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Warren Buffett spun riches out of chocolate. Then he got burned by Kraft Heinz

Key Points
  • Warren Buffett's Berkshire Hathaway on Saturday wrote down over $3 billion related to its investment in Kraft Heinz.
  • Buffett helped finance Heinz's deal with Kraft in 2015, but so far that investment has been rocky.
  • A previous food combination he financed, Mars and Wrigley, fared much better.
Mars M&M chocolates. 
Adam Jeffery | CNBC

Warren Buffett's bet on Kraft Heinz is looking like an acquisition stumble with an unclear path forward.

Buffett's Berkshire Hathaway on Saturday turned in a $25.4 billion loss in the fourth quarter, weighed down in part by a $3 billion write-down, largely connected to its investment in the food giant. Last year, Kraft, one of Berkshire's largest holdings, pulled the conglomerate's results down with a $2.7 billion loss, compared with the $2.9 billion in earnings it added in 2017.

Berkshire, along with private equity firm 3G Capital helped finance H.J. Heinz Company's merger with Kraft Foods Group in 2015. But the union has been rocky, underlined this week when ketchup maker delivered earnings and revenue sharply lower than estimates, slashed its dividend by 36 percent and took a $15 billion write-down on two of its biggest brands, Kraft and Oscar Mayer. The news sent Kraft Heinz's stock down about 30 percent on Friday and slashed the value of Berkshire's stake in the company by more than $4 billion.

Buffett has wanted to do a large acquisition, but he has said he has viewed such deals as pricey and he has moved cautiously. Lessons from the Kraft Heinz deal and how it has compared to other similar transactions may illustrate why he has moved so slowly in spending Berkshire's massive cash pile, which had grown to $112 billion by the end of last year. He last year remarked to CNBC it is "very hard" to offer a premium for a packaged food company, noting the industry is more difficult than it was ten years ago.

In the past when Buffett has put his money where Americans' mouths are, he has seen success. His bet on candy and gum raked in millions. Berkshire helped finance M&M-owner Mars' acquisition of Wm. Wrigley Jr., the maker of Extra gum and Altoids mints, for $23 billion in 2018. By the time he sold out of the company in 2016, he had earned at least $680 million from the deal and roughly $840 million dividends from its preferred shares in it, according to media reports.

The parallel to draw between the two deals is simple: both offered iconic brands Americans liked to eat.

"These are brands I liked 30-plus years ago, and I like them today. And I think I'll like them 30 years from now," Buffett told CNBC's Becky Quick shortly after the Kraft Heinz deal was announced.

Warren Buffett speaks to CNBC's Andrew Ross Sorkin
CNBC

But the paths for both companies since their deals have been diametrically divergent, and as has, thus far, the return on the billionaire's investment.

The contrast in fortunes can be attributed to many forces. Even as tastes have changed, consumers are more wiling to pay up for their favorite brand of chocolate than they are for cheese. Today's indulgences are more likely to be small and snackable, like a bag of M&M's or a Twix candy bar, and they are less likely to include processed foods like an Oscar Meyer bologna sandwich.

Led by the Mars family, the company has decades of experience in running the confectionery empire, which also includes a petcare business. Kraft Heinz is led by 3G Capital, the private equity firm that has proved itself in dealmaking and cost-cutting but not yet in running the day-to-day operations of a food company.

But there is another force at play, which speaks more broadly to the pressures facing the consumer industries at large: Mars is a private company while Kraft Heinz is public. Unlike the confectionery giant, Kraft Heinz has had to battle the changes in the consumer industry under the public pressure of quarterly earnings.

For any company, that spotlight can be harsh; for a food company over the past few years, it has been nearly impossible. Companies from General Mills, Campbell and Kraft Heinz are grappling with vast portfolios of brands that Americans are no longer eating. Sales across food companies are generally stagnant or declining, forcing many of them to take large, expensive bets.

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Kraft Heinz used to get a pass from investors, who bought shares expecting it to find growth through dealmaking and cost-cutting. But as dealmaking has slowed and cost-cutting has run dry, its investors are punishing it for finding itself no better than its peers.

Like all major food companies, it is now stuck in the precarious position of battling low growth and rising costs in the public eye. Making any demonstrable change in brand and portfolio to appeal to today's consumers will likely come at the expense of quarterly earnings, thereby reaping immediate punishment.

Mars, meantime, is entirely owned by the Mars family, who has run its $35 billion business for the long-haul. Without investor scrutiny, Mars made long-term investments in its chocolate business, like spending $100 million on the capacity to make caramel M&Ms. It also made changes for its future, paying $9 billion for animal hospital company VCA as Mars as eyes a firmer hold of the growing pet industry.

The contrast between a company for the long-term rather than short is one with which Buffett is intimately familiar. Buffett, an opponent of quarterly earnings guidance, took a swing at managing for the quarter in this year's annual letter.

"Charlie and I have seen all sorts of bad corporate behavior, both accounting and operational, induced by the desire of management to meet Wall Street expectations. What starts as an 'innocent' fudge in order to not disappoint 'the Street' – say, trade-loading at quarter-end, turning a blind eye to rising insurance losses, or drawing down a 'cookie-jar' reserve – can become the first step toward full-fledged fraud."

Indeed, Kraft Heinz revealed earlier this week it was the target of an U.S. Securities and Exchange Commission investigation into its "accounting policies, procedures, and internal controls." It has said it is implementing certain measures to "mitigate" the risk of making the mistakes in the future.

Details around the nature and remedies surrounding the investigation are vague, and there is no evidence it is anything other than an honest mistake.

"We continue to cooperate fully with the SEC, and at this time the Company does not expect matters subject to the investigation to be material," a Kraft spokesman said in a statement.

Still, not fully recording costs each quarter is one way companies have, in the past, helped boost their quarterly performance — and it could be the type of behavior Buffett has warned against.

He told investors at a 1995 shareholder meeting, that when investing "the most important thing [is] trying to find a business with a wide and long-lasting moat around it … protecting a terrific economic castle with an honest lord in charge of the castle," according to a clip found using CNBC's Warren Buffett Archive.

There was a time when making blue boxes of Kraft Mac & Cheese dinner or hot dogs, promoted with their own iconic touring "Weinermobile," seemed like the right fortress on which to stake a claim, but that may not be the case any longer.

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