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Heinz and Kraft: how a new food giant will come together

Appeal of Kraft and Heinz to shoppers is pretty enduring, says Warren Buffett

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Some of the most familiar names in ketchup, cheese, coffee and sauces are set to come under the same roof after H.J. Heinz Co. announced plans Wednesday to buy Kraft and create one of the world’s largest food and beverage companies.

The deal would bring together an array of longtime staples in kitchens in Canada, including Jell-O desserts, Miracle Whip spreads, Maxwell House coffee, HP Sauce and, of course, Kraft cheese and Heinz ketchup.

READ: What does Heinz-Kraft merger mean for Canada?

The combination of the two companies–each more than a century old–was engineered by Warren Buffett’s Berkshire Hathaway and Brazilian investment firm 3G Capital, which teamed up just two years ago to buy Heinz.

While shoppers are not expected to see any major changes, the creation of The Kraft Heinz Co. reflects the pressures facing some of the biggest packaged food makers.

As consumers increasingly migrate away from popular packaged foods in favour of options they consider less processed, companies including Campbell Soup, General Mills and Kellogg have been slashing costs or striking deals to update their products offerings.

The Heinz-Kraft deal is in many ways just the latest example of that, although Buffett noted that the two companies still have a strong base of customers.

“I think the tastes Kraft and Heinz appeal to are pretