One of the most totemic deals in the consumer goods industry could soon be unwound – the 2015 combination of HJ Heinz Co. and Kraft Foods Group Inc. This is more than one transaction gone awry. The saga challenges the justifications made for so many mergers and acquisitions. Above all, it underscores that scale is often more of a hazard than a benefit.
Kraft Heinz Co., as the united firm was renamed, is mulling a split into companies focused on condiments and groceries respectively, the Wall Street Journal reported earlier this month. It’s been clear for many years that the original tie-up failed to deliver. A breakup would finally acknowledge that the enterprises could more likely thrive apart.
As with so many deals, Kraft Heinz promised much more than the savings that come from eliminating duplicate head offices and better buying power for things like office stationery. 3G Capital Inc., the private equity firm that had earlier taken over Heinz along with legendary investor Warren Buffett, would be in the driving seat. It could supposedly run Kraft better. After all, 3G had improved Heinz’s margins substantially in fewer than two years. It also pledged to make research and development more productive, with innovation targeted on “big, bold bets.”
Then there was the revenue opportunity, marketing Kraft products including Lunchables and Velveeta outside the US through Heinz’s international distribution network. Increased scale in North America, meantime, would help the company negotiate more shelf space at US food retailers.
What’s striking about all this is that there were doubts from the get-go. The argument for focus rather than scale had been demonstrated by Kraft Foods Group’s own history: In 2012, it had been spun out of Kraft Foods Inc., the parent then focusing on global confectionery markets and renaming itself Mondelez International Inc.
As one skeptical analyst said on the conference call a decade ago for the Kraft Heinz transaction, “frankly the scale argument just didn't ever seem to work out very well.” Others noted that 3G’s efficiency drive at Heinz had come at the expense of sales; one specifically asked what revenue growth might be “let's say, if we're sitting here in like 2017” once the cost had been shrunk. No guidance was forthcoming from management, other than pointing to the international sales opportunity for Kraft products.
In fact, early 2017 would see Kraft Heinz mount a failed bid for Unilever Plc, after which the US firm’s stock began to underperform. Investors seemed to fear that the company needed another cost-cutting deal to maintain profit growth. In early 2019 came a colossal asset writedown and an admission from Buffett that Heinz had overpaid.
Since then, Kraft Heinz shares have continued their slide. Revenue acceleration hasn’t materialized and the business has remained overwhelmingly North American. Another six years on, amid new threats from appetite-suppressing weight-loss drugs, you can see why Chief Executive Officer Carlos Abrams-Rivera might have become convinced that the logic of the original Kraft split early last decade was correct.
The primary problem for the legacy food giants isn’t profitability but the challenge of responding to changing consumer tastes. This requires more than repackaging existing products, or substituting ingredients with substances that can be labeled “natural.” And when it comes to innovation, scale can be hinderance.
Larger companies can find it harder to be creative – look at how the pharmaceuticals industry, despite mammoth R&D budgets, relies heavily on acquiring biotechs to expand its pipeline of promising medicines. Young creative talent is often drawn to start-ups. Deals for scale’s sake can just make matters worse, even before layering on people worrying about their jobs instead of fighting the competition.
Then there are alleged revenue synergies. The effectiveness of shunting an acquired product through a buyer’s larger distribution network depends on the market. In food, for example, tastes are largely local. There are some exceptions, like ketchup. But scale benefits accrue within countries more than across them.
Of course, we know all this. But the ketchup-mac’n’cheese deal still happened, and for 10 long years the company has clung on to the hope that the structural combination of stuff that goes on your plate with stuff that goes on the side of it might work.
Dissolving Kraft Heinz would, of course, involve one-off costs and add ongoing expense by duplicating shared functions once again. So be it. The opportunity is to create an international company with growth potential comprising mainly of Heinz condiments, while much of Kraft’s packaged foods business could form a mature, cash-generative dividend play. Analysts at Barclays Plc call this “essentially a ‘GrowthCo’ and ‘CashCo’ move as we’ve seen numerous times across the industry in the past.”
Most deals fail goes the cliche. It’s not that investors aren’t aware of the risks. They routinely ignore claims for revenue synergies, valuing announced cost reductions only. They accept that increased size brings its own problems, and that acquisitive management teams may not be all they’re cracked up to be. But you can never have enough refresher lessons.
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