CASE STUDY: BERKSHIRE HATHAWAY

END OF CHAPTER CASE STUDY: BERKSHIRE HATHAWAY

AND 3G BUY AMERICAN FOOD ICON HEINZ

Case Study Objectives: To Illustrate

• Form of payment, form of acquisition, acquisition vehicle, and postclosing organizations

• How complex LBO structures are organized and financed.

In a departure from its traditional deal making strategy, Berkshire Hathaway (Berkshire), the

giant conglomerate run by Warren Buffett, announced on February 14, 2013, that it would buy

food giant H.J. Heinz (Heinz) for $23 billion or $72.50 per share in cash. Including assumed debt,

the deal is valued at $28 billion. Traditionally, Berkshire had shown a preference for buying

entire firms with established brands and then allowing them to operate as they had been.

Investors greeted the news enthusiastically boosting Heinz’s stock price by nearly 20% to the

offer price and Berkshire’s class A common stock price by nearly 1% to $148,691 a share.

Unlike prior transactions, Berkshire teamed with 3G Capital Management (3G), a Brazilianbacked

investment firm that owns a majority stake in Burger King, a company whose business is

complementary to Heinz, and interests in other food and beverage companies. Heinz’s headquarters

will remain in Pittsburgh, its home for more than 120 years. The major attraction to

Berkshire is the extremely well-known Heinz brand and the opportunity to use Heinz as a

platform for making additional acquisitions in the global food industry. Berkshire is adding

another widely recognized brand to his portfolio which already contains Dairy Queen and Fruit

of the Loom. The strong Heinz brand gives it the ability to raise prices.

The deal is intended to assist Heinz in growing globally. By taking the firm private, Heinz

will have greater flexibility in decision making not having to worry about quarterly earnings.

Currently, about two-thirds of the firm’s total annual revenue comes from outside the United

States. Heinz earned $923 million on sales of $11.65 billion in fiscal 2013.

 

 

 

 

 

At 20 times 2013 current earnings, the deal seems a bit pricey when compared to price to earnings

ratios for comparable firms (Table 13.4). The risks to the deal are significant. Heinz will

have well over $10 billion in debt, compared to $5 billion now. Before the deal, Moody’s

Investors Service rated Heinz just two notches beyond junk. If future operating performance

falters, the firm could be subject to a credit rating downgrade. The need to pay a 9% preferred

stock dividend will also erode cash flow. 3G will have operational responsibility for Heinz.

Heinz may be used as a platform for making other acquisitions.

Risk to existing bondholders is that 1 day they own an investment grade firm with a modest

amount of debt and the next day they own a highly leveraged firm facing a potential downgrade

to junk bond status. On the announcement date, prices of existing Heinz triple B rated bonds fell

by over two cents on the dollar, while the cost to ensure such debt (credit default swaps) soared

by over 25% to a new high.

The structure of the deal is described in Figure 13.3. H.J. Heinz Company, a Pennsylvania

Corporation, entered into a definitive merger agreement with Hawk Acquisition Holding

Corporation (Parent), a Delaware corporation, and Hawk Acquisition Sub (Merger Sub), Inc., a

Pennsylvania corporation and wholly owned subsidiary of Parent. The agreement called for

Merger Sub to merge with Heinz, with Heinz surviving as a wholly owned subsidiary of Parent.

Berkshire and 3G acquired one-half of the common stock of Parent for $4.12 billion each, with

Berkshire also purchasing $8 billion in 9% preferred stock issued by Parent, bringing the total

cash injection to $18.24 billion. The preferred stock has an $8 billion liquidation preference (i.e.,

assurance that holders are paid before common shareholders), pays and accrues a 9% dividend,

and is redeemable at the request of the Parent or Berkshire under certain circumstances. The use

of preferred stock has been a hallmark of Berkshire deals and has often included warrants to

buy common stock.

Parent used the $18.24 billion cash injection from Berkshire and 3G (i.e., $14.12 from

Berkshire1$4.12 from 3G) to acquire the common shares of Merger Sub. J.P. Morgan and Wells

Fargo provided $14.1 billion of new debt financing to Merger Sub. The debt financing consisted of $8.5 billion in dollar-denominated senior secured term loans, $2.0 billion of Euro/British

Pounds senior secured term loans, a $1.5 billion senior secured revolving loan facility, and a $2.1

billion second lien bridge loan facility. Total sources of funds equal $32.34 billion, consisting of

$18.24 in equity plus $14.1 billion in debt financing.

The deal does not contain a go shop provision, which allows the target to seek other bids

once they have reached agreement with the initial bidder in exchange for a termination fee to be

paid to the initial bidder if the target chooses to sell to another firm. Go shop provisions may be

used since they provide a target’s board with the assurance that it got the best deal; for firms

incorporated in Delaware, the go shop provision helps target argue that they satisfied the socalled

Revlon Duties, which require a board to get the highest price reasonably available for the

firm. While Heinz did not have such a go shop provision, if another bidder buys Heinz, it will

have to pay a termination fee of $750 million, plus $25 million in expenses. If Berkshire and 3G

cannot close the deal they must pay Heinz $1.4 billion before they can walk away.

Heinz may not have negotiated a go shop provision which is common in firms seeking to

protect their shareholder interests because it is incorporated in Pennsylvania. Pennsylvania

corporate law is intended to give complete latitude to boards in deciding whether to accept or

reject takeover offers because it does not have to consider shareholders’ interests as the dominant

determinant of the appropriateness of the deal (unlike Delaware). Instead, the directors can base

their decision on interest of employees, suppliers, customers and creditors and communities.

This may explain why Berkshire and 3G have agreed to have Heinz’s headquarters remain in

Pittsburgh, keep the firm’s name, and preserve the firm’s charitable commitments. Firms incorporated

in Delaware may be subject to greater pressure to negotiate go shop arrangements

because Delaware corporate law requires the target’s board to get the highest price for its

shareholders.

 

 

 

 

 

Discussion Questions

1. Identify the form of payment, form of acquisition, acquisition vehicle, and postclosing

organization? Speculate why each may have been used.

2. How was ownership transferred in this deal? Speculate as to why this structure may have

been used?

3. Describe the motivation for Berkshire and 3G to buy Heinz.

4. How will the investors be able to recover the 20% purchase price premium? Explain your

answer.

5. Do you believe that Heinz is a good candidate for an LBO? Explain your answer.

6. What do you believe was the purpose of the $1.5 billion senior secured revolving loan facility,

and the $2.1 billion second lien bridge loan facility as part of the deal financing package?

7. Why do you believe Berkshire Hathaway wanted to receive preferred rather than common

stock in exchange for its investing $8 billion? Be specific.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

END OF CHAPTER CASE STUDY: THERMO FISHER ACQUIRES

LIFE TECHNOLOGIES

Case Study Objectives: To Illustrate How Acquirers Utilize Financial Models To

• Evaluate the impact of a range of offer prices for the target firm, including what constitutes

the “maximum price”

• Determine which financing structures are consistent with maintaining or achieving a desired

credit rating

• Investigate the implications of different payment structures (form and composition of the

purchase price)

• Identify the impact of changes in operating assumptions such as different revenue growth rates

or the amount and timing of synergy.

Background

Almost 9 months after reaching an agreement to combine their operations, the merger

between Life Technologies Corporation (Life Tech) and Thermo Fisher Scientific Inc. (Thermo

Fisher) was completed on January 14, 2014. Thermo Fisher is the largest provider by market

value of analytical instruments, equipment, reagents and consumables, software, and services

for scientific research, analysis, discovery, and diagnostics applications. Life Tech is the second

largest by market value provider of similar products and services to the scientific research and

genetics analysis communities. While the fanfare surrounding the closing echoed sentiments

similar to those expressed when the deal was first announced, the hard work of integrating

the two firms was just beginning. What led to this moment illustrates the power of financial

models. Life Tech had been evaluating strategic options for the firm since mid-2012, concluding that

putting itself up for sale would be the best way to maximize shareholder value (see Case Study

11 titled “Life Tech Undertakes a Strategic Review” for more detail.). After entering into discussions

with Thermo Fisher in late 2012, the two firms announced jointly on April 15, 2013, that

they had reached an agreement to merge. Exuding the usual optimism accompanying such pronouncements,

Mark N. Casper, president and chief executive officer of Thermo Fisher stated

“We are extremely excited about this transaction, because it creates the ultimate partner for our

customers and significant value for our shareholders. . . enhancing all three elements of our

growth strategy: technological innovation, a unique customer value proposition, and expansion

in emerging markets.” Expressing similar confidence, Greg T. Lucier, chairman and chief executive

officer of Life Tech noted “This transaction brings together two companies intent on accelerating

innovation for our customers and achieving greater success in a highly competitive global

industry.”

This case study utilizes the publicly announced terms of the merger of Life Tech into a

wholly owned subsidiary of Thermo Fisher, with Life Tech surviving. The terms were used to

develop pro forma financial statements for the combined firms. These statements are viewed as

a “base case.”42

The financial model discussed in this chapter is used to show how changes in key deal terms

and financing structures impacted the base case scenario. The discussion questions following the

case address how the maximum offer price for Life Tech could be determined, what the impact

of an all-debt or all-equity deal would have on the combined firms’ financial statements, and the

implications of failing to achieve synergy targets. Such scenarios represent the limits of the range

within which the appropriate capital structure could fall and could have been part of Thermo

Fisher’s predeal evaluation. As announced by Thermo Fisher, the appropriate capital structure is

that which maintains an investment grade credit rating following the merger. Thermo Fisher’s

senior management could have tested various capital structures between the two extremes of alldebt

and all-equity before reaching agreement on the form of payment with which they were

most comfortable. Therefore, the form of payment and how the deal was financed were instrumental

to the deal getting done.

Payment and Financing Terms

According to the terms of the deal, Thermo Fisher acquired all of Life Tech’s common shares

outstanding, including all vested and unvested outstanding stock options, at a price of $76 per

share in cash, with the Life Tech shares canceled at closing. The actual purchase price consisted

of an equity consideration (i.e., what was paid for Life Tech’s shares) of $13.6 billion plus the

assumption of $2.2 billion of Life Tech’s outstanding debt.

The purchase price was funded by a combination of new debt, equity, and cash on Thermo

Fisher’s balance sheet. Thermo Fisher executed a commitment letter, dated April 14, 2013, with

JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC, and Barclays Bank PLC that provided

a commitment for a $12.5 billion 364-day unsecured bridge loan facility. The facility enabled the

firm to pay for much of the purchase price before arranging permanent financing by issuing new

debt and equity in late 2013.

Maintaining an Investment Grade Credit Rating

In an effort to retain an investment grade credit rating43 by limiting the amount of new

borrowing,44 Thermo Fisher issued new common equity and equity linked securities such

as convertible debt and convertible preferred totaling $3.25 billion to finance about one-fourth

of the $13.6 billion equity consideration. The $3.25 billion consisted of $2.2 billion of common

stock sold in connection with its public offering prior to closing, and up to a maximum

of $1.05 billion of additional equity to be issued at a later date in the form of convertible

debt and preferred shares. Thermo Fisher financed the remaining $10.35 billion of the

purchase price with the proceeds of subsequent borrowings and $1 billion in cash on its

balance sheet.

Thermo Fisher and Life Tech compete in the medical laboratory and research industry. The

average debt-to-total capital ratio for firms in this industry is 44.6%,45 and the average interest

coverage ratio is 4.0.46 Thermo Fisher expects that available free cash flow will allow for a rapid

reduction in its debt. The firm expects to be below the industry average debt-to-total capital ratio

by the end of the third full year following closing and about 12 percentage points below it within

5 years after closing. The firm’s interest coverage ratio is expected to be equal to the industry

average by the second year and well above it by the third year and beyond. These publicly stated

goals established metrics shareholders and analysts could use to track the Thermo Fisher’s progress

in integrating Life Tech.

Consistent with management’s commitment to only make deals that immediately increase

earnings per share, Thermo Fisher expects the deal to increase adjusted earnings per share during

the first full year of operation by as much as $0.70_$1.00 per share. Adjusted earnings per

share exclude the impact on earnings of transaction-related expenses and expenses incurred in

integrating the two businesses. Including these expenses in the calculation of EPS is expected to

result in a $(0.16) per share during the first full year following closing, but excluding these

expenses will result in $0.99 per share.47

Quantifying Anticipated Synergy

Realizing synergy on a timely basis would be critical for Thermo Fisher to realize its publicly

announced goal that the deal would be accretive on an adjusted earnings per share basis at the

end of the first full year of operation. Synergies anticipated by Thermo Fisher include the realization

of additional gross margin of $75 million and the realization of $10 million in SG&A savings

in 2014, the first full year following closing. Gross margin improvement and SG&A savings are

projected to grow to $225 million and $25 million, respectively, by 2016, and to be sustained at

these levels indefinitely. Most of the cost savings are expected to come from combining global

infrastructure operations. Revenue-related synergy is expected to reach $25 million annually

from cross-selling each firm’s products into the other’s customer base by the third year, up from

$5 million in the first year.

Conclusions

Mark Fisher, CEO of Thermo Fisher knew that the key to unlocking value for shareholders

once the deal closed was realizing the anticipated synergy on a timely basis. However, rationalizing

facilities by reducing redundant staff, improving gross margins, and increasing revenue was fraught with risk. Eliminating staff had to be done in such a way as not to demoralize employees

retained by the firm and increasing revenue could only be achieved if the loss of existing

customers due to the attrition that often follows M&As could be kept to a minimum. He also

knew to expect the unexpected, despite having completed what he believed was an extensive

due diligence.

Having been through postmerger integrations before, he knew first hand the challenges

accompanying these types of activities. At the time of closing, many questions remained.

What if synergy were not realized as quickly and in the amount expected? What if expenses

and capital outlays would be required in excess of what had been anticipated? How patient

would shareholders be if the projected impact on earnings per share, a performance metric

widely followed by investors and Wall Street Analysts alike, was not realized? Only time

would tell.

Discussion Questions

Answer questions 1_4 using as the base case the firm valuation and deal structure data in the

Microsoft Excel model available on the companion site to this book entitled Thermo Fisher

Acquires Life Technologies Financial Model. Please see the Chapter Overview section of this chapter

for the site’s internet address. Assume that the base case assumptions were those used by

Thermo Fisher in its merger with Life Tech. The base case reflects the input data described in

this case study. To answer each question you must change selected input data in the base case,

which will change significantly the base case projections. After answering a specific question, either

undo the changes made or close the model and do not save the model results. This will cause the model

to revert back to the base case. In this way, it will be possible to analyze each question in terms

of how it is different from the base case.

1. Thermo Fisher paid $76 per share for each outstanding share of Life Tech. What is the

maximum offer price Thermo Fisher could have made without ceding all of the synergy value

to Life Tech shareholders? (Hint: Using the Transaction Summary Worksheet, increase the

offer price until the NPV in the section entitled Valuation turns negative.) Why does the offer

price at which NPV turns negative represent the maximum offer price for Life Tech? Undo

changes to the model before answering subsequent questions.

2. Thermo Fisher designed a capital structure for financing the deal that would retain

its investment grade credit rating. To do so, it targeted a debt-to-total capital and

interest coverage ratio consistent with the industry average for these credit ratios.

What is the potential impact on Thermo Fisher’s ability to retain an investment grade

credit rating if it had financed the takeover using 100% senior debt? Explain your

answer. (Hint: In the Sources and Uses section of the Acquirer Transaction Summary

Worksheet, set excess cash, new common shares issued, and convertible preferred shares

to zero. Senior debt will automatically increase to 100% of the equity consideration plus

transaction expenses.48) Undo changes to the model before answering subsequent

questions.

3. Assuming Thermo Fisher would have been able to purchase the firm in a share for share

exchange, what would have happened to the EPS in the first year? Explain your answer.

(Hint: In the form of payment section of the Acquirer Transaction Summary Worksheet, set the percentage of the payment denoted by “% Stock” to 100%. In the Sources and Uses

section, set excess cash, new common shares issued, and convertible preferred shares to zero.)

Undo changes made to the model before answering the remaining question.

4. Mark Fisher, CEO of Thermo Fisher, asked rhetorically what if synergy were not realized as

quickly and in the amount expected. How patient would shareholders be if the projected

impact on earnings per share was not realized? Assume that the integration effort is far more

challenging than anticipated and that only one-fourth of the expected SG&A savings, margin

improvement, and revenue synergy are realized. Furthermore, assume that actual integration

expenses (shown on Newco’s Assumptions Worksheet) due to the unanticipated need to

upgrade and colocate research and development facilities and to transfer hundreds of

staff are $150 million in 2014, $150 million in 2015, $100 million in 2016, and $50 million in

2017. The model output resulting from these assumption changes is called the Impaired

Integration Case.

What is the impact on Thermo Fisher’s earning per share (including Life Tech) and the

NPV of the combined firms? Compare the difference between the model “Base Case” and

the model output from the “Impaired Integration Case” resulting from making the changes

indicated in this question. (Hint: In the Synergy Section of the Acquirer (Thermo Fisher)

Worksheet, reduce the synergy inputs for each year between 2014 and 2016 by 75%

and allow them to remain at those levels through 2018. On the Newco Assumptions

Worksheet, change the integration expense figures to reflect the new numbers for 2014,

2015, 2016, and 2017.)

 
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