The Proposed Kraft-Heinz Merger

How Will This Marriage of Food Giants Affect Investors and Consumers?

The Proposed Kraft-Heinz Merger
April 27, 2015

A mega-merger was announced recently that, if approved by regulators, will bring together two of the most iconic brands in packaged foods — Kraft (NASDAQ: KRFT) and Heinz (NYSE: HNZ) — and create a new worldwide food and beverage behemoth.

Private investment group 3G Capital and Warren Buffett’s Berkshire Hathaway bought H.J. Heinz Company in 2013. Now they plan to acquire Kraft Foods Group Inc. and create The Kraft Heinz Company, which will become the third-largest food and beverage company in the U.S. and fifth-largest in the world. The Kraft Heinz Company will have total worldwide annual sales of about $28 billion and a market value exceeding $80 billion.

Not the First Go-Round

3G Capital has some experience in merging well-known consumer brands. It took over Anheuser-Busch in 2008 to create Anheuser-Busch InBev, the world’s largest brewer. In addition, it acquired Burger King in 2010 and then merged it with the Tim Hortons doughnut chain last year to form Restaurant Brands International, a new restaurant company.

Interestingly, this mega-merger of processed food giants is occurring at a time when many health-conscious households are moving away from the processed food staples like Kraft mac and cheese, Lunchables, and Velveeta cheese for which the companies are best known. However, early reviews of the merger have been mostly positive. Many analysts believe the merger is a smart move, as it will enable the newly merged company to benefit from more international growth opportunities and greater economies of scale, thus helping offset the negative effects of increasingly cost-conscious food consumers.

For example, Heinz has a much larger global footprint than Kraft, with 60 percent of its sales derived from regions other than North America. Conversely, 98 percent of Kraft’s sales occur within North America. The merger should enable Kraft products like Velveeta, Planters and Lunchables to gain much more exposure overseas.

Mega Cost Savings

Management projects up to $1.5 billion in cost savings for The Kraft Heinz Company due to increased economies of scale, primarily in North America. Higher sales volumes should enable the company to negotiate better deals with large and specialty food retailers and restaurants. The result will be improved operating margins and better placement on retail shelves.

Reducing the total number of employees at the new combined company and closing inefficient manufacturing facilities should also yield significant cost savings. The new executive team at Heinz implemented drastic cost-cutting measures after the 3G Capital-Berkshire Hathaway acquisition, including a four percent workforce reduction, the closing of several factories and the grounding of corporate jets. Therefore, it is reasonable to expect the same kind of financial belt-tightening at Kraft Heinz.

In addition, zero-based budgeting is a financial and accounting tool used by 3G Capital that has led to major cost savings at many companies it owns, including Heinz. This budgeting technique requires managers to start from scratch (or zero) with their budgets every year with no regard to previous years’ financial trends.

The merger should also result in significant supply chain benefits. Both Kraft and Heinz have sophisticated supply chain cultures that should be easy to integrate, and they both use advanced analytics in their supply chain management operations. The merger will give the new company more supply chain leverage over suppliers, enabling it to improve supply chain efficiency further.

Both Kraft and Heinz use advanced market clearing algorithms to identify market-based savings opportunities and challenge internal operating constraints. These algorithms can prove invaluable in helping to make sure projected cost savings like those described here are actually realized.

Are the Benefits Realistic?

It is not uncommon for companies to trumpet rosy and optimistic forecasts of synergies and huge cost savings when announcing a mega-merger like this one, only to see most of them vaporize after the merger is complete and the real work begins. So how realistic are the merger benefits being touted by Kraft and Heinz?

Writing on Forbes.com, a supply chain expert said he believes the cost savings target of $1.5 billion is actually very conservative: “Each company spends nearly $1.5 billion annually on just the transportation of these supplies and products, making their combined transportation network spend about $3 billion annually. By simply optimizing the combination of these two networks, there’s probably 10% on the table. That’s just one example. There are many more.”

Of course, the proposed merger must be approved by regulators before it can proceed. However, the consensus among those in the regulatory community is that there should not be any significant antitrust hurdles to overcome for approval. In an article in The New York Times, one former FTC official noted: “These product lines seem to be more complementary, but where they find any overlaps they could look for a divestiture of the overlap lines.”

Overall, the proposed Kraft-Heinz merger looks like a win for everyone: both companies, their shareholders and their customers.

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