the

The Rise and Fall of Kraft Heinz

the rise and fall of kraft heinz was

unexpected

because when heinz asked for craft's

hand in marriage he did so

under the promise of becoming the number

five global food and beverage company

merging sauces cheeses and meals and

putting their combined 29.1

billion of revenue right behind mandalas

crafts former lover mondelez and craft

used to be the same company

but they had an amicable split in 2012.

after the split kraft kept the falling

brands including

macaroni and cheese planters peanuts

oscar meyer turkey breast

and maxwell house but the smaller size

would make craft a target

for another companion realizing this two

matchmakers

came up with a deal these matchmakers

were two of the world's most legendary

investors

warren buffett the octogenarian who grew

berkshire hathaway from a small textile

manufacturer

into the seventh largest company as of

2019

and giorgio paulo lehmann a former

tennis player

turned financier and the richest man in

brazil

with a net worth of 20 billion buffett

said of raymond

right before the kraft heinz marriage

whatever the structure

we feel good when working with george

apollo

putting together two legendary investors

and the iconic brands of crafton hines

would seem to be a recipe for success

but this is the story of the rise and

fall

of craft times if you like this type of

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articles how did kraft rise to become

the current

fifth largest food and beverage company

in north america

and at one point in time the second

largest food and beverage company only

behind nestle

the founding was in 1903 by james l

craft james had 65 or 1900

inflation adjusted which he used to buy

a horse and carriage

he and his horse named patty would

deliver cheese from warehouses to local

shops

this was done in chicago illinois which

remains the present day headquarters

by 1909 james and patty expanded

james added his brothers and the

business was renamed

j.l kraft brosco by 1915

recognizing that he was losing money

because of spoiled cheese

james sought to make the shelf life

longer his contribution to the cheese

industry

was being the first person to develop

pasteurized cheese

by 1916 sales had expanded to 150

000 or 4 million inflation adjusted

perhaps with visions for the future

they decided to share the pattern with

the phoenix cheese company in 1921

who is also experimenting with

pasteurized cheese at the time as craft

continued to expand

a giant was emerging national dairy

products

thomas mchenry its founder is arguably

the most integral piece of the craft

story but perhaps he is less known

because he did some very wall street

things such as using

a roll-up strategy a roll-up strategy is

taking a few firms

and merging them together the goal is

combining certain tasks

such as accounting or administration and

gaining economies of scale

national dairy had acquired over 40

companies by 1930

and its sales and market value grew

rapidly right before the great

depression

it had sales and a market value of 300

million

or about 4.5 billion in today's dollars

national dairy had great ambitions craft

bought the phoenix company in 1928

the two dairy giants would meet in 1930.

at this time

national dairy had 300 million of

revenues compared to 86 million

of craft because the acquisition was so

large it drew the attention

of the us government anti-monopoly

commission but mckinnery

assured the government that this would

not be a monopoly for now

craft was the subsidiary national dairy

was the largest producer of dairy

its products included milk ice cream and

cheese

but dairy products such as cheese were

cyclical

and the seller had little control over

the price therefore crafts innovation

of products was welcomed it introduced

miracle whip in 1933

as a salad dressing and macaroni and

cheese in 1936

despite a drop in sales during the great

depression national dairy was becoming a

powerhouse

especially once the us entered world war

ii in 1941.

