UL Unilever PLC

By Stephen Wilmot and Paul J. Davies 

Even at the lowball price Kraft Heinz Co. has offered, buying soap-to-soup giant Unilever PLC would stretch its balance sheet to its limits. But the U.S. food group needs a deal.

Investors cheered news of the potential acquisition, sending Kraft Heinz shares up 8% at the open. 3G Capital -- the Brazilian investment firm that teamed up with Warren Buffett 's Berkshire Hathaway to buy Heinz in 2013 and then merged it with Kraft two years later -- is a legendary costcutter. Kraft Heinz's operating margin last year was roughly 23%; before the merger Kraft's was 10%.

But it will take an aggressive sleight of hand even by 3G's standards to acquire Unilever, which has roughly the same enterprise value as Kraft Heinz.

Unilever said the U.S. food group had proposed $30.23 a share in cash, plus 0.222 new shares, equivalent to $20.80 after the Friday morning pop. Kraft Heinz already has $29 billion of net debt, and would need to take on a further $90 billion to fund the cash portion of the deal. Add in Unilever's debt, and the combined total rises to $132 billion -- about 7.5 times combined earnings before interest, taxes, depreciation and amortization.

That is a much higher leverage than in last year's consumer-goods megadeal: Anheuser-Busch InBev's purchase of SABMiller to create the world's biggest beer maker. The comparison is apt because the beer giant was built by Carlos Brito, who formerly worked for the three billionaires that run 3G Capital. Before cost savings, ABI's near-$110 billion offer was expected to leave the combined company with net debt at about 4.5-times forecast Ebitda.

If Kraft Heinz succeeds in buying Unilever, axing costs would boost expected profits. The London-based company has made much of its use of "zero-based budgeting" -- the cost-cutting tactic favored by 3G -- but its operating margin last year was 14.8%, well below the level at Kraft Heinz or ABI. That said, finding savings is much easier in the merger of two brewers than two producers of packaged food -- and other products. Food, in which Kraft Heinz specializes, accounts for only 43% of Unilever's portfolio, notes Citi.

The debt-averse Warren Buffett might intervene to make the deal possible. Berkshire Hathaway owns 26.8% of Kraft Heinz, has roughly $85 billion in cash and helped fund the Kraft-Heinz merger. That may explain the apparent lack of concern among Kraft Heinz's independent shareholders.

However, a higher bid is needed. The $51 dollar-a-share offer values Unilever at roughly 15.4 times expected Ebitda, compared with almost 21 times for SABMiller. This month Unilever's U.K.-listed peer Reckitt Benckiser offered 19 times for U.S. infant-nutrition company Mead Johnson, calculates Barclays.

The food group is motivated by an inexorable logic: There is little growth in consumer products, so the model appears to be: Buy, cut costs and buy again. Kraft Heinz believes it needs a big new target. It will likely prove a determined hunter.

Write to Stephen Wilmot at stephen.wilmot@wsj.com and Paul J. Davies at paul.davies@wsj.com

(END) Dow Jones Newswires

February 17, 2017 14:14 ET (19:14 GMT)

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