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The Science of Hitting
The Science of Hitting
Articles (437) 

Some Thoughts on 3G

Recent look at Kraft Heinz prompts examination of investment manager

Warren Buffett (Trades, Portfolio), chairman, president and CEO of Berkshire Hathaway (BRK.A) (BRK.B), discussed Kraft Heinz’s (KHC) proposed bid for Unilever (UL) in an appearance on CNBC last Monday. As part of that discussion, Buffett touched on an interesting component of the 3G model that is rarely discussed:

“One thing I would emphasize about 3G: They are wonders at productivity, there's no question about it. But I've been on 20 boards: I have never seen anybody any better about marketing and product development and all that. I mean, that is what we talk about at board meetings. And it's hours and hours. And I've been on other consumer goods companies’ boards, and they're nothing like the intensity they bring. They don't just bring it to productivity, they bring it to new products. I learn about what's going on in the marketing world when I'm at the meetings of Kraft Heinz because it's their game. I was at the last meeting a month ago. We spent hours and hours [discussing different channels – online retailers versus brick-and-mortar]; they really understand their business. It's so much more of an informed discussion than I've heard at most board meetings in my life; it's night and day. Every aspect of management, they excel in.”

A few months back I did a deep dive on Kraft Heinz (along with reading “Dream Big” by Cristiane Correa). My conclusion was that the picture commonly painted of 3G is incomplete. When Berkshire first became associated with 3G, many were shocked by the tie-in. Their concern was based on the presumption that 3G followed the “LBO/private equity” playbook that Buffett has ridiculed – buy a business with a sliver of equity and a boatload of debt, blindly cut costs to maximize short-term profits, and then prep the business to be sold ASAP. The problem is that this doesn’t mesh with reality: for example, 3G has been in the beer business for nearly 30 years with no intentions of exiting (as Marcel Telles noted in the early 1990s, “We have zero interest in selling [Brahma]. It’s a super long-term investment”).

This is probably closer to the truth: 3G is a performance-based culture that demands meritocracy and ownership. Its goal is to maximize productivity and create sustainable value for the owners of the business; they achieve these goals by ruthlessly cutting unnecessary expenses (“costs are like fingernails – you have to cut them continuously”) and properly incentivizing employees to think and act like owners. Management by objectives (MBO) and zero-based budgeting (ZBB) are two of the management tools used to achieve those goals (with the latter implemented at 3G after surprisingly high transportation, travel and meal expenditures were discovered at Brahma in the late 1990s). In a word, these practices mean one thing for most of 3G’s targets: change.

This different approach is succinctly captured by Jim Collins in the introduction to “Dream Big”:

“Performance, not status; achievement, not age; contribution, not position; talent, not credentials.”

Unlike some of their peers, 3G doesn’t appear constrained by “the way things have always been done”. This is one of the things they catch some flak for, even when the arguments don’t make much sense. For example, consider a recent Fortune article – "Buy. Squeeze. Repeat" which is largely focused on the quick closure of a Kraft plant in Wisconsin after the merger with Heinz (and its impact on the employees); the odd thing about this article is the author readily admits the plant should’ve been shuttered (quoting a retired Kraft executive: “Closing it was probably the right thing to do”).

A willingness to make difficult decisions is a hallmark of the 3G way; a ruthless push for improvement is what enables 3G to run its businesses at a level rarely reached by industry peers. This is most notable when looking at post-deal margins: at Kraft Heinz, Restaurant Brands International (NYSE:QSR) and AB InBev (BUD), profit margins have expanded by more than 1,000 basis points in a few years under 3G’s leadership; in each of those three businesses, their margins are best-in-class.

Management is held to the targets communicated to shareholders (read some articles about Carlos Brito for a current example). Results are transparently presented with no attempt to bend reality (as Buffett once quipped, “At too many companies, the boss shoots the arrow of managerial performance and then hastily paints the bullseye around the spot where it lands”).

Based on what I’ve seen, my conclusion is that 3G is a refreshing change from what you find a lot of other places – both in the way they communicate with owners and how they run their businesses (to be more specific, the strategy of rationalizing SKUs and focusing on the “bold bets” makes a lot of sense for Kraft Heinz). For long-term investors, these are the type of people with whom to partner.

Kraft Heinz common is not that cheap at current levels (without building in more aggressive M&A assumptions than I'm personally comfortable with). It was moving lower after the company reported fourth-quarter results, but that quickly ended after the Unilever discussions were made public. It will probably be awhile before I have a chance to buy Kraft Heinz. In the meantime, I’ll watch from the sidelines and keep learning.

Disclsoure: Long Berkshire Hathaway (NYSE:BRK.B).

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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Comments

snowballbuilder
Snowballbuilder - 2 months ago    Report SPAM

Hi science interesting article and topic

I would add a personal and maybe just provocative thought

I think that - after Buffet - the 3G team could be able to buy BRK.

Even more i think they would probably generates an enourmus amount of money with and out of BRK.

They could sell many of the listed investments to finance the acquisition , spin off the giant insurance operation (or use the cheap float to buy quite the entire world) and run and make a lot more effectiveness many of the operating business while selling the ones they dont like/need.

I think that wuold be one of the most interesting and most lucrative acquisition of the 21 century.

For a team that have always dreamed big .... what is bigger and more diversifided of BRK ??

Just some thoughts best snow

Sivaram
Sivaram - 2 months ago    Report SPAM

Snowballbuilder,

I'm not a shareholder of Berkshire Hathaway but I hope 3G never buys BRK. That would completely destroy the company. In any case, it's never going to happen.

The problem with these management companies, even as good as 3G is, is that it is hard to tell if their management consulting techniques are a fad or not; and where the limits of their benefits are.

