of debt) was just $4 billion.
Fast forward to 2015, and 3G Capital and Berkshire Hathaway made another transformative merger in the food industry. This time, the two companies arranged for a merger between publicly-traded Kraft Foods and privately-held H.J. Heinz to create publicly-traded Kraft Heinz (KHC).
Why is this significant?
Well, at the time of Kraft Heinz’s most recent proxy statement, 3G Capital owned 290,727,687 shares of Kraft Heinz, amounting to 23.8% of the company’s publicly-traded common shares, with a current market value of approximately $23.5 billion. For context, the Brazilian investment firm invested only $4 billion of cash into the deal when it bought Heinz, and an additional $5 billion when it merged with Kraft.
Think about that…3G has invested, in aggregate, just $9 billion into this consumer foods conglomerate and currently has a stake of $23.5 billion. 3G’s stake has more than doubled in a few short years, although this reflects the company’s significant use of debt to acquire the inaugural Heinz shares. In any case, the company appears to be doing something special.
With that in mind, this article will provide a detailed case study on 3G Capital’s into Heinz (and Kraft Heinz) to determine how the company was able to build such substantial shareholder value.
Who is 3G Capital
3G Capital is a Brazilian investment firm that is most well-known for its laser-like focus on cost-cutting at its investees and on retaining and developing the best managerial talent.
3G’s name comes from having three founders:
- Jorge Paolo Lemann
- Marcel Herrmann Telles
- Carlos ‘Beto’ Sicupira
These three founders are the inspiration for the ‘3’ in 3G’s name and are the source of the company’s relentless focus on operational efficiency.
“Costs are like fingernails: they always have to be cut.” – Carlos Sicupira, one of 3G’s Founding Partners
3G Capital’s Founding Partners are pictured below.
Source: Financial Times
The first creation of these three business partners was the Brazilian investment bank Banco Guarantia. The “G” in Guarantia contributes the “G” in 3G Capital’s name. Guarantia was sold to Credit Suisse in the late 1990s.
As mentioned, one of 3G Capital’s most notable characteristics is the firm’s focus on cost control. The company makes avid use of a concept called zero-based budgeting to improve the operational performance of the companies it invests in.
Zero-based budgeting, or ZBB for short, is significantly different than normal budgeting procedures. In a traditional budgeting process, managers begin with the prior period’s budget, review financial performance and then make adjustments based on assumptions about future operating conditions. Only new expenses must be approved after closing the books on a completed reporting period.
Zero-based budgeting is different because managers will start with a blank budget for each time period. By building the budget from the ground up, managers are forced to justify every expense, which naturally improves operational efficiency over time.
Despite its effectiveness, zero-based budgeting is unpopular for two reasons.
First, it is highly disruptive. Entire departments can be eliminated after a zero-based budget analysis determines them to be a poor use of shareholder capital. In the past, these inefficient business units remained operational simply because they had always been there. The propensity for zero-based budgeting to cause layoffs and other slashes to corporate expenditures are the first reason why this managerial technique is not fully appreciated.
The second factor is up-front cost. Zero-based budgeting is highly expensive to implement in the beginning, resulting in large accounting charges that are later ‘paid back’ by recurring cost savings delivered by the leaner organizational structure.
Intuitively, it is not surprising that ZBB is expensive to executive. Zero-based budgeting requires extensive analysis. It often involves the use of external consultants who perform detailed cost-volume-profit calculations on each department of a corporation. With that said, zero-based budgeting still makes sense after accounting for the initial required investment, particularly when managers operate with a long-term orientation.
Without a doubt, 3G Capital is best known for its ruthless cost-cutting. The firm also has other notable characteristics that are not as well-covered by the media but deserve some attention in this analysis.
First of all, 3G Capital has a profoundly experimental culture. The firm is known to be a leader thanks to its continuous improvement through experimentation in marketing, product development, and operational efficiencies (unsurprisingly). With that said, 3G is quick to shut down experiments that have a poor long-term outlook.
The following quote from one of 3G’s founders, Marcel Telles, illustrates this:
“Any idea or innovation needs to be prototyped… Most innovations you can prototype in a very basic and simple way to understand the first feeling of the product for a company or a group of consumers. After going through this first stage it looks a lot like venture capital. ‘Oh yeah, okay, here is $50,000 for you, in three months show me a little more.’ Three months from now there are ten guys showing off their work, two are going to be good, you have to be merciless in cutting those that do not deliver what you want.”
