(Corrects date of Heinz and Standard & Poor’s performance comparison to December 2008 in second paragraph.)
After the announcement this month that Berkshire Hathaway Inc. was leading a partnership to buy H.J. Heinz Co., the ketchup maker was hailed as a growth stock and an indomitable brand. By many accounts, Berkshire’s chairman, Warren Buffett, has pulled off another brilliant feat in spotting an opportunity in food stocks.
If the market is truly that dumb, it must also have been an oversight that Heinz lagged the Standard & Poor’s 500 Index from December 2008 to January 2013. That wide performance gap still shows up if you go back to January 1997 to exclude the noise of the bubble era; Heinz stock rose about 67 percent, while the index doubled. Heinz has been in and out favor with investors in that period and Buffett says he studied the company all the while. Yet until now, Berkshire hadn’t made a significant investment.
A more realistic explanation is that Heinz’s stock was fairly priced before the deal. As in every leveraged buyout, it was debt that hoisted the price to 20 percent over market. (They don’t call it leverage for nothing.) To make the deal work, Buffett got terms to warm Don Corleone’s heart. Berkshire is putting down minimal equity in exchange for half of Heinz, a 9 percent dividend on $8 billion of redeemable preferred stock, and warrants on top of that.
So what are we to make of Heinz? It’s always tough for a board of directors to turn down a cash deal with a 20 percent premium to market. When the company’s stock is a chronic laggard, the directors may have no other option.
This raises an interesting question about investor expectations. Let’s assume the stock market’s future performance is more modest than in past decades, as seems inevitable, given that growth forecasts are being cut.
Sluggish growth will put even more pressure on companies that turn in Heinz-like performances (or worse). This is a serious challenge for those who manage and govern public companies, half of which, by definition, will perform below average in an already below-average market. We should expect more transactions such as Office Depot Inc.’s $1.2 billion purchase of OfficeMax Inc., a merger of weaklings, and the defensive $11 billion US Airways Group Inc. combination with AMR Corp. If nothing else, these deals give companies more costs to cut and appease their shareholders.
At this point, some readers are probably considering the evidence showing that companies are usually better off returning capital to shareholders than buying each other. This is true. However, Wall Street doesn’t like businesses to shrink, and companies that decapitalize are often punished. Investors create incentives for acquisitions. This isn’t necessarily always irrational. The accumulated capital that turned Berkshire into a $250 billion company is a major business advantage.
Berkshire, for example, outperformed the S&P and Heinz from January 1997 to January 2013. But since January 2008, Berkshire also has lagged the index, as it had for lengthy periods in the past. Why isn’t Berkshire facing pressure from shareholders? They trust Buffett, though he won’t be around forever. When Berkshire investors look at the company he has built, they realize that his creation resembles a slice of the economy. As such, it could operate essentially on autopilot for some time. Not only that, Berkshire has reached the size that elevates it to a corporate nation-state.
Berkshire and other giants such as General Electric Co., Google Inc., Amazon.com Inc. and Wal-Mart Stores Inc. aren’t just huge. They have economies of scale, supply-chain advantages, dominance in distribution, entrenched consumer brands, and political, economic, regulatory and business clout that allows them to effectively cripple their competition. These companies aren’t “too big to fail,” but for the foreseeable future, they are “too big to mess (or substitute your verb of choice) with.”
United Air Lines Inc. and Delta Air Lines Inc. are examples of companies that already merged their way to this status. Their combination was the natural prompt for US Airways and American Airlines to join, leaving the U.S. with three airlines that aren’t just powerful, but indispensable.
Likewise, Heinz will gain new advantages through its ownership by Berkshire, which has the respect of Wal-Mart, Costco Wholesale Corp. and other retailers, as well as friendly relations with regulators. And of course, there is Buffett himself, who will soon appear in Heinz advertisements drowning his French fries in ketchup. Buffett’s other value is that he has the ear of the media -- and of President Barack Obama.
Buffett has always been fond of monopolies and years ago he invented a concept: “survival of the fattest.” Each “little” business that Berkshire buys dominates its market. Some are virtual monopolies. Yet Buffett also has avoided combining with companies so large and visible that they would put a bull’s eye on Berkshire. Berkshire probably could buy a Heinz-size company every year for decades without attracting complaints of being predatory.
In this sense, Buffett is unique, and uniquely cautious. The other behemoths can rest assured that the U.S. government is now so dependent on large businesses for anti-terrorism work, Internet security, national defense, and carrying out economic policy that it is hard to see how these interests could be disentangled even if anyone in Washington wanted to do so.
Even with stagnant wages and high unemployment, a steady widening of corporate profit margins has continued thanks to deregulation, lax oversight of financial institutions, lower taxes, disempowered unions, shrunken worker benefits, tamer judicial activism and a virtual freeze in social legislation.
The first major reversal of this trend in many years was the enactment of Obama’s health-care law in 2009 and a steamroller of new financial-service regulations. The one thing these rules didn’t affect was the market dominance of a small number of companies that are either too big to fail or too big to mess with.
Even so, there is no assurance that the economy will continue to move in this winner-take-all direction. In fact, history says otherwise. Modern U.S. antitrust law emerged in a short period around the beginning of the last century. Courts and public opinion, once wary of big government, underwent a swift, savage cultural reversal under Theodore Roosevelt, leading to the breakup of companies that had a tight grip on major industries, including railroads, oil and tobacco.
Will the fragile reed of public tolerance ever snap? So far, Americans have put up with crooked mortgage lenders, bailed-out banks, “pink slime” in beef, Facebook privacy policies, salmonella tomatoes and cruise ships full of germs.
Bursts of public outrage at the businesses responsible flare and dissipate. Slowing growth, margin pressure, and unstoppable competition from too-big-to-mess-with companies all point toward more consolidation, at least for the time being. That sound you hear in the distance is investment bankers revving the engines of their Lamborghinis.
Meanwhile, if the public ever revolts against the corporate nation-states, the one company that probably is safe from retribution is Berkshire Hathaway.
(Alice Schroeder is the author of “The Snowball: Warren Buffett and the Business of Life” and formerly a top-ranked insurance analyst on Wall Street. The opinions expressed are her own.)
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