Kraft deal puts more pressure on low-growth foodmakers: Real M&A

[NEW YORK] The looming merger of Kraft Foods Group and HJ Heinz is ratcheting up the pressure on other foodmakers to shape up or seek deals of their own.

The two food giants are combining to create North America's third-largest food and beverage company in a deal backed by 3G Capital and Warren Buffett's Berkshire Hathaway. 3G has been shaking up the food industry with its penchant for acquisitions and reputation for merciless cost-cutting. To keep up, rivals in packaged food will need to follow its model.

Mondelez International and Campbell Soup are among those already taking steps to comb through their budgets, and others are likely to follow. The next step for some may be to join forces.

Nestle, which will face a tougher competitor in the new Kraft Heinz, could decide the time is right to bid on US$32 billion Cheerios maker General Mills, said Kevin Dreyer of Gabelli Funds. The Kraft transaction, announced Wednesday, also adds support to the benefits of merging PepsiCo's snack business with Mondelez, according to Sachin Shah of New York- based Albert Fried & Co.

"Everyone in the industry is going to be thinking, 'We could be next, so let's pull out all the stops to increase value as a standalone company,'" Mr Dreyer said in a phone interview from Rye, New York. Gabelli parent Gamco Investors Inc. oversees shares of Kraft, General Mills and several other consumer-goods makers. "If they can't on a standalone basis, then there may be other strategic options for a lot of companies," he said.

Soy milk producer WhiteWave Foods or Emerald nuts maker Diamond Foods are also ripe for a takeover, said Alexia Howard of Sanford C Bernstein & Co. Mr Buffett and 3G likely aren't done with dealmaking either, though they may take a hiatus to digest Kraft. General Mills, Mondelez and Kellogg are among their potential next targets.

"This puts the entire group on alert," said Brian Yarbrough, a St Louis-based analyst at Edward Jones & Co. "There are too many of these food players and there's very little growth if you're not natural, organics or protein. So how do you grow? You buy. I think this is just the beginning." The Kraft transaction, which values the macaroni-and-cheese maker at about US$46 billion before net debt, is the biggest food deal on record. It surpasses Mr Buffett and 3G Capital's takeover of Heinz for more than US$23 billion in 2013. Berkshire also provided financing for 3G-owned Burger King Worldwide's acquisition of Tim Hortons last year.

When it makes an acquisition, 3G whittles down expenses at the target. The Brazilian-led investment firm has been able to increase profitability even at companies that were pretty efficient to begin with, said Yarbrough of Edward Jones. Kraft and Heinz are aiming to trim US$1.5 billion in annual costs by the end of 2017.

3G's approach to slashing costs may serve as a model for other large North American packaged-food companies seeking to improve returns, according to Ken Shea, an analyst at Bloomberg Intelligence.

"Any inefficient food company had best '3G' themselves if they desire to ward off the new barbarians in the grocery aisle," David Rolfe, who manages about US$11 billion including Berkshire shares at Wedgewood Partners, wrote in an e-mail.

Cost cuts may only go so far in helping rebuild revenue growth. The industry's profits have been crimped as consumers shift toward healthier foods. To overcome the challenges, packaged-food companies will probably need to get bigger.

Nestle has been considered an obvious buyer of General Mills by some analysts and investors because the two companies already have a joint venture for cereal sales. The Swiss chocolate maker now may finally feel the push to make an approach.

The Kraft-Heinz merger relies on similar logic to what Nelson Peltz used to argue for a combination of PepsiCo and Mondelez, the maker of Oreo cookies that split with Kraft in 2012, said Albert Fried's Mr Shah. In 2013, the activist investor urged Pepsi to separate its snack business from its beverages, or combine with Mondelez, or both. He later abandoned his calls for a merger and has forged a truce with Pepsi.

"If they don't want to split the company, then they may want to consider making acquisitions," Mr Shah, a special situations and merger-arbitrage strategist at Albert Fried, said in a phone interview. "The bottom line here is the Kraft-Heinz deal puts a spotlight on Pepsi and its snack business and the value that could be created." Kraft and Heinz could also look to sell assets such as Heinz's Ore-Ida frozen french fries and Smart Ones meals. Those could appeal to Pinnacle Foods, owner of Birds Eye frozen vegetables, David Palmer, a New York-based analyst at RBC Capital Markets, a unit of Royal Bank of Canada, wrote in a report Wednesday.

The Kraft deal may be the biggest food deal ever, but it's certainly not the last.

Foodmakers "have to step up to the plate," Albert Fried's Mr Shah said. "To do nothing is unpalatable."

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