Letter published in the Financial Times, February 20th 2013

Buffet overpaid? I don’t think so

I have not yet read a proper analysis of Warren Buffett and Charlie Munger’s thinking in going for the Heinz deal. Here is my take.

Imagine you are sitting there with billions of dollars. A deal comes along that offers a yield of almost 7 per cent. This comes about because you allocate $12bn in two ways: $8bn gets you 9 per cent yield (the preference shares) and $4bn gets you 2.8 per cent (the yield on the equity). Furthermore, that yield is likely to rise because the dividends on the equity portion will rise over time, as they have decade after decade.

Not good enough for you yet? Perhaps you prefer Irish government bonds at 3.6 per cent, or gilts at 2.2 per cent. Or how about junk bonds at 6 per cent? Are these investments any more safe than a company with such a strong economic franchise that in all likelihood it will keep pumping out the dividends for decades to come.

Now here is the icing on the cake. You also get 50 per cent of the equity in a company whose market power you have gazed at wide-eyed from afar since 1980. All that upside on top of a 7 per cent (and rising) yield.
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If that is overpaying then I’m a banana. In this case Berkshire Hathaway’s risk-reward position hinges on the preference share position, not on the price/earnings ratio of the equity position. 3G, on the other hand, has pure equity risk – and it is high. I do question the price they paid ($4bn for 50 per cent of the equity). They must be optimistic about boosting profits, I guess.