Raiders Of The Lost Ark.

     The closing decades of the twentieth century saw the predatory M&A culture at its zenith. Hostile takeovers, poison pills, Pac-Man defences, greenmail, activist investors, white knights, black knights and bidding wars were the order of the day, at a time when the American markets were on a major bull run. And then, somewhere along the way, after the East Asian financial crisis, the Dotcom Bubble and the Financial Crisis that spanned the last and first decades of the twentieth and twenty first centuries respectively, the world of M&A suddenly became a less exciting place to live in. Hostile takeovers lost their flavour, companies built up their defences, shareholder activism gained prominence in the wake of sloppy results at several companies and private equiteers preferred working with managements rather than trying to depose them, even as the world grappled with increased uncertainty over the past decade. But now, with the global markets gaining steam, big-ticket M&A seems to be taking off once again.

     While it was indeed private equity that fuelled American M&A some decades ago, a combination of surplus funds, low organic growth and desperation not to be left behind is goading the same private equity players to deploy funds, even at heightened valuations. Today, private equity’s role is a stark change from that of the yesteryears, with PEs looking to partner companies and not do anything drastic to upset the proverbial apple cart. But then again, not every PE fund goes by the new normal and resorts to being a meek observer, a financial investor or a mere activist shareholder. For, there happens to be a certain PE fund out there that’s known to play by its own rules, often muscling its way into companies via the hostile route, changing managements, focusing on nothing but the bottomline and turning companies upside down and inside out, all while squeezing every last dollar out of them.  Having already made a failed move a few months ago towards what would have easily been one of the largest M&A deals of all time and in what is sure to strike fear in the hearts of many a management, that said PE fund is lurking with a lot of firepower in its arsenal, waiting for the right time to strike.

     3G Capital. Perhaps no other PE fund out there is the manifestation of the old school PE culture of focusing on the profitability of an investment and nothing else. For over two decades, the trio of Jorge Paulo Lemann, Marcel Telles and Carlos Sicupira has employed a simple but effective formula – Acquire, Change Management, Restructure, Cut Costs, Kill Excesses and Boost Margins. The firm has always targeted the biggest players in the consumer goods industry and its acquisitions usually reek of similar characteristics – underperforming consumer giants that have lost their way, slowed by their heft, burdened by heavy cost structures and several layers of management. It pursues companies that indicate huge potential of showing better results but have managements that seem to focus on everything else but driving financial performance and their stock prices. 3G eyes companies that lag in operational performance but which have portfolios of enviable albeit underperforming brands, which could easily be leveraged to drive margin expansion, combined with brutal cost-cutting, all in the endeavour to spur profitability.

     To fuel its megadeals, 3G Capital forks out a small portion of equity, backed by massive quantities of debt that are then loaded onto its target’s balance sheet. After gaining control of its target, what 3G Capital does next borders on cruelty. To support the increased interest outgo and boost profits, its acquisition is stripped to the bone. Every cost that can be cut isn’t spared. Every sliver of excess, right from the coffee machine to the corporate jet is done away with and sold. Production plants are streamlined and non-core facilities are sold, resulting in thousands of job losses. Excess staff at the corporate headquarters is trimmed and wages are brought in line with industry standards, with stock options replacing a large part of corporate bonuses, forcing the company to focus on its stock price for its employees to hit pay dirt. All the resultant savings are then ploughed towards debt repayment and invested in brand building, which the outgoing management largely ignored and which then goes on to increase market share and drive profitability. 3G Capital’s signature ‘zero-based budgeting’ is always implemented, with each and every cost needing a justification, sans a reliance on the previous year’s figure, for an approval. While 3G’s targets are always loaded with an alarming level of debt at the onset of the acquisition, its subsequent cost cutting and investments go on to boost margins, pay back debt and turn the company into a lean and efficient machine.

