Kraft/Heinz merger changes the food value chain competitive landscape

Posted by Fuld + Company on Mar 26, 2015 3:21:00 PM

Commentary from Fuld + Company analysts.

CNNimagKraftHeinz2Packaged food industry giants Kraft and Heinz recently announced that they were merging to form Kraft Heinz Co, with global revenue of about $28 billion dollars, as reported by the Wall Street Journal. This will have a major impact on the industry. We pulled together a group of Fuld + Company analysts to get their take on some of the competitive implications.

Ken Sawka, CEO + President

This merger is a significant transaction which will create the third largest food manufacturer in the United States. Sound competitive strategizing means examining the impact along the entire food value chain. At Fuld + Company we have worked with leading participants from farmer to retailer, and this merger looks like further evidence of the consolidation trend that has been underway in the industry for many years. In other words, this is not that surprising a transaction. However, it does call into question some fundamental assumptions, including:

  • For growers, how is their supplier power diminished as food manufacturers get bigger and bigger?
  • For packagers, what must their R&D investment priorities be to potentially have to supply a smaller and smaller number of larger and larger food manufacturers with flexible packaging for an increasingly diverse array of products?
  • For food manufacturing competitors, how will they achieve scale to be able to lower costs and compete?
  • For retailers, is the purchasing power of the big box stores threatened by ever-larger suppliers?

Transactions like this have a ripple effect along the entire value chain, and companies that rely on strong competitive strategy tools and frameworks will be the ones to spot new opportunities, interpret changing industry structures, and act to achieve or maintain leadership positions.

Martha Culver, Vice President

FoodValueChainWe may see more of this kind of activity as processed food manufacturers contend with consumer shifts to healthy and organic. The big food companies are panicking about sourcing ingredients and wondering whether organic is just a fad or long-term trend. If it’s the latter and demand keeps growing, they do not have anywhere near the organic supply they need. It just doesn’t exist right now. This applies not just to meat fruits and vegetables, but also to ingredients like soybean oil and additives. This highlights the urgent need for strategic uncertainty management, such as war gaming and scenarios, to shed light on the challenges players in the industry face.

Adriane Musgrave, Senior Consultant

I agree with Martha who said that Kraft’s troubles stem from their inability to get more fresh, wholesome food items in their product line-up. Kellogg, Campbell’s and General Mills are struggling – to various degrees – with the same thing. You had an entire food industry built up around the idea of “better food through science,” but today’s generation doesn’t want science food. These days it’s all about produce, natural ingredients, and homemade (organic too).

The landscape has shifted considerably (Porter’s Five Forces). At the same time, today’s consumers are putting more trust in their grocery store (Whole Foods, for instance) to give them better product than the big food firms like Kraft and Kellogg.

Did Kraft know about these consumer trends and fail to act? Or, were they unaware?

Diane Borska, Senior Vice President

I think this is a cautionary tale about early warning (sensing the shift so you can act in time) and also about strategic gaming. If you are Mondelez or Kellogg’s or General Mills, etc., you’ve got to be thinking, who’s next and what should I do? Who are the predators in this industry and who are the prey? Wouldn’t it be a good idea to be prepared with contingent strategies.

Ken Sawka

Let’s not overlook the investor angle here: Buffett and 3G Capital Partners, the Brazilian private equity firm. They have a history of making smart acquisitions and integrating those acquisitions effectively. A New York Times article notes that this was the same group behind acquisitions of Burger King and Tim Hortons. When those properties were acquired the PE firm sold the private jet and canceled an annual million dollar party in Italy.

This may be nothing more than two investors sensing an opportunity to create the third largest food company in the US, improve its profitability, and then flip it.

Still, all these points about consumer preferences, health and nutrition are valid. It may be that all these things are unintended consequences of the transaction, but impactful nonetheless. Big players buy and sell companies for their own reasons, but these deals have competitive strategy ramifications.

Adriane Musgrave

I think that’s an important counterpoint, Ken. How are other big food firms looking at this? There’s a good argument that they should really concerned about the merger. Efficiency programs and cost cutting bring additional cash that can then be given to shareholders (most likely) or invested in new businesses (to exploit long-term trends).

Jacob Golbitz, Research Director

Financially this is a no-brainer. Buffett and 3G acquired Heinz two years ago through a leveraged buyout for $16 billion (really more like $8 billion, as half of which was preferred underwritten by Berkshire). Now, for another $10 billion in cash they will own 51% of a company with an estimated enterprise value of $111 billion.

If I were a competitor – especially an innovative, growing company in packaged foods (think Hain Celestial) I would be wondering whether Kraft Heinz Co. will be content to let 3G reduce costs while using the size of the company for sourcing and pricing advantage, or are they going to do something interesting? The numbers of this deal may be compelling, but if you’re committed to building a huge footprint within the food processing value chain, why stop at buying companies with flat growth?

From Fuld's Financial Services Team

The bank angle is interesting; boutiques making huge gains at expense of the larger players. Here’s a quote from another New York Times article:

“In each of the last six years, boutiques have continued to gain market share in advising on American deals. Boutiques took 18 percent of the advisory business last year, up from 8 percent in 2008, according to Dealogic.”

Tess Fagan, Analyst

“I've been watching the food market for a few years. I think the next company perfectly positioned for a major acquisition, similar to Heinz's acquisition in 2013, is J.M. Smuckers!”

Often overlooked, Smuckers has a great brand, and a solid performing stock with a wonderful dividend, however it has also has an ageing 67 year old CEO, and slightly lagging sales. This puts it in almost the exact same position as Heinz in 2013, which before it’s acquisition was also a family controlled company with a great brand, solid stock performance and dividend, and high potential for growth with slightly lagging sales.

Here's an interesting article from Marketwatch on the topic.

Diane Borska

If you devote the time and resource to monitoring the market, you’ll achieve an early warning of fundamental market shifts and begin to develop appropriate long term strategies, like a transformative merger a la Kraft Heinz Co. Further, you can anticipate events like industry consolidation (because let’s face it, who didn’t know this sort of a combination was coming) and develop contingent strategies, depending on how things play out. It gives you time to decide what your role should be: predator or prey. In either case, you gain some control over your future instead of simply letting events occur around you while you flounder for alternatives.

 

Topics: Competitive Intelligence, Consumer Goods, Industry Convergence

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