3G Capital also makes extensive use of consultants, particularly with regards to creating budgets and identifying cost savings opportunities. Accenture is the consulting firm that 3G Capital has used in the past (most notably for the Burger King, Tim Horton’s, and Heinz deals); the two firms appear to have a very strong business relationship.
The last important characteristic of 3G Capital that we will discuss in this article is the company’s meritocratic management approach. 3G is very willling to reward employees that work extremely hard and deliver spectacular business performance; conversely, the firm is quick to cut underperformers.
The firm also pays very little attention to age. If the best employees of one of its investees happens to be young, they will be promoted nonetheless.
This focus on performance with no regard to age can be tangibly observed by looking at Burger King’s senior management changes after 3G’s appointed CEO (Bernardo Hees, one of 3G’s non-founding Partners) left for Heinz. Hees’ successor, Daniel Schwartz, was only 33 years old when he became CEO (he was CFO previously). Schwartz’ successor as CFO was only 26.
Without a doubt, 3G Capital is a unique organization and has characteristics that are unlike many of its peers. These traits have undoubtedly contributed to some of the firm’s tremendous successes over the years:
- The world’s largest beer company, AB InBev, saw EBITDA margins soar from 23% to 37% after 3G Capital initiated a stake in the company
- 3G Capital grew Burger King’s profits by 33% in the two years after purchasing the company, and performance has continued to be strong after the firm merged Burger King with Tim Horton’s and Popeye’s to form Restaurant Brands International
3G Capital also has an excellent reputation among other members of the activist investment community. Bill Ackman of Pershing Square Capital Management has said the following of 3G Capital.
“Everyone talks the talk [about efficient management], but 3G really does it. These guys are the best.”
If you’re interested in reading more about 3G Capital’s style of running businesses (but not specifically their involvement with Heinz), the following articles can provide some useful insights:
- Intelligent Fanatics: It’s More Than Buy, Squeeze, & Repeat With 3G Capital
- Financial Times: The Lean and Mean Approach of 3G Capital
- Fortune: What Happens When 3G Capital Buys Your Company
Moving on, the remainder of this article will discuss 3G Capital’s involvement with Heinz in detail.
3G Capital’s Investment in Heinz
3G Capital’s original investment in Heinz happened back in 2013. More specifically, 3G Capital and Berkshire Hathway together paid $28 billion (including the assumption of debt) to acquire and privatize the Heinz business effective March 30, 2013.
Headquartered in Pittsburgh, Heinz is the leader in the ketchup industry, and also has a significant presence in frozen foods, soups, beans, pasta meals, and infant nutrition.
In fiscal 2012, the most recent year before the company was privatized, Heinz generated revenues of $11.6 billion. The geographic breakdown of Heinz’s fiscal 2012 revenues was a testament to the food maker’s high degree of geographic diversification; Heinz generated just 40% of sales in the United States, with the remainder coming from abroad.
The price that the two firms paid for Heinz’s then-publicly-traded common shares was expensive by any quantitative yardstick of value. The purchase price of $72.50 per share was 20% higher than the stock’s closing price on the day prior to the announcement and 19% higher than Heinz stock’s all-time high.
Berkshire Hathaway and 3G Capital owned Heinz’s common equity 50-50 following the purchase, with each firm putting up about $4 billion in cash for the purchase. The remainder of the acquisition was financed with bank debt. The significant leverage used in the transaction served to magnify the impressive returns generated by 3G and Berkshire.
Berkshire Hathaway also contributed an additional $8 billion to receive a tranche of preferred shares that pay a 9% annual dividend.
All said, the deal was worth $23 billion, or $28 billion including the assumption of debt of Heinz’s debt (these figures do not include the price that Berkshire paid for its separate-but-related preferred stock investment).
Unlike many private equity transactions, it appeared that both firms planned to be the owners of Heinz for the long run. Buffett, in particular, seemed interested in accumulating a larger interest in the ketchup giant, saying the following in an interview following the transaction’s close:
“We may increase our ownership if any members of the 3G Group ultimately want to sell out later.”
Indeed, Berkshire and Buffett must have been pleased with the work that they had completed with 3G Capital, as this was not the last deal that the two firms orchestrated together. In 2014, Berkshire was one of the main financiers of 3G Capital’s $13.3 billion acquisition of Tim Horton’s, which is merged with Burger King and spun-off as Restaurant Brands International (QSR) later.