A good example is Jack Welch, the former CEO of GE who is still held in high regard in some management circles for the performance of GE in the 90's and early 2000's, but all he seemed to have done is convert a strong industrial giant into a quasi-financial company that would have been bankrupt during the financial crisis if it weren't for US taxpayers lending a hand. I'm not equating 3G to what happened at GE or what McKinsey does or stuff like that, but one needs to be careful with management consulting techniques and the future outcome is never clear.

Having said all that, Buffett has high praise for 3G so I'm sure they are superior to their competitors, but I'm not sure of the limits of their approaches.

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

Snow,

Well that's an idea!

"For a team that have always dreamed big .... what is bigger and more diversifided of BRK ??"

Not much! We're talking real elephants once you hit half a trillion dollars :)

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

Sivaram,

Good points - thanks for sharing!

fung9815
Fung9815 - 2 months ago    Report SPAM

Snowballbuilder, indeed a thought-provoking idea, but I think it's not gonna happen. Warren is a hands-off CEO while 3G is exactly the opposite. When Warren was acquiring the subsidiaries, he committed to the selling CEOs that Berkshire will stay out of their management and operations forever. Those are the promises that Warren will not break even after his passing. The CEOs of the subsidiaries will be extremely concerned if 3G is to takeover Berkshire. Of course, as time pass, there are some problematic subsidiaries that need more supervision (which is why Warren hires Tracy), but having a micro-managing HQ like 3G is completely un-Berkshire-Hathaway.

Sivaram, I think equating 3G to a "management company" is incorrect. If anything, they are also capital allocator like Berkshire/Warren. They eat their own cooking by having skin in the game. They invest in mis-managed companies (which are supposed to have great moat but somehow didn't), they increase productivity, reduce inefficiencies, promote meritrocracy, encourage creativity, and most importantly, they intend to own the improved cashflows forever (unlike other PE funds). It's hard for Warren to not love them. On "but I'm not sure of the limits of their approaches", I think they have no limits.

snowballbuilder
Snowballbuilder - 2 months ago    Report SPAM

@sivaram

Maybe you misanderstood my comment .. I m not a blind fan of 3G

While i m sure they are doing great for their shareholders (even the minority shareholders) and thats really important

Im not sure if their brutality /aggressivness (like the spirit of the free market made human) is good or not for the entire society.

That sayed i repeat i think - after Buffet - 3G has the ability to buy BRK and made tons of money doing so and out of it.

You say "in any case, it's never going to happen."

After buffet and munger i would not be so sure. You cant be so sure.

They could do it.

They have the ability.

They would easily find the money

They are ambitious.

They always built big and dream bigger.

They enjoy pushing to the limits

We are talking of a guy who have played at wimbledom, surfed giant waves and built an empire.... You really think "he cant " ?

@fung9815

Again i think they could do it

Of course the 3G BRK wuold probably be really different from the actual one

As for the concerns of the operating managers... In 3G style... Who care ...They could sell some off them (even to the managers) , spin off someothers and directly run the few they like and where they see more money to make.

It could happen or not .... But is not impossible.

Just to think... In few days they could sell aapl, ibm and others, they could integrate the position in heinz and burger king, they could take the helm of coke and so on and on ......

Of course these are only personal and provocative thoughts... But again i think is not impossible.

Best snow

fung9815
Fung9815 - 2 months ago    Report SPAM

Snowballbuilder,
Yes, not impossible (nothing is impossible), but extremely improbable. Let me explain why.
Warren has in many occasions mentioned that he expects long-term continuity of the Berkshire System after his passing, and such vision and culture will be closely monitored by the board members, including his son Howard and also Bill Gates (Trades, Portfolio).
Bill Gates (Trades, Portfolio) is an important piece of this puzzle. Since Warren's BRK shares will be gradually donated to the Bill & Melinda Gates Foundation (BMGF) over time, the continuity of Berkshire's compounding power is very important to the foundation. I'm pretty sure that BMGF, which will become the single largest shareholder of BRK one day, will not let any major shake up happen to BRK. A "3G shake up" as suggested by you is the last thing that BMGF and many other BRK shareholders want. If it really happens, I'm quite sure that BRK's share price will fall to the floor because many long-term shareholders (who wants the Berkshire System to remain) will be scrambling to sell.
Whoever is in line for the next CEO of BRK, I'm quite sure that he/she will strive to maintain the continuity of Berkshire System. 3G will, at best, continue to be a great partner of BRK.
Again, not impossible, but highly improbable.

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

This note from the "Owner-Related Business Principles" at the end of Berkshire Hathaway's annual report is worth considering (as it relates to this discussion):

"On my death, Berkshire’s ownership picture will change but not in a disruptive way: None of my stock will have to be sold to take care of the cash bequests I have made or for taxes. Other assets of mine will take care of these requirements. All Berkshire shares will be left to foundations that will likely receive the stock in roughly equal installments over a dozen or so years."

One final comment from Warren:

"You can be sure that the directors and I have thought through the succession question carefully and that we are well prepared"

stephenbaker
Stephenbaker - 2 months ago    Report SPAM

Once most of the shares are in the hands of the public anything can happen. The foundations are not in existence to own stock; they need money to fulfill their purposes. The shares will eventually be transferred and once that happens, the Berkshire as we know it will cease to exist.

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

"Once most of the shares are in the hands of the public anything can happen... The shares will eventually be transferred and once that happens, the Berkshire as we know it will cease to exist."

Two important caveats (IMO): first, we're talking 10+ years out (at least); second, assuming continued earnings retention, the market cap will be in the trillion dollar range. We shall see! Thanks for the comment.

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