     3G Capital’s portfolio companies are usually bought when their margins are in the low teens but a few years of 3G treatment nudges them to a range of the high teens to the mid-twenties, a level unheard of in the consumer goods industry. Of course, the firm’s strategy works wonders in the consumer goods space but a similar formula may not yield the same results in any other industry that may require a high level of capital expenditure or which is service-oriented. And while it has been criticized for being almost barbaric in its acquisitions, 3G Capital is one of the most successful names in its industry today, having built up large stakes in some of the most dominant consumer good companies out there. 

     3G Capital’s strategy may work wonders on the cost front and on the bottomline but a major drawback is that it only works up to a point where margins peak, beyond which 3G would have to look for a new target to feed its acquisition machine and grow again. The firm has generally made a big acquisition every 2 years and its last big move came in 2015, when its group company Anheuser Busch – InBev swallowed SABMiller. And if history is anything to go by, 3G Capital is all set to strike in the near future. It has reportedly raised around 10-15 billion dollars of funds (incidentally, Gisele Bundchen is a major contributor) and a debt lever of 5 to 6 times that amount is a given for any bid. Moreover, 3G Capital has had the support of Warren Buffett and Berkshire Hathaway in several deals. Its AB-SAB deal topped $100 billion and earlier this year, it made a bold move for Unilever in a deal topping $140 billion, which Unilever rejected. Of course, as far as 3G’s next target goes, the market continues to speculate as to where the next big shake-up in the consumer goods landscape would happen. And in all likelihood, 3G Capital’s next move will have a large impact on a market much closer home – India.

     How so, you might ask? Well, a certain provision in SEBI’s Takeover Code states that if a listed Indian company’s foreign parent is acquired, the acquirer must make an open offer for the Indian subsidiary as well, due to a change in its parent’s management. With 3G Capital back at square one post the Unilever debacle, it may soon strike again and barring a few instances, any target that it zeroes in on will have a bearing on the Indian market and could result in a massive open offer and a potential delisting. With Kraft Heinz needing a new growth impetus, it is most likely to front 3G Capital’s next bid. Here’s the lowdown on where 3G Capital could strike next.

A 3G Invasion.

     It’s safe to say that no one saw it coming. Earlier this year, 3G Capital and Warren Buffett shocked the world by bidding for Unilever via Kraft Heinz, in a $143 billion deal that would have combined two stellar brand portfolios and created a consumer goods colossus. Unilever rejected a $50 offer per share as undervaluing the company and political opposition to the deal from Theresa May’s government forced 3G and Kraft Heinz to retreat. Of course, while it may have been rebuffed, there’s no saying that 3G Capital won’t bid for Unilever again after August, when the 6 month ‘Put Up or Shut Up’ cooling period, dictated by UK Takeover Laws, expires. Unilever fits perfectly into the 3G framework – a bevy of leading brands straddling virtually every segment of the FMCG industry, a growing emerging markets presence but more importantly, flab in the form of low margins, a heavy cost structure and underperforming divisions. Unilever has always put its focus on community development and social initiatives over shareholder returns and while its CEO Paul Polman’s talk of sustainable growth and being a good corporate citizen might make Mother Earth smile, any capitalist would cringe at what Unilever is today and what it could have been. Of course, 3G Capital was the first to actually do something about it in an attempted bid, which did shake things up at Unilever, which subsequently announced a plan to shed its spreads business, increase dividends, execute share buybacks and boost margins via cost-cutting, which has already sent its stock up by around 20% since the bid. Curiously, its plan is broadly on the lines of what 3G does to a target, without the brutality and narrow view on profitability of course. If 3G were to bid again for Unilever, which is a possibility given its track record of persistently pushing for acquisitions despite being repeatedly spurned (à la AB-InBev and SABMiller), it would have to raise its bid significantly. As far as the Indian angle goes, with Unilever owning around 67% in HUL, an open offer for the Indian subsidiary would be triggered, the possibility of which has already driven HUL’s scrip from levels of Rs. 840 to over Rs. 1150 and an eventual delisting at a handsome premium, post a Kraft Heinz bid and an open offer, isn’t impossible at all. Then again, Unilever’s own open offer for HUL in 2013 didn’t garner as many shares as it would have liked, only taking its stake to 67% instead of 75%, and a buyback or a delisting by the parent itself, as a part of the buybacks announced in its turnaround plan could materialize.

