Economic optimism spawning big deals; interest rate also key for Heinz acquirers

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Tremors from a spate of mergers and acquisitions reverberated in Pittsburgh last week with the $28 billion offer for H.J. Heinz made by Warren Buffett's Berkshire Hathaway and 3G Capital.

The deal puts Heinz's ketchup, Ore-Ida french fries, Weight Watchers and other familiar brands into the hands of buyers who paid a 20 percent premium over the current price of Heinz's stock. Considering that the shares were trading at an all-time high, the price tag looks even more gold-plated.

The Heinz deal is one of several megadeals made possible by record low interest rates, increasing faith in the economy and other factors. The deals include the $11 billion merger of US Airways and bankrupt American Airlines; Michael Dell's $24.4 billion bid to take the computer company he founded private; and Comcast's plan to spend $16.7 billion to acquire the 49 percent block of NBCUniversal it does not own from General Electric.

More than low interest rates are behind the deal-making, said John Frankola of Vista Investment Management in Pittsburgh. Before they leap, buyers have to believe the economic outlook justifies meeting the seller's asking price and convinced that the acquisition fits their strategic objectives.

"Most of all, it's a vote of confidence in the economy that acquirers are willing to step up and put money up and make a big acquisition," Mr. Frankola said.

The Federal Reserve Bank's policy of keeping interest rates artificially low forces investors seeking more than paltry returns to gravitate to stocks and other riskier assets. They are more inclined to take those risks than they were four years ago, when the Great Recession brought deal-making to a halt, low interest rates notwithstanding.

"Hedge funds and private equity are sitting on a ton of cash earning zero and they're going to jump on these deals," said Greg Melvin of C.S. McKee, a Downtown investment management firm. "We've been waiting four years for mergers and acquisitions to come back and I think it's coming back hard."

Berkshire had nearly $42 billion in cash on its books at the end of the third quarter, leaving Mr. Buffett with plenty of ammunition even after he invests $12.1 billion in the Heinz deal.

Despite his preference for well-managed companies with strong global brands, some were surprised by how much the opportunistic investor from Omaha, Neb., is willing to pay for Heinz.

The price reflects another impact of record low interest rates: They drive up asset prices.

Low mortgage rates and easy credit sparked a frenzy of house buying in the middle of the last decade. The result was a housing bubble that burst in 2008, leading to the severest recession since the Great Depression. Four years later, the housing market finally is starting to show signs of real recovery.

"With a lot of companies' stocks back to where they were in 2007, you're seeing more willing sellers, like the guys at Heinz," said Christopher Wiles of Rockhaven Asset Management in Mt. Lebanon.

Mr. Buffett is relying on 3G Capital to make the acquisition pay off despite its price tag. The New York private equity firm is controlled by two Brazilians, Jorge Paulo Lemann and Alex Behring. Unlike Mr. Buffett, they specialize in refurbishing troubled companies such as Burger King. Mr. Behring, who will be the point man, is expected to tap international growth opportunities Heinz overlooked and to spend less than what it took Heinz CEO William Johnson and his management team to run the global food giant.

If the cost-cutting that generated the blowout quarterly profits Burger King reported Friday is any indication, big changes could be in store in Pittsburgh and elsewhere in Heinz's far-flung operations.

"This is not going to be a hands-off acquisition. They are not passive investors," Mr. Wiles said.

The risks involved in the Heinz deal are reflected in at least two ways.

On Friday, Fitch Ratings said Heinz's debt no longer merited an investment grade rating, reducing it to junk bond status. The credit ratings firm cited a "substantially higher level of financial risk" and warned further downgrades are possible. Ratings could improve if, as expected, Heinz's new owners sell parts of the company to pay down debt, Fitch said.

The $28 billion purchase price includes about $5 billion in Heinz debt Berkshire and 3G Capital will assume.

The risks are also reflected in the 9 percent dividends Mr. Buffett will collect on the $8 billion in preferred stock he will receive as part of the $12.1 billion investment. 3G Capital is kicking in $4.1 billion. The rest, $14.1 billion in debt, will be provided by J.P. Morgan and Wells Fargo.

Mr. Buffett has a fondness for preferred shares, which are less risky than the common stock most investors are familiar with. Four years ago, Goldman Sachs and General Electric fortified themselves during the depths of the recession by enlisting Mr. Buffett as an investor. They offered him 10 percent dividends on the $8 billion in preferred shares Mr. Buffett purchased. Both companies repurchased the shares three years later.

"If they're paying Buffett 9 percent, that's a pretty risky credit," Mr. Melvin said.

Heinz's ability to pay those dividends depends on 3G Capital's ability to generate new growth and reduce costs.

"Apparently they think there's some waste in Heinz that they can get rid of," said Ronald Heakins of OakTree Investment Advisors in Shadyside.

He cautioned against expecting the wave of mergers and acquisitions to contribute to economic growth.

"The buyer sees synergies, which means that employees get laid off and a lot of the increase in earnings is from cost cutting," Mr. Heakins said.

For Heinz employees, anticipating that may elicit bittersweet memories of the Carly Simon lyrics that inspired one of their company's most memorable television commercials and cause them to wonder whether these are the good old days.

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Len Boselovic: lboselovic@post-gazette.com or 412-263-1941.


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