Additional details of the exact terms of the transaction can be read in the following article:
- New York Times: Berkshire and 3G Capital in a $23 Billion Deal For Heinz
- San Diego Union Tribune: Buffett’s Heinz Buy Puts Spotlight On Big Deals
So how exactly did 3G Capital manage to improve performance at Heinz?
There are three main strategies used:
- Methodical cost-cutting
- Management & culture changes
- A focus on efficiency and operational improvements
Given the overview of 3G’s investment strategy provided earlier in this analysis, the changes that the firm made at Heinz are relatively unsurprising.
What is more surprising is how quickly 3G enacted changes.
Ten days after the deal had closed, Heinz’s 50 top executives met at Four Seasons hotel in San Fransisco at their regular annual offsite.
Typically, the event had a rather straightforward agenda: strategy meetings, market commentary, and a speech from Heinz’s long-time Chief Executive Officer Bill Johnson.
This year was significantly different. Because of 3G’s reputation for ruthless cost-cutting, many of the 50 executives in attendance wondered if this would be the last time the event was held. Job safety was also a significant concern.
The aforementioned Heinz CEO, Bill Johnson, had handed the reins of his company to Bernardo Hees, a non-founding Partner from 3G Capital. This year’s leadership summit gave Hees the opportunity to present his vision for the ‘new’ Heinz: to be the world’s most efficient food company.
Hees acted quickly. During the same annual offsite, many executives were summoned to a side conference room where some were informed that they no longer had a future with Heinz. Importantly, it was not ruthless firing; Heinz allowed the executives to leave with fully vested stock options and unchanged retirement plans.
In their place, Hees often eliminated management roles completely. In other cases, the new executive replaced them with competent managers that he had worked with at other 3G Capital businesses, or, more rarely, other individuals from the Heinz organizational chart. Often, the replacements that Hees chose to fill these roles were significantly younger than their predecessors, which emphasizes 3G’s meritocratic approach to talent management.
The impact of 3G Capital’s executive cost-cutting is hard to overstate. In the August after 3G’s investment closed (recall that the transaction was completed in March), Heinz announced the layoff of 350 of its 1,200 full-time staff at headquarters. This amounts to a headquarters head count reduction of 29%.
3G Capital aggressively attacked Heinz’s other fixed costs (outside of salaries). Many of Heinz’s corporate jets were sold, and the company quickly found a way to merge its two corporate headquarter buildings into one. 3G promised to kept the company headquartered in Pittsburgh, given Heinz’s rich history in the city. If this were not the case, it is possible that 3G would have relocated the city completely to a more desirable (think New York) or affordable location.
We have seen earlier in this article that the financial impact of 3G Capital’s previous investments has been extraordinary.
How did the Heinz investment perform in comparison?
In the two years following 3G’s original investment in Heinz, the foodmaker’s net profit margin expanded by a remarkable 58%, to 28%. For context, Bernstein Research estimates that the average profit margin in the food industry is about 16%, implying that Heinz – after intervention from 3G – generates about 75% more net income for every dollar of sales when compared to the industry average.
This is an amazing achievement. With that said, 3G Capital’s work is far from over.
After making significant progress at the original Heinz business by taking it private in conjunction with Berkshire Hathaway, 3G Capital executed a significant merger with publicly-traded Kraft Foods, creating food conglomerate Kraft Heinz (KHC).
Looking ahead, there have been rumors that Kraft Heinz is looking for another merger candidate, continuing the company’s streak of accretive acquisitions.
Unilever (UL) in particular was noted in several M&A rumors to be an acquisition target for Kraft Heinz in recent months.
Importantly, though, the company does not need acquisitions to drive future growth. The following quote from a 3G Capital representative illustrates this point nicely.
“Kraft Heinz doesn’t need another acquisition to drive profitable growth for the long term. As always, we will evaluate any opportunity that makes strategic sense, with the objective of growing for the long term, whether in the US or internationally.” – Alex Behring, Parter at 3G Capital
3G Capital’s investment in Heinz is a phenomenal case study on the importance of cost management and the incredible impact that management changes can have on corporate profitability.
This article is by no mean a complete history of 3G Capital’s involvement with Heinz.
If you’re interested in reading more about the company’s remarkable turnaround, the following articles may be of interest to you: