M&A's- Kraft-Heinz

Mergers and acquisitions have been a common theme in many of my past blogs.  In this blog I will focus on the details about companies merging and taking over other companies, reasons behind companies doing so and the potential benefits gained.  This blog will be centred on the recent announcement of Heinz taking over Kraft.

On 25^th of March 2015, the Brazilian investment firm 3G Capital and billionaire investor Warren Buffet announced they have once again teamed up to form a company that will create the world’s fifth largest food and drink company. The takeover occurring between Heinz and Kraft will be the world’s largest merger and acquisition (M&A) to happen this year and will bring together some of the biggest household brands in the US (BBC News, 2015).  While the final transaction value is still subject to change, once the transaction has been completed it is believed that Kraft– Heinz will be 51% controlled by Heinz, with 3G paying a $10bn cash and stock investment and Warren Buffet is to pay a $16.50 share special to Kraft shareholders (Fontanella-Khan et al., 2015). If you are interested in reading further about the cost of capital and WACC please find my previous blog here: http://costofcapital-wacc.blogspot.co.uk/2015/04/bt-buys-ee-capital-structure.html.

So what is the difference between a merger and an acquisition? The combining of two separate business entities under common ownership is known as a merger. However, an acquisition occurs when one company purchases and takes over another to establish sole control, no new company is formed (Arnold, 2013).  There are three main types of mergers; horizontal, vertical and conglomerate.  Kraft- Heinz would be an example of a horizontal merger, the two companies are within the same industry therefore they could create synergies and achieve increased market share.  Companies subject to vertical mergers generate different products and services and are not competitors. Instead, they are generally suppliers or customers of each other prior to the transaction. This would create transactional efficiencies and cut out the costs of having a middle man.  Additionally, another type of merger is conglomerate, these are usually two companies completely unrelated therefore generally purchased by an investment or private equity company (Erchinger & Rowles, 2005). An example of a conglomerate merge would be investors Retail Acquisitions taking over BHS in 2015, having no previous experience in retail (Butler & Rankin, 2015).

There may be many reasons behind companies pursuing with M&A’s, the main motives are listed below:

• Expansion and extension- organisations may use M&A’s to expand their scope in terms of geography, products or markets. This creates increased market power and allows the company to diversify their product range (Hankir et al., 2011). Once Kraft and Heinz merge they will have combined sales worth $29bn (BBC News, 2015).
• Combining capabilities – this could allow an organisation to enter a new market by enhancing competencies for example increasing technological knowhow. This was likely to be the case when BT purchased EE in order to enter the mobile network industry successfully, this was covered by my previous blog, which you can find using the following link: http://acquisitionmarketefficiency.blogspot.co.uk/2015/03/bt-acquires-ee-markeyefficiency-due-to.html.
• Financial savings- this is ultimately the main reason behind M&A’s. General costs decrease through more efficient processes, improved economies of scale and tax relief, especially in horizontal mergers. The combined firm, Kraft-Heinz Company, expects to make annual cost savings of $1.5bn by the end of 2017 (BBC News, 2015).  These savings are often achieved by the creation of synergies, these are defined as positive or negative economic results arising as a consequence of an M&A transaction that affect the future performance of the combined businesses and that could not have occurred without the M&A occurring  (Erchinger & Rowles, 2005).
• Managerial motives- I would argue this is potentially a more sinister reasoning behind M&A’s.  Some managers may seize the opportunity to enhance their CV and complete an M&A to achieve personal ambition.  This is usually done in their self-interest and not strategically focussed on what is best for the organisation. Another motive could be created by the bandwagon effect, managers may feel pressured to do so to prevent becoming a takeover target or simply because everyone else is doing the same.

It has previously been suggested that M&A activities occurs within waves.  So why M&A’s continue to take place in such great magnitude particularly when the previous waves often end in failure?  