     Another possible target is the world’s largest food company, Nestlé. From the looks of things, Nestlé has all the trappings of a 3G target – low sales growth, underperforming divisions and a dominant brand portfolio that could complement that of Kraft Heinz. Nestlé’s stagnant American chocolates business, underinvested pet care brands that could easily rival those of Mars and a large stake in L’Oréal, acquired in the era of François Mitterrand, all make for divestment targets. The only deterrent to a bid would be a strong Swiss Franc and its resilience to the greenback but then again, 3G Capital isn’t likely to cower at the sight of a strong currency. Earlier this year, Nestlé too suffered the same fate as Unilever but on a much smaller scale, with Dan Loeb’s Third Point acquiring a small stake and demanding better financial performance. Nestlé responded with a plan to boost margins and increase share buybacks. Nestlé India, which is still recovering from the Maggi crisis, is on a major drive to grow its other segments and cut its overdependence on the aforementioned brand and any bid for its parent would trigger an open offer. Then again, with Nestlé owning around 62% in Nestle India, its share buyback programme could easily spill over to Indian shores, either via a buyback or an open offer.

     If one had to consider a target in the broader consumer space, Colgate-Palmolive would be a possibility, especially given that its CEO has gone on record to say to state that the company would be up for sale at a price of $100 per share. Colgate would allow Kraft Heinz to expand its portfolio into oral care, soaps and pet food, while gaining a stronger reach in the Latin American consumer goods market, where Colgate has unmatched distribution strength (incidentally, Colgate did ruffle a few feathers in South America, with its eponymous brand name sounding eerily similar to ‘cuelgate’, which is Spanish for ‘go hang yourself’). Its margins though are much higher than those of Kraft Heinz itself, leaving little scope for 3G Capital to employ its playbook. Colgate owns around 51% of Colgate India and it was one of the few MNCs that did not raise its stake in the Indian entity in the wave of open offers that hit the Indian markets in 2011. Then again, there’s no saying that it won’t do so in future and a 3G bid would force its hand.

A Bigger Swig?

     3G Capital was founded on and reaped its early successes in the beer business. Starting out with a company called Brahma, it later formed AmBev and then merged with Interbrew to create InBev. The hostile takeover of Anheuser Busch followed in 2008 and in 2015, AB-InBev’s acquisition of SABMiller created the world’s largest brewer, which today produces one in three beers on the planet. While SABMiller gave AB-InBev a major presence in Africa, AB-InBev has a stranglehold in Latin America. Slower growth in both Africa and South America though, on the back of economies in crises, isn’t doing it any favours. Around two years ago, Heineken found itself in the crossfire of the AB-SAB deal, with SABMiller trying to acquire it to bulk up and fend off AB-InBev. Heineken’s family shareholders refused, baulking at SABMiller’s offer, leaving SABMiller at the mercy of AB-InBev. Going forward, if AB-SAB does intend to build a strong presence in the Asia-Pacific markets, Heineken would be its next target, given its dominance in several markets. While a SAB-AB-Heineken deal would truly create a global beer behemoth, it would also see major anti-trust and competition concerns in several markets, calling for multiple divestments. A bid for Heineken would also see a resultant offer for United Breweries, in which Heineken is already the largest shareholder and keen on eventually acquiring.

