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March 14, 2014

Heinz, Mondelez and the private equity effect

Private equity dominated the February Consumer Analyst Group of New York (CAGNY) conference, even without a formal presence - a measure of the extent to which the buyout funds' operational methods have permeated the food industry. While leveraged buyouts have not yet recovered their pre-2008 scale or volume, the big buyout houses emerged from the meltdown bigger than ever as complex financial conglomerates for whom pillaging companies is only part of the business of buying and trading everything. But private equity is not a closed universe. The funds' substantial footprint in the processed food industry, as elsewhere, has brought into the mainstream the financial engineering and aggressive cost-cutting developed through decades of leveraged buyouts.

Heinz, taken private last year in a leveraged buyout by Brazilian 3G Capital and Warren Buffett's Berkshire Hathaway, now sets the benchmark for the food business. 3G built a Brazilian brewer into global giant AB InBev through ruthless cost-cutting, and achieved the seemingly impossible by squeezing even more cash out of Burger King when they took over from earlier rounds of private equity investors who effectively vacuumed out large quantities of cash. Two years later Burger King was returned to the stock market.

In their first year in charge of Heinz, 3G has shuttered 3 plants in the US and Australia, eliminated over 10% of the global workforce and brought in advisors Accenture to implement their "zero-based" cost-cutting budget program. The rest of the industry has taken notice.

"Many in the industry have been surprised (scared!) by the size of the savings squeezed out of Heinz, a company that was previously considered well-run and efficient," Rabobank analyst Nicholas Fereday wrote in a report previewing this year's CAGNY conference. "This has left them sifting through their own business operations for savings knowing that if they do not, they might just find themselves on the menu of private equity."

Heinz's reputation for financial efficiency (read: souped-up returns) stems from pressure applied by hedge fund investor Nelson Peltz, whose Trian Funds shook up Heinz in 2006. Now Peltz is back at Mondelez and has a seat on the board, while Jana Partners and other hedge funds load up on Mondelez stock.

Mondelez is not scared by 3G's work at Heinz, but inspired. CEO Irene Rosenfeld told the Financial Times at the conference "We've watched the work that 3G has done with AB InBev and Heinz - Accenture was the partner with them and we believe they can be of great help to us." CFO David Brearton told the CAGNY meeting that Mondelez has hired Accenture "to help us rapidly take out costs."

Mondelez perfectly illustrates the private equity effect - a publicly listed company that substantially resembles an LBO in its capital structure, targets and methods. Debt was the vehicle for the acquisitions which propelled the former Kraft Foods Inc. into the "global snacks powerhouse" which is today Mondelez. When Kraft was split and Mondelez was spun off, virtually all the debt was loaded onto the new company. The pressure on cash flow remains considerable. Mondelez has since taken on new debt solely to fund shareholders and top management. Three weeks after being targeted by Peltz's Trian fund last year, Mondelez hiked its share buyback authorization by 400% and announced an 8% increase in the dividend. New borrowing to reward top management on an already leveraged balance sheet is precisely the mechanism of the classic private equity dividend recapitalization. And no food manufacturing company with an eye on the longer view would set the profit targets Mondelez has recently announced. But like 3G at Burger King or Peltz at Heinz, the current crew probably doesn't plan on sticking around for the long haul. For the moment their eyes and those of the entire industry are glued on Heinz and their private equity bosses.