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Baked beans on toast for two of the world’s richest men

Kraft-Heinz-Main-BrandsBrazil’s richest man Jorge Paulo Lemann has teamed up with Warren Buffett to engineer a deal to merge with Heinz which will not generate much enthusiasm amongst the gourmet elite of this world.  But the Kraft Heinz merger has everything it takes to get financial markets excited, with the promise of USD 1.5bn annual savings by 2017 and combined sales of USD 29bn, making the future group North America’s third largest food and drink company and the world’s fifth.

Two unknowns remain.  Will the Kraft Heinz Company manage to generate growth beyond the annuity it will derive from savings in overhead costs?  And can it develop new product lines to evolve away from the very 1970’s image that characterizes much of the present range?

Why Oscar Mayer dogs, Mayo®, HP Sauce®, Jell-O®, Philadelphia® and Kool-Aid® can still generate billions

Changing living patterns and the increasing involvement of women in full-time employment created fast growing demand for time-saving foods through the 1950s until the early 1980’s; this was an era of instant coffee and Wonder Mash® which also witnessed the global expansion of fast-food restaurant chains.  But the world has moved on since the days of Macaroni and cheese.  Improvements in Supply Chain efficiency combined with advances in food science now allow supermarkets to offer a broad choice of ready meals of increasing sophistication.  Today, “convenience” also includes anything from fresh ready-to-eat mango salad to ready-to-cook peeled vegetables, as well as meal modules which consumers can combine to produce healthy balanced meals, with a starter, a main course and a dessert if they so desire, that provide the taste, nutrition value and visual appeal of the “real thing” without all the fuss of starting with basic ingredients.

So with every consumer survey telling us that people are now opting for organic or at least more natural foods from sustainable sources, and with the abundance and variety of quality foods on today’s supermarket shelves, how is it that companies such as Kraft and Heinz still manage to achieve sales that combine to USD 29 billion?

Karft-Portfolio
Kraft’s broad portfolio of brands will add to the Heinz range.
Now spot the missing item : the healthy option

Part of the explanation is to be found in the significant price gap between today’s high quality fresh products and run-of-the-mill heavily processed foods.  The average household’s budget priorities have changed over the past decade, with electronic gadgets, leisure and entertainment claiming an increasing share of the consumer’s wallet.  It is tempting for large families or for those on lower income to make savings on food when cheap alternatives can provide the same feeling of satiety at a fraction of the cost of the fancier items beautifully displayed on the supermarket shelves.

Secondly, one also needs to bear in mind that decades of mass-produced processed foods have created a degree of addiction to sugar, fat and salt, so that the consumers who opt for a large plate of French fries smeared with a generous layer of Heinz Ketchup may do so by choice rather than as a result of financial constraints.

There is, however, pressure from all sides to move consumers away from the heavily processed and generally unhealthy types of foods that come off the production-lines of companies such as Heinz and Kraft.  Eating habits do not change overnight, but the change will happen gradually.  Increasingly, the cost saving will become the only justification for buying “junk” food, and when that is the case, consumers guided by the need to make savings might opt for a supermarket’s own brand or a completely generic product rather than “premium branded” processed food.  This is not good news for the future Kraft Heinz Company in the longer term.

Management style will change things faster than eating habits

When Brazilian 3G and Warren Buffet’s Berkshire Hathaway acquired Heinz in 2013 and took the company private, it must clearly have been part of their plan to make another acquisition in that sector to create a paradigm shift within Heinz and change the balance of forces on the market.  Merging with Kraft turns that potential into a reality.  The shake-up is about to begin.

Jorge Lemann
3G’s Jorge Lemann
Warren Buffet
Warren Buffet

3G have acquired a reputation for very aggressive cost cutting, not just the excess or even the frills, but deep cuts everywhere possible whilst also challenging the priorities and seeking solid justification for any capital project or major item of expenditure.  Advertising costs are therefore most likely to be put under close scrutiny.  In my first job in the 1970’s as advertising research executive in one of London’s major advertising firms, my line manager told me “advertising is a unique product: we don’t know how it works, the client cannot tell for sure whether it works or not, and if it doesn’t the client doesn’t get his money back”.  3G surely won’t see it that way and today’s advertising gurus will need to come up with convincing reasons to justify every dollar of advertising spend if they want to retain the Kraft Heinz Company’s account.

Once the fat and duplication has been trimmed off the combined business and further savings are achieved through wiser allocation of sales and marketing funds, let us hope that the Kraft Heinz Company will re-invest some of their USD 1.5 billion annual saving into developing new lines of food to regenerate their portfolio, fuel longer term growth, and preserve the notoriety of those household brand names.

No celebrations for the banks this time

As not all mergers end up being successful, conventional wisdom would say that mergers and acquisitions present shareholders with the potential for value creation, whereas they offer banks and advisers immediate value through fees and financing arrangements.  The deal struck by Warren Buffett and Jorge Paulo Lemann is about to cause a serious dent in that conventional wisdom.

