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NEW YORK (Reuters Breakingviews) - The world's wiliest takeover artists have found their biggest target yet. Kraft Heinz, the Kool-Aid-to-Velveeta conglomerate, has offered $143 billion for Unilever, its Anglo-Dutch rival. Even for 3G Capital, the private investment firm behind Kraft Heinz, beer giant Anheuser-Busch InBev and Burger King owner Restaurant Brands International, it's an audacious move. To land Unilever, which rejected the offer, Kraft Heinz may need to pass the hat around to shareholders like Warren Buffett.
The secret sauce that 3G's five Brazilian founders apply to the companies they invest in is what's known as zero-based budgeting. This is the practice of starting from scratch in assessing the expenses of every part of the business. As frightening as that sounds for employees, it has been a boon for shareholders. So much so, that rivals of 3G enterprises now often pepper their corporate-speak with the short-form "ZBB."
Unilever offers a salivating opportunity for 3G to work their cost-cutting magic. The sprawling group led by Paul Polman, whose brands spread from Magnum ice cream and Dove soaps to Lipton teas, reported a 2016 operating profit margin of just 15 percent, compared to 23 percent at Kraft and around the same at Procter & Gamble. If 3G could capture Unilever, slash expenses and close that gap, it might generate more than $4 billion a year of extra pre-tax profit.
The present value of those potential savings, after tax, is more than sufficient to cover the roughly $20 billion premium Kraft Heinz offered. In fact, it leaves room to sweeten the 18 percent uplift significantly. The problem, though, is paying for it. As it stands, the offer is over 60 percent in cash. Funding that $86 billion slug with debt would triple the net amount currently borrowed by the two companies combined to roughly $130 billion. Even allowing for generous cost savings, the ratio of debt to EBITDA could surge well above five times, Breakingviews calculates.
Of course Kraft Heinz could also raise cash by issuing new shares, reducing the need to borrow. Here's where 3G and its cash-rich partner, Buffett's Berkshire Hathaway, come in. If they want to retain their current majority control, they might have to pony up $50 billion or more between them. That would bring the enlarged company's leverage down to below three times EBITDA.
As well as keeping the two investors in charge, the Kraft Heinz M&A machine would then have much more capacity to continue devouring other food companies and spreading the ZBB cult across the planet.