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Market Update

Buffett Bags Elephant With Purchase of Heinz

Despite some concerns, Berkshire's engineering of a deal for the packaged-food firm, in which two thirds of the investment is guaranteed to yield 9%, is money well spent, according to Morningstar's Gregg Warren.

Wide-moat-rated  Berkshire Hathaway (BRK.A) (BRK.B) announced this morning that it has agreed to acquire packaged foods firm  H.J. Heinz in a $28 billion deal that has been put together in conjunction with 3G Capital, a Brazilian private equity firm. Early indications are that Berkshire and 3G Capital will be putting up most of the cash portion of the deal (equal to $23.2 billion), with Warren Buffett noting that Berkshire and 3G Capital will each be directing $4 billion toward the joint buyout, with Berkshire also paying $8 billion for preferred shares. The rest of the cash portion of the deal will be covered by debt financing.

Our gut reaction to the deal, which involves Berkshire actually partnering with a private equity firm, is that Buffett has once again lent his name (and capital) to a transaction in return for a somewhat higher yield (in this case preferred stock with a 9% coupon). That said, at $72.50 per share, the acquisition represents a nearly 30% premium to our fair value estimate for Heinz and a 20% premium to Wednesday's closing price for the shares. 

Although this is a classic Buffett type of name, similar to other consumer goods firms--like  Coca-Cola (KO) and Gillette--that have found their way into Berkshire's portfolio over the years, we are a little concerned about the valuation (at just over 12 times our adjusted fiscal 2014 EBITDA estimate) and need more concrete details about the terms of the transaction to determine the full impact on Berkshire. That said, Berkshire came into 2013 with well over $40 billion in cash that was earning next to nothing, so engineering a deal where two thirds of the investment is guaranteed to yield 9% is money well spent.

Morningstar Premium Members gain exclusive access to our full  Berkshire Hathaway and  Heinz Analyst Reports, including fair value estimates, consider buying/selling prices, bull and bear breakdowns, and risk analyses. Not a Premium member? Get these reports immediately when you try Morningstar Premium free for 14 days.

Greggory Warren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.