A merger of the magnitude of Heinz and Kraft’s would normally be toasted with champagne by the investment banks whose names invariably pop-up each time a deal is struck.  But in this particular case, the only toast will be the one covered in humble Heinz baked beans, because the two giants behind the deal are sitting on huge cash reserves and will not need big financing.  This means that Wall Street’s major banks will all miss out on their share of what is currently being tagged as the biggest M&A deal of 2015.

Oh well, we’ve only just reached the end of Quarter 1, there is still some time for other big guys to spark off a few more “biggest M&A deals of 2015” during the coming nine months.

On course for becoming the world’s number one

Last April when Holcim and Lafarge announced their intention to merge, I was not the only one to predict that this mega-merger project would be a feast for the anti-trust regulators across the world, and indeed it has been.  However, given the complexity and magnitude of the deal, we must acknowledge one year down the road the accuracy with which the outcome of the regulatory process has matched the two giants’ advisors prediction as far as Europe is concerned.

HOLCIM Y LAFARGE ASEGURAN QUE SU FUSIÓN NO IMPLICA EL CIERRE DE FÁBRICASJust over a decade ago, uniting Holcim and Lafarge would have been unthinkable.  Regulators used to spend their time and energy scrutinizing the cement industry to detect any signs of collusion between the key operators of what had already been an oligopoly for many years.  But in today’s global scale economy, European regulators have become less shy about allowing the formation of giant companies capable of capturing sizable shares of the market in major European countries; after all, Europe needs a few such global heavy-weights to avoid being completely dwarfed by Asia and the Americas.

Lafarge’s spokesperson mentioned last April that they and Holcim were expecting to have to divest up to 15% of the new group’s assets to secure the anti-trust authorities approval of the deal and this is where they now stand, having received the approval of the EU anti-trust authorities on the condition that a sale of that magnitude is made before the two giants proceed with their merger.

Biggest hurdle removed

It was always clear that the bulk of divestments required by the regulators would be within Europe, and many external observers (including myself) feared that obtaining an acceptable price for the sale of cement business in Europe’s saturated market might prove difficult or impossible.  Divesting European assets piecemeal would have been lengthy and risky, delaying and possibly jeopardising the whole deal as the sale of all those assets was a pre-condition set by the EU antitrust regulators.

Holcim and Lafarge’s decision to auction the assets as a bundle was risky but has now paid dividends.  The presence on the market of a single acquirer interested in taking on those assets as a bundle has secured the value and clarified the time-line of the merger.  The Deus ex machina who has offered EUR 6.5 billion for the bundle is Cement Roadstone Holdings, better known as CRH, whose insatiable appetite for acquisitions has made the whole Holcim – Lafarge deal possible.

Just when everything is looking fine, someone spoils the game

india_cementWhereas the course of events in Europe has followed a well predicted roadmap, the unpleasant surprise on the path to Holcim and Lafarge’s union has now come from India where the regulators fear that the Holcim – Lafarge deal would cause a serious imbalance on their very vast and growing market.  In an interesting and quite unusual move, India’s CCI (Competition Commission of India) required Holcim and Lafarge to publish the details of their proposed deal on their respective websites as well as in a selection of national newspapers, so that every interested party in the Indian subcontinent could have access to the relevant information and be given sufficient time to formulate comments and possible objections.  This is only the second time that a merger proposal is submitted to general public scrutiny under Section 29(3) of India’s Competition Act, 2002.

The CCI delivered its decision earlier this month, allowing Holcim and Lafarge to proceed with their merger provided assets including large limestone reserves situated in eastern India are divested.  There is a welcome proviso, however, in that these assets do not necessarily have to be sold to a competitor, consequently these forced divestments might still fetch a price which will not cause Holcim and Lafarge to cringe.  They now have 30 days to respond to the CCI’s decision.  India was not on the regulatory radar screen of Holcim Lafarge; this will have been a nasty surprise but is unlikely to be a show stopper at this advanced stage of the game.

Some players have won before the lottery is drawn …

Far from the challenges and uncertainty that lay ahead for Holcim, Lafarge and CRH, some of the players involved in this giant M&A scheme can already shout : “BINGO”.  The number of transactions involved in the pulling together of Holcim and Lafarge, and the added opportunity of overseeing the divestments that will be required to allow the merger project to complete, are an absolute bonanza for all the banks and investment houses involved in advising the two players.  Can you spot anyone missing in the impressive list of those who have advised Holcim, Lafarge and CRH:  UBS, Bank of America Merrill Lynch, JPMorgan Chase, Davy Group of Ireland, BNP Paribas, Morgan Stanley, Zaoui & Co, Rothschild, HSBC, Credit Suisse and Goldman Sachs.