     In 2015, a target that 3G was eyeing before it zeroed in on SABMiller was Diageo. Years of slow growth, a greater push towards emerging markets and a range of dominant brands in every segment of the alcobev market made it a classic 3G pick. Now, two years later, not much has changed on those fronts. Diageo is still a company built on excesses and owns several non-core assets that could be hived off. It has a history of overpaying for acquisitions, as seen in its buyout of some of Seagrams’ brands around two decades ago, or even paying nearly 5 times sales for United Spirits and more recently, over twenty times sales for Casamigos, George Clooney’s tequila company. Its North American business is just gradually picking up and the company suffered a blow in China post the Chinese Government’s crackdown on corruption, which hit its premium scotch sales. A Brexit – induced weak Pound makes Diageo an attractive buy at the moment, a factor that would have no doubt helped a potential buyout of Unilever as well. 3G Capital’s portfolio company, Burger King, was once owned by Diageo, which is another example of the alcobev giant experimenting with a non-core asset. The only dampeners to a possible bid are Diageo’s margins, which are already near 30% and leave little headroom for further nudging, and the possibility of the British Government interfering again to prevent its corporate icons from falling into American hands. A bid for Diageo would trigger an open offer for United Spirits, in which Diageo owns 55%. Then again, given Diageo’s track record of first acquiring a majority stake in a company, turning it around operationally and then increasing its stake further, Diageo is itself likely to launch an open offer for the Indian entity in the not too distant future, in a move to raise its stake to a level near 75%. And that’s neither a prediction nor a prophecy; that’s a spoiler.

     While a bid for any of the aforementioned names would trigger an open offer in India, 3G Capital is surely eyeing other names as well. P&G, which is another name with a listed Indian subsidiary, is itself in spring cleaning mode by selling several brands and ramping up its performance, but it could be a distant possibility, being too large a target. Mondelez, which was spun off from Kraft, is an obvious and long speculated name, with its margins just over 10%, offering huge scope for improvement and its snacks, biscuits and chocolates brands fitting neatly alongside those of Kraft Heinz. Taking a page out of SABMiller’s book, Mondelez tried to acquire Hershey in 2016 to gain some heft and make for a less attractive target to Kraft Heinz but that move failed. Mondelez’s recent CEO change could provide the right opportunity for Kraft Heinz to strike. Additionally, Campbell Soup, PepsiCo, Coca Cola, Kellogg’s and J&J are just some of the other names doing the rounds as far as 3G’s next victim goes. Of course, 3G Capital’s restaurant arm Restaurant Brands International (Burger King and Tim Hortons), which acquired Popeyes Louisiana Kitchen earlier this year, follows the 3G formula as well and it may be on its own acquisitive drive soon.

     While the global equity markets continue on an upward trajectory, the Indian markets continue to rally as well, driven by strong domestic flows, low inflation and the expectation of an economic lift-off in a GST-powered environment. The only difference is that while earnings are growing globally, the same can’t be said for India and valuations aren’t exactly in a comfort zone. Several sectors are seeing valuations increase while earnings stagger along, the early makings of a bubble. The consumer goods space in India trades at a forward multiple of around 50-60 times earnings, as seen in most FMCG companies, which is not cheap by any standards, given that global peers trade at less than half that range. But then again, if rumours of a 3G acquisition and a triggered open offer resurface, those valuations would only inch higher.

     As far as 3G Capital goes, an Indian open offer for a subsidiary of a global target would be a tiny part of the whole deal and not a major cause for concern, especially in a mega deal amounting to $100 billion or more. At the end of the day, it goes without saying that 3G Capital is already zeroing in on its next big raid, one which would transform a wandering and underperforming laggard of today into an efficient consumer giant and highly profitable sector leader of tomorrow. Furthermore, its portfolio company, Kraft Heinz would have to strike soon, with its sales growth ebbing and its appetite growing. And if 3G Capital’s audacity to bid for Unilever and take on Paul Polman is indeed a sign of things to come, it’s safe to say that no consumer goods company out there is safe from its clutches and it could be anyone’s guess as to what – or who – is next. The bloodthirsty shark, after all, must keep swimming.