During the quarter we purchased shares of the Kraft Heinz Company (NASDAQ:KHC). Earlier this year, privately -held H.J. Heinz Company acquired publicly traded Kraft Foods in exchange for stock in the combined company and a one-time special dividend. Key to this transaction were the private equity shop 3G Capital, as well as another Focused Growth portfolio holding, Berkshire Hathaway. Prior to the Heinz-Kraft transaction, H.J. Heinz Company’s ownership was held exclusively by 3G Capital and Berkshire Hathaway, after a 2013 deal that took Heinz private. The newly combined Kraft Heinz Company began trading in July, with Berkshire Hathaway and 3G Capital combining to own just over half of the shares of the new Company.
We think Kraft Heinz’s new leadership and culture, as brought to bear by 3G Capital’s rigorous, time-tested methods of recruiting and installing exceptional managerial talent, will be the Company’s primary competitive advantage and means for generating sustainably superior profitability.
While the concept of a private-equity led management team executing a high productivity strategy is hardly revolutionary, we think Kraft Heinz’s approach will be differentiated. First, we expect Kraft Heinz leadership will execute a strategy more consistent with the long-term value-creating goals of a business owner, as opposed to the short-termism seen when owners are motivated by an “exit strategy.” We surmise that a business-owner culture and mentality will be pervasive as KHC is majority owned by 3G Capital and Berkshire Hathaway. For example, Berkshire Hathaway’s Chairman and CEO has explicitly stated “we will be in the stock forever...it’s a permanent holding, on our part…the one thing I can promise you, is that you will not see Berkshire reduce its interest.”2 Further, while Kraft Heinz ownership is yet to be disclosed, 3G Capital’s founding members exhibit similar long-term conviction, consistent with a business owner's mentality. For example, the three founding partners of 3G Capital (two of which are on the KHC board) hold a controlling interest in Anheuser-Busch InBev (ABI), stemming from investments that were made more than a decade ago during the creation of Ambev, now a subsidiary of ABI34. Post-3G Capital’s involvement, ABI now sports the highest margins in the beer industry, while continuing to grow volume at above-industry rates. Far from cutting “muscle and bone,” ABI’s strategy focuses on instilling a culture that blurs the line between employees and business owners. It is this culture of obsessive accountability that we believe, will quickly emerge at Kraft Heinz and lead to superior profits.
Second, we expect the culture shift at the Company will start and be maintained by leadership, particularly the board of directors. Under the new ownership structure, Kraft Heinz’s Board of Directors now consists of: Warren Buffett (Trades, Portfolio) (CEO of Berkshire Hathaway); Greg Abel (Chairman of Berkshire Hathaway Energy); Tracy Britt Cool (CEO of Pampered Chef, a subsidiary of Berkshire Hathaway); Jorge Paulo Lemann (founding member of 3G Capital); Marcel Hermann Telles (founding member of 3G Capital); Alexandre Behring (managing partner from 3G Capital); as well as five board members from the previous Kraft Foods Company. Further, of Kraft Heinz’s announced executive team of 11 senior employees, 9 are from the 3G Capital and Berkshire controlled HJ Heinz. 5
So, to reiterate, we think the culture of business ownership is less about cost cutting and more about maintaining a rigorously competitive, meritocratic organization, with hungry employees - not unlike that of a start -up. Of course, on the face of it, an organization such as Kraft Heinz is about as far from “start-up” as one can imagine, but that is why we think this Company will have a unique advantage, relative to peers.
We expect to see rapid profitability growth over the next few years as 3G Capital instills its highly disciplined culture of minimizing cost and expanding margins at the under-earning Kraft Foods Corp (along with further optimization at Heinz). Once KHC margins have been maximized, we expect KHC to plow that capital back into more M&A and repeat this process with other branded staples that exhibit bloated cost structures. We expect this exceptional compounding of profits will drive exceptional performance at KHC for several years.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third quarter 2015 letter.
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