… for others, the work has only just begun

crh-dispute-2012
Hopefully better times ahead for CRH after their staff demonstration in 2012

CRH’s EUR 6.5 billion acquisition provides them with a series of businesses in Europe, as well as in Brazil, the Philippines and Canada; a golden opportunity to leap ahead on their very ambitious growth curve. CRH are serial acquirers, well accustomed to integrating the companies; the Irish company of the 1970’s has become a global player, with some previous experience of acquiring businesses from Lafarge in recent years.

According to the Financial Times, CRH has spent some USD 24 billion on approximately 650 acquisitions since 2000. However, the acquisition of the Holcim – Lafarge bundle will be of a magnitude they have never experience before.  Growing one’s business by 33% in one single step is no easy task.

As for Holcim and Lafarge, their merger remains incredibly ambitious, with this future world leader set on transforming the whole industry with products and concepts that may revolutionise modern construction. A lot of interesting developments to be observed over the coming two or three years.

 

And exciting 2015 looms…

In recent weeks, early signs of big changes to come in the UK’s telecom landscape have sparked off speculation as to which of the key players might join forces, or possibly even quit the UK scene to re-invest elsewhere.  Why now?

UK consumers and businesses enjoy one of Europe’s most competitive Telco market, due to the number of operators and presence amongst them of some game changers, such as Talk-Talk, who upset the cosy rules that prevailed on the market when British Telecom had to give up its monopoly.  Such competition obviously leads to meagre margins, and the belief of many of the operators is that end-users need to be offered a “bundle” of services, covering fixed and mobile telephone, internet access and on-line TV content.

logo_telecomsJust in the same way mobile phone tariffs are difficult to decipher, those all-in-one “quad” service bundles blur the cost of each of the services; and so the proliferation of such bundle offers in recent years is possibly better explained by the fact that they protect the operators’ margins rather than offer the end-users any tangible benefits.  If that were not the case, the take-up of these new bundle offers would have seduced more than the current 17% of users who have subscribed to them.  Selecting a common supplier for fixed telephone and broadband makes logical sense, particularly with the generalisation of voice over IP, but I strongly suspect that the choice of mobile provider is also strongly influenced by territory coverage (which is still quite imperfect in the UK), roaming tariffs and the choice of features offered by the operator, rather than a supposed simplification resulting from having just one supplier for all of the services.

Join forces, stay as is, or quit?

Telecom operators have not had it easy in the last few years; websites and on-line applications require ever increasing flows of data as digital content is consumed through real-time streaming, forcing the providers to offer ever-growing bandwidth for which the end-users are not prepared to pay any more than they did in the past.

Whilst the strong competition that has prevailed thus far in the UK has created a very favourable environment for end-users by keeping prices down, the margins generated on the UK market are probably insufficient over time to allow the massive and continuous investments that will be required to satisfy the users’ appetite.  If bundling fixed telephony, broadband access, mobile telephony and digital content is the only way of protecting the revenue required to growth further and survive in this very demanding market, dedicated mobile operators such as Vodafone, O2, Three or EE, will need to seek alliances to gain presence across the spectrum of telecom services, and this will require them to have cost effective access to fibre networks.

Vodafone has already taken a few steps in that direction with the recent acquisition of Ono in Spain and Kabel Deutschland, so it would only be logical for that company to seek a similar move in the UK to build further on its 2012 acquisition of Cable & Wireless.  Current speculation about Vodafone making a bid to acquire Liberty Global, which operates Virgin Media in the UK as well as very high-speed broadband networks in ten other European countries, would allow Vodafone to leapfrog ahead of its competitors. If the regulators don’t object to such a concentration of control over fibre networks in Europe, the other players will be forced to either rent the networks owned by BT or Vodafone, or pull out of the British market.  Building an alternative broadband fibre network would be another possibility, but it could prove prohibitively costly, unless that third offering were limited to a few large conurbations where the density of users might justify the huge investment.

One thing is certain.  If Vodafone teams up with Liberty Global, the other mobile operators will not survive on a status quo and will be forced to move.

Exit the UK market, really?

What would have sounded inconceivable a year or so ago is becoming a distinct possibility; or at least it is envisaged by EE, the joint venture of Orange and Deutsche Telekom, as well as by O2.  Both companies are reported to be exploring the possibility of selling their UK businesses to BT and exiting the exceedingly competitive British mobile business, to seek their fortunes elsewhere, in countries where a consolidation of fixed and mobile telephony with broadband networks may be easier to achieve rapidly.

If the so-called “quad” bundles of services are really the panacea that will allow telcos to thrive in Europe, then something big is likely to spark-off during 2015, but the magnitude and complexity of any deal, as well as the scrutiny to which such deals will be inevitably submitted by the regulatory authorities, means that the European telecom landscape may take much longer before any radical change really materialises.