A graph showing M&A activity that occurred within the US between 1887 and 2005

Figure 1 (Kummer & Steger, 2008).

In figure 1 above, the graph shows the M&A activity that occurred within the US between 1887 and 2005.  These waves generally follow trends closely related to the economic situation, M&A activities drastically reduce when the economy is struggling.  This is understandable as more companies will have less cash available to purchase other companies and will become increasingly risk adverse.  I believe another one of these peaks can be directly related to the ‘.com’ bubble, many companies will have invested in M&A’s in order to enter the ‘.com’ market and increase their technological knowledge.  Steger and Kummer (2008) explain the reasoning behind the magnitude of the waves, they believe it is due to the time lag that is created before M&A failures are realised, allowing the M&A to slowly increase due to the band wagon effect I mentioned earlier.

Although there are many benefits that result from M&A activities if successful, many academics oppose the idea. It can be argued initial aims are not met so there are no actual improvements subsequent to the acquisition also there is a redistribution of wealth and therefore not actually increasing shareholder wealth.  Saying that it appears Kraft shareholders support the Kraft-Heinz merge by looking at their share price below (see figure 2) which has drastically increased in the last month since the announcement of their merge.  Therefore, I would suggest Kraft shareholders seem keen on the idea and the benefits they could obtain.

Figure 2 (Bloomberg, 2015)

In conclusion, it is clear M&A’s are not straightforward and there are many complications involved.  However, I believe Kraft- Heinz will successfully merge due to the previous experience both 3G Capital and Warren Buffet have, as a billionaire investor he clearly knows what he is doing. Their horizontal merge will create significant benefits by increasing value and efficiency and achieving substantial savings within their transactional costs.  Kraft’s shareholders have noticed a significant wealth gain and if Kraft-Heinz attain the cost savings and increased revenue in which they aim shareholders should receive additional dividends from their share of the profits.  M&A’s are not the answer for every organisation, however I believe for Kraft and Heinz it makes logical business sense to merge.

References

BBC News (2015). Kraft shares soar on Heinz merger. Retrieved from http://www.bbc.co.uk/news/business-32050266

BBC News (2015). Kraft and 3G Capital in $40bn takeover talks: reports. Retrieved from http://www.bbc.co.uk/news/business-32046120

Bloomberg (2015). Kraft Foods Group Inc. Retrieved from http://www.bloomberg.com/quote/krft:us

Butler, S. & Rankin, J. (2015). BHS sold for £1 – Sir Philip Green announces disposal of loss-making chain. Retrieved from http://www.theguardian.com/business/2015/mar/12/sir-philip-green-sells-off-lossmaking-bhs

Chen, L. (2015). Next Kraft Foods? 12 Struggling Food Brands Ripe For Takeover. Retrieved from http://www.forbes.com/sites/liyanchen/2015/04/09/next-kraft-foods-12-struggling-mega-food-brands-ripe-for-takeover/

Erchinger, H., & Rowles, T. A. (2005). Synergies and M&A Transactions. Valuation Strategies, 8(4), 28-33. Retrieved from http://search.proquest.com/docview/232494112?accountid=12860

Fontanella-Khan, J., Massoudi, A. & Daneshkhu, S. (2015). Heinz swallows Kraft in deal engineered by Warren Buffett and 3G. Retrieved from http://www.ft.com/cms/s/0/fe532334-d289-11e4-9c25-00144feab7de.html#slide0

Hankir, Y., Rauch, C., & Umber, M. P. (2011). Bank M&A: A market power story? Journal of Banking & Finance, 35(9), 2341-2354. doi:10.1016/j.jbankfin.2011.01.030

Kummer, C., & Steger, U. (2008). Why merger and acquisition (M&A) waves reoccur: the vicious circle from pressure to failure. Strategic Management Review, 2(1), 44-63. Retrieved from http://www.strategicmanagementreview.com/doi/pdf/10.4128/1930-4560-2.1.44