BREAKINGVIEWS-Kraft Heinz carvery would hinge on new sandwiches

By Jennifer Saba

NEW YORK, July 17 (Reuters Breakingviews) - Kraft Heinz KHC.O is trying anew to squeeze value out of its disastrous deal. As part of a strategic review unveiled in May, the Kool-Aid and Philadelphia cream cheese maker may undo the merger whipped up a decade ago by Warren Buffett’s Berkshire Hathaway and Brazilian buyout shop 3G Capital. The success of any split, however, will depend on yet more M&A.

The $46 billion blockbuster combination of H.J. Heinz and Kraft in 2015 was predicated on turbo-charging international and North American growth while slashing costs using 3G’s infamous zero-based budgeting process. The company’s operating profit margin expanded, but sales growth – including from new products such as “salad frosting” – has been lackluster. Kraft Heinz and Buffett conceded that the acquisition was overvalued, and Berkshire’s directors stepped down earlier this year.

Given the weak performance, a potential breakup from boss Carlos Abrams-Rivera, as reported by the Wall Street Journal, sounds appetizing in theory. In the 10 years since the merger, Kraft Heinz has generated a negative total shareholder return, including reinvested dividends, of more than 40%. Unilever and Mondelez International, by comparison, have doubled shareholders’ money and the S&P 500 Index delivered 260% over the same span.

In practice, however, it would serve up bland fare. Most of the legacy Heinz division housing its eponymous ketchup, Grey Poupon mustard and other condiments accounts for 44% of the company’s $25 billion in net sales estimated for this year. With an EBITDA margin of 28%, per Bank of America analysts, the business would yield about $3 billion. On a blended McCormick and Campbell’s multiple of 11 times, this piece of the enterprise would be worth $34 billion.

The Kraft section, including Oscar Mayer hot dogs and Velveeta cheese, is less tantalizing. Put this more sluggish portion on a multiple of 9 times, back out $1 billion of lost synergies – using 7% of sales as a guide – and it imputes $19 billion of value. The $53 billion sum of the parts is about the same as the whole today.

Some of Kellogg’s special sauce might zest things up. When the Froot Loops and Cheez-it producer split snacks from cereals in 2023, neither company’s shares moved much. Only after Mars agreed to pay $36 billion for Kellanova, a 33% premium to its undisturbed price, did the extra value come through. Italian confectioner Ferrero also is now buying WK Kellogg for $3 billion. A similar smorgasbord would help Kraft Heinz cook up a better outcome.

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CONTEXT NEWS

Kraft Heinz, which said on May 20 that it was reviewing potential strategic options, is considering a breakup, the Wall Street Journal reported on July 11, citing unnamed sources.

The owner of the Velveeta and Oscar Mayer brands also said that Warren Buffett’s Berkshire Hathaway, which owns a 27% stake, gave up two board seats.

The company was formed in 2015 when H.J. Heinz, backed by Berkshire and Brazilian private equity firm 3G Capital, merged with Kraft Foods in a $46 billion deal.