Ketchup maker H.J. Heinz Co, backed by Warren Buffett's Berkshire Hathaway Inc (BRKa.N) and Brazilian private equity firm 3G Capital, will combine with Kraft Foods Group Inc KRFT.O in a $46 billion deal to create the third-largest North American food company, executives said on Wednesday.
Shares of Kraft, known for its namesake macaroni and cheese in a box, as well as Velveeta, Maxwell House coffee and Oscar Mayer processed meats, closed up nearly 36 percent at $83.17.
The deal gives Buffett more leading U.S. food brands, as well as that of 3G founder Jorge Paulo Lemann, Brazil's richest man. The two teamed up to buy control of Heinz in 2013 and collaborated on the 2014 merger of fast-food chain Burger King and Tim Hortons Inc, which runs coffee and doughnut shops.
Food industry experts see Kraft benefiting from Heinz's international presence, which generates more than 60 percent of its sales. Kraft brands are in 98 percent of North American households, the companies said, but would have a greater opportunity to expand overseas.
The combined company, which will be publicly traded under the name Kraft Heinz Co, expects to save about $1.5 billion in annual costs by the end of 2017. 3G has a reputation for introducing aggressive cost cuts and improving efficiencies at other companies it has invested in, including Heinz and Anheuser-Busch InBev NV (ABI.BR).
"Mature businesses look for cost cutting. 3G takes cost cutting to a different level," said Bob Goldin, executive vice president at food industry consultant Technomic. Goldin noted that neither Kraft nor Heinz are major players in the sector's growth segments, from organic to fresh foods.
The deal calls for the exchange of each Kraft share for one share in the combined Kraft Heinz Co, plus a special cash dividend of $16.50 per share to existing Kraft shareholders. The $10 billion behind the special dividend will be funded by an equity investment by Berkshire Hathaway and 3G.
Heinz shareholders will own 51 percent of the combined company and Kraft shareholders the rest. The transaction is worth about $46 billion for Kraft shareholders, based on Kraft's market capitalization of $36 billion on Tuesday before news of the deal emerged plus the special dividend.
Packaged-food makers from Kraft to General Mills (GIS.N) and Kellogg (K.N) are battling sluggish demand as consumers shift to brands that are perceived as healthier, including foods that are organic or less processed.
Kraft's efforts to revamp its own products, such as combining its higher-protein snacks like meat and nuts into one container called the P3 pack, have not shifted the tide enough.
In December, Kraft named John Cahill as chief executive, who acknowledged the company has not changed enough in the face of shifting consumer tastes. Cahill overhauled his leadership team last month, announcing the exit of three senior executives.
Cahill said on a call with analysts that 3G Managing Director Alex Behring approached him at the end of January about a possible deal. The discussions picked up in the second half of February.
While Kraft had been developing its own plan for change, the board saw the 3G opportunity as more compelling, said Cahill, who will be vice chairman of the combined company. Behring will serve as chairman of Kraft Heinz Co and Bernardo Hees, CEO of Heinz, will become CEO of the combined company.
Kraft Heinz Co will retain headquarters both in the Chicago area and in Pittsburgh. It will have combined revenue of about $28 billion, about half that of market leader PepsiCo in 2014.
Berkshire Hathaway will own more than 320 million of the approximately 1.22 billion Kraft Heinz shares outstanding, Buffett told CNBC, adding "We will be in the stock forever."
"Heinz goes back to 1859," he said. "I think those tastes are pretty enduring. There will be plenty of people that want to eat other things, but there are many people who want to eat the products that Kraft/Heinz turn out"
The deal is unlikely to face regulatory hurdles as there is little overlap in products, antitrust experts said. Areas that could draw regulatory scrutiny include steak sauces - Kraft makes A1 and Heinz makes Lea & Perrins.
"Whatever divestitures there are will be easy, and they will be kind of minor," said Fiona Scott Morton, who teaches economics at the Yale University School of Management.
Industry watchers had speculated for months that 3G would buy another food company after the Heinz acquisition.
Kraft's appeal, according to some, is that its brands occupy shelf space in the center of many stores, just like Heinz. That could lead to cost savings in merchandising and sales.
Kraft is 3G Capital's fifth major deal in the food and beverage industry since 2008, when it engineered the takeover of Anheuser-Busch by brewer InBev (ABI.BR).
3G Capital also controls Restaurant Brands International Inc (QSR.TO), formed when Burger King business bought Canada's Tim Hortons. 3G Capital and Berkshire Hathaway acquired Heinz for $23.2 billion in 2013.
Kraft split into two companies in 2012, with Kraft Foods focusing on grocery products in North America and Mondelez International Inc (MDLZ.O) on snack products.
Lazard was Heinz's financial adviser, while Cravath, Swaine & Moore and Kirkland and Ellis were its legal advisers.
Centerview Partners LLC was Kraft's financial adviser and Sullivan & Cromwell its legal adviser.
(Additional reporting by Diane Bartz in Washington and Lisa Baertlein in Los Angeles; Writing by Lisa Von Ahn; Editing by Michele Gershberg, Alden Bentley and Bernard Orr)