Kellogg looks like someone wants to eat it for breakfast. Takeover speculation has helped the U.S. company’s shares rise more than 8 per cent since April, bestowing it with a $25-billion (U.S.) market value. Kellogg may be too big for a Hillshire-like takeover battle, and carries too much debt to make a traditional leveraged buyout palatable. But a deal like the one Warren Buffett and a group of Brazilian financiers struck for ketchup-maker Heinz last year might work.
Kellogg’s $7.4-billion of net debt limits how much a buyer could borrow to juice returns in a straight LBO. A deal struck at a 20-per-cent premium to the Corn Flakes maker’s current market cap, funded with 30 per cent equity, would burden it with net debt of more than nine times earnings before interest, tax, depreciation and amortization. That’s too high for comfort.
Heinz shows a more digestible solution. Mr. Buffett and his Brazilian partner 3G financed their $28-billion acquisition with around $8.2-billion of equity and $8-billion of preferred shares. A similar move would value Kellogg at an enterprise value of about $37-billion. Net debt would be 5.4 times EBITDA, a tad lower than the leverage slathered on Heinz. Interest cover would be tight at 1.5 times EBITDA, including the cost of preferred dividends. But Mr. Buffett and friends left Heinz similarly stretched.
Such a deal would still present challenges, requiring a huge equity check and the same long-term approach to returns that Mr. Buffett and 3G took. These partners might double their money on Heinz, but it’ll take 10 years and require that sales grow 4.5 per cent a year and margins jump by a third, Breakingviews calculated at the time.
Mimicking that at Kellogg will be harder. Soggy U.S. cereal sales mean analysts don’t expect revenue growth to top 3 per cent before 2018, according to Thomson Reuters data. And fierce competition in the breakfast aisle may limit gains from cost cuts.
Still, if Kellogg could coax out 5-per-cent EBITDA growth, investors could feasibly make a 12-per-cent return on their equity investment, excluding the 9-per-cent return on the preferred shares. If the Sage of Omaha wants to do a Heinz with Kellogg, he’ll need a solid operating partner – and bowls full of patience.
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