world war ii was a time for expansion as

the us government ordered 6 million

pounds

of its cheese as we moved into the 1950s

the two founders would pass on and soon

so with the national dairy tradition

in 1953 with sales of 1.2 billion

or 12 billion inflation adjusted 24

of sales were in other products such as

miracle whip and 23

in cheese a business line heavily

influenced by kraft

in 1953 national dairy invented skim

milk which was originally formulated by

its scientists to combat the excessive

waste

from making cheese and butter but it was

soon marketed

as a health product this would help

propel sales to 1.5 billion

by 1957. as we move through the 1960s

the subsidiary craft introduced more

products such as marshmallows

fruit jellies barbecue sauce and craft

singles

crafts revenue continued to expand and

by the late 1960s

craft cheese and other products were 70

percent of the business

up from just under 50 percent in 1953

craft had gained such dominance

that shareholders wanted a name change

they voted on kraft corp

as thomas mchenery's national dairy

would be lost to the sands of time

as we moved through the 1970s sales

accelerated

and reached 6.4 billion by the end of

1979

the craft name was more ubiquitous than

ever and dairy products were now

only 7 of the company earnings after tax

also reached a record of 188 million

by 1979. kraft was now a large company

and it needed to follow what other large

companies at the time did

so it became a conglomerate it merged

with dart industries

which was owned by justin dart who was

in his late 70s

once merged kraft ranked as the 27th

largest industrial company

with a total market value of 2.2 billion

we were in

the age of conglomerates the major

brands of the conglomerate

darden craft were kraft duracell

and tupperware tupperware was all the

rage in the 1980s

and was a highly sought after investment

as the popularity of tupperware parties

was growing in order to understand craft

at the present date

we must detour on general foods buffett

would get his first taste of kraft

indirectly through a 1979 purchase of

general foods

he slowly built his position in the

company that had brands such as jello

and kool-aid when philip morris the

largest tobacco company in the united

states

bought out general foods in 1985

buffett's profit

was a staggering 300 million or

one-fourth

of his entire equity portfolio at the

time buffett said regarding the deal

they made us a lot of money at the time

general foods was one of the largest

companies

and was on the dow jones which is an

index comprising america's most

influential companies

after the purchase philip morris became

part of the dow

philip morris was large very profitable

young

and cocky it was america's 17th most

profitable company

and it also owned other major brands

such as miller beer

and 7up back onto kraft

while its conglomerate was operating

swimmingly

the 1980s saw the rise of the activist

investor

like carl icahn who has a current net

worth of 20 billion

and is known as a corporate raider as he

profited off of hostile takeovers

by buying poorly understood companies

and selling off

their assets kraft quickly decided to

avoid corporate raiders

and it deconglomerated meaning it

started

to sell off its non-related pieces which

included tupperware

and hobart's its kitchen appliances

segment to reflect this change

the name was changed back to craft from

dart and craft

too bad for justin dart who died just

two years earlier

in 1984 in 1988 crafts realized the

battery business was also unrelated

and it sold off duracell for 1.8 billion

craft was highly profitable

and that sale gave it a lot of cash it

had over 12 billion of revenue

and over 1 billion of profit this gave

the whale

philip morris an idea philip morris the

company who recently purchased

general foods stunned the market with an

11.5 billion

offer for craft but craft the company

with powerful brands

and over 50 000 employees rejected the

offer feeling its value was not properly

reflected

philip morris then upped the ante to

13.6 billion or 106 dollars a share

and craft agreed at the time this was

the largest

non-oil merger ever and represented a 77

premium to crafts pre-deal price the

long history of craft

starting from national dairy can now be

seen for the first time since 1923

it was no longer a public company acting

like a hedge fund manager

philip morris sought to combine the two

divisions to increase

efficiencies the food division would

have over a hundred thousand employees

and some of the following notable brands

what was even better for philip morris

there was little overlap between the

brands

kraft primarily made dinners while

general foods

mostly made beverages cereals and snacks

in 1990

the smoking food empire would be

cemented further by the purchase

of the swiss company jacob suchard who

made most of

its money from chocolate bars and coffee

philip morris was now the second largest

food and beverage company in the world

behind only nestle while craft general

foods did not begin

falling under phil morris if anything it

strengthened

under its ownership craft had eight

percent operating margins

in 1988 operating margins are how much

profit you make before taxes

and interest expense divided by revenue

it is a measure

of a firm's pricing power and efficiency

at the end of the 90s

craft's operating margins would double

to 16

but philip morris perverted the identity

of craft general foods

and played a part in the fall decades

later philip morris

got rid of low margin businesses such as

breyer's ice cream

even though this brand had been with

craft since its origins in 1923

the business was also significantly

restructured

food division employees went from over

100

000 to 71 000 but operating income would

soar from 2.1 billion

to nearly 4 billion by 1994. in 1995

once again the craft name would live on

the name craft general foods

was confusing consumers therefore the

general foods name was dropped

once again another name was lost but the

craft name

lived on in the late 1990s philip morris

offered a voluntary buyout for four

percent of the workforce

crafts profitability had never been

better operating margins

and profits reached record highs as the

90s came to a close

but despite increasing operating profit

of craft

the tobacco legal settlements were

taking its toll

on the profitable giant the stock

rallied in november 1988

when a large legal settlement of around

400 billion was announced

philip morris still pays part of this

settlement today

but then its stock started to fall again

this was a weird time for tobacco

companies

as investors were worried about

individual settlements

philip morris would soon be ordered to

pay 3 billion by a jury

to just one man and later 28 billion to

one woman

while these claims were later reduced to

around 10 million

in 1999 this uncertainty represented

panic

because of its low stock price philip

morris allowed kraft

to step out of his shadow but before

doing so

it made kraft an even greater powerhouse

it bought nabisco

or national biscuit company which had

well-known brands

like oreos for 14.9 billion

and craft extended its lead in north

american food sales

reaching 24.5 billion it also passed

unilever as the second largest food and

beverage company

the purchase added to crafts snack mix

which was the fastest growing meal

category at the time

the combined company would have over 117

000 employees

giving room for synergies a favorite

word of philip morris

to step out of its shadow philip morris

announced the second largest

initial public offering ever at 8.7

billion

where it would carve out less than 20

percent of its shares

to the public market a carve out is a

tax-free transaction

because tax rules state if you maintain

over 80 percent of the stock you didn't

effectively sell

hence there are no capital gains the

sale would give craft a total market

value of 52 billion

over four times the price when phil

morris bought it

morris did the carve out for three

reasons with its low share price it felt

the craft brand was not being correctly

valued inside its company

if it needed to exit the position to pay

for high smoking liabilities

it could raise cash quickly it had

waited to have enough

assurance that in the case of bankruptcy

creditors could not come after the craft

assets

craft was happy to be somewhat separated

but philip morris still

owned over 80 percent of the stock and

had no intention to sell

so its similar cost cutting strategies

continued

employees were reduced to 90 000 by the

end of 2006.

revenue stagnated despite now owning

nabisco

but in 2001 kraft was happy to have some

way to express its freedom

and it reminded investors that it was

very big

craft eagerly showed off its brands in

its 2001

annual report despite initial excitement

kraft

stock remained relatively flat over the

remaining period

of philip morris ownership finally some

good news for kraft

philip morris now named altria said it

would spin off at stake

in march 2007 kraft was independent

again

and the company was ready to begin a new

chapter in its long history of changes

in 2006 it named irene rosenfeld as ceo

she noticed stagnating revenue growth

since philip morris bought the company

back in the 1980s she wanted to make

craft a growth company once again

in 2007 she sold post cereals through a

split off transaction

which is the transaction shown in the

top left a split off is a tax-free

transaction

in order to do it a company determines

the value of the business unit

such as post-food cereal and allows

shareholders to trade

their craft shares for shares in this

new company noticing the turnaround

warren buffett now 20 years older

returned to buy craft shares

but this holding wouldn't make him a lot

of money like it did in 1985

and buffett went to war with craft ceo

rosenfeld the conflict would soon come

out because of

irene's growth ambitions craft saw

that the north american market for snack

foods and dinners

were stagnating while developing markets

were growing

so it bought da nan a french company for

7.6 billion

in november 2007. in 2008 craft was

added to the

prestigious dow jones index it was now

seen as one of the largest most

influential companies

in america it replaced aig in september

2008

kraft feeling good as a member of the

dow jones had more growth ambitions

it announced in september 2009 that it

would purchase

the united kingdom's cadbury cadbury had

a lot of its business

in fast-growing developing markets

making it attractive

to craft but cadbury rejected the offer

and buffett told rosenfeld

to be careful about a bidding war the

transaction was also controversial as uk

residents wanted kraft to get lost but

she did get into a bidding war

and craft's offer was raised by over 10

to 19.4 billion

the acquisition was completed in january

2010.

what annoyed buffett was that kraft sold

its highly profitable pizza business

which had earnings before taxes of 341

million

for 2.7 billion after tax therefore

buffett noticed that they sold a

business

and under 8 times operating profit to

buy a business at 23 times however irene

saw

synergies which would make the

transaction at only 13 times

and she felt cadbury was positioned for

better growth

when asked about the criticism rosenfeld

said buffett would be sending her

a congratulatory card in less than five

years

craft stock went on to increase by over

41 percent over the next two and a half

years

but unfortunately buffett was fed up and

he soon exited his position at a small

loss

by august 2011 kraft was ready for its

next step

it was going to split up into kraft and

mondelez

mondelez is a mash-up of two words mondi

meaning world and de lez

meaning delicious craft would focus on

stable north american grocery

and mondelez the fast-growing snack and

developing markets

craft was now far away from its smoking

past as it

had separated into two snack giants

irene would stay on as mondelez's ceo

until 2017. irene had respectable

performance

over her term as ceo when she stepped

into kraft

the market value of the company was 50

billion in 2006.

when she left mandalas had a value of 60

billion alone

and kraft had a value of 40 billion this

means

she added 50 billion to the market value

of the two companies

or 8 percent a year very respectable

the split allowed the new smaller craft

to recognize and focus

on its weakness kraft noticed before it

separated

that its marketing and r d were too low

and well below the peer average

so it substantially increased

advertising following the separation

craft was finally operating like it did

before the philip morris acquisition

with advertising and r d increase kraft

got

its innovation groove back it noted that

in 2008

almost all its new product launches

failed but in 2013

it created three new brands that already

had sales of over 100 million

including meo beverage craft was doing

well as a separate entity

its stock was up almost 50 percent or 15

on average a year but then philip morris

re-entered in another form

as warren buffett and 3g capitals

investors were excited to have two

legendary investors

jump back into the fray but their

decisions over the next few years were

costly

and the fall of craft heinz began

buffett and 3g capital

made their first mistake by using too

much leverage

it all started with their 2013 purchase

of heinz for 23 billion

where they used a significant amount of

debt the deal was odd for buffett

as he had spent much of his career

lecturing people on debt

in 2004 he said his one piece of advice

just don't go into debt it's very

tempting to spend more than you earn

obviously buffett has always been known

to break his own rules but this break

was extremely odd heinz now had a very

levered structure

it had issued 12 billion of debt and 8.3

billion of preferred stock to buffett

preferred stock is essentially debt but

with a few less rights in the case of

bankruptcy

buffett's preferred dividends consumed

all of heinz's profits in 2014

and this must have made 3g capital

uneasy 3g

had contributed 4.25 billion of equity

but it was not earning any returns on

the other hand buffett had contributed

12.5 billion

but his return was only the preferred

stock dividend of 720 million or six

percent

a year furthermore heinz's earnings were

now not much more than its debt

heinz's operating income to interest

expense showed very high risk

at 1.6 billion of operating income to

700 million of interest expense

or 2.3 times which is worrisome

unbeknownst to the market

but in trouble the duo orchestrated a

larger deal

they benefited from their image and that

heinz's financials had not been public

for two years

in order to convince craft shareholders

buffett and georgia apollo

put in another 10 billion combined this

would fund a large 16.5 dollar dividend

a share

to craft shareholders they eagerly

accepted

for only 18.5 billion buffett and

georgia apollo

now owned 51 percent of kraft and heinz

a large

discount to their pre-buyout prices and

they assumed craft's bigger size could

support the large amount of debt that

heinz couldn't alone

however kraft heinz was no longer

conservatively run it was highly levered

you would have expected buffett to

adhere to what he knew

that leverage could amplify returns and

losses 3g's strategy of leveraging up

companies worked with restaurant brands

international

an investment they formed in 2014 the

strategy worked as long as a business

can improve its results

but unfortunately for them craft heinz's

results worsened for two reasons

the first reason was somewhat external

the changing tastes of consumers in

north america

the second was their error they cut

spending on research and development and

advertising

drastically the second mistake was a

combination

of them not seeing the changing trends

and errors made by berkshire and 3g

capital

national brand sales slowed to only 7.4

percent growth over five years

compared to 41 percent of private label

private label is a store's own brand

such as costco's kirkland

however national brands still had growth

and craft heinz performed

much worse than the industry second

consumers were looking

for organic food options more and more

but the changing trends could have been

thwarted

in 2013 craft got back its innovation

groove

by increasing spending in r d and

advertising

therefore this leads into mistake number

three cutting spending

in 2012 kraft outlined that they spent

only 2.9 percent on advertising

and that this was too low but when 3g

and buffett took over

they cut advertising to 2.2 percent of

revenue worse r d

shrunk to only 109 million in 2018. the

combined company

had lower r d in 2018 than kraft had on

its own

in 2014. it also had lower advertising

expense the drop

in spending hurt once powerful brands

such as maxwell house

once one of craft's most important

brands kraft is now trying to sell it

for less than 3 billion

but there are no buyers coffee sales are

down 9

already in 2019 furthermore the cut in

spending is

hurting its perception among the younger

demographic

who view craft unfavorably compared to

their

elder statesmen sales of jello have

dropped 26

from 2013 to 2018. at one time jello was

actually seen as a friendly food for

dieters

craft needed to spend money to convince

consumers to use its old products

and research and development to develop

new healthy products

its ceo bernardo heeze who left in 2019

said that he was having trouble

revamping all the products in such a

short time frame

perhaps if they didn't cut spending so

drastically he would have had less

trouble

its final mistake is perhaps the most

unforgivable of all

in 2017 kraft heinz hired a 29 year old

to be the cfo

he was a weird choice for a few reasons

one his prior experience

as shown by linkedin was at 3g capital

not

at an operating company that would mean

he had no experience in a consumer

package

goods company the next indication that

it may have been a mistake is looking at

a salary

cfo is a more senior position but his

salary appears to be lower

than other executives articles have been

written about 3g

for firing older workers and hiring

younger workers

at restaurant brands international in

order to save on pay

was 3g doing that here given his lower

salary we can speculate that

more evidence that he was unqualified

was kraft filed

its annual report late it then promised

to have its quarterly filings by the end

of july

however craft was late on these two

furthermore david

the cfo made a weird comment in crafts

conference call on april 18 2019. he

said crafts

would start growing in 2020 because of

its strong organic growth

he said let me elaborate on why i'm so

confident on 2020. we have strong

organic growth

but in what world was he living in craft

has not had strong organic growth in

years

craft heinz is the story of two

legendary investors

who did not see changing consumer tastes

who broke their own rules

and are now going to suffer the

consequences of holding

this investment if you like this type of

video please subscribe and hit the like

button

so where do we go from here craft heinz

in 2019

was put on notice for a credit downgrade

a credit rating

cut could make it more expensive for

kraft to refinance its debt

and it has a lot of debt it needs to

increase its spending to revitalize its

brands

but with operating income near interest

expense this seems unlikely to be

possible

warren buffett and 3g have few options

all they can do is hope for a turnaround

but as can be seen from this final chart

warren buffett

has only put in 4.73 billion and 3g

5.3 billion when subtracting all

dividends paid to them

meaning their loss will likely only be

this amount people might speculate that

buffett and 3g would buy out the

remaining part of the company

but this would add a lot of risk to them

as there's 31 billion of debt

to protect themselves they may choose to

buy some of the debt of craft

however they may be hesitant to invest

more capital in a business like this

and buffett may be willing to cut his

losses craft heinz will likely go down

as warren buffett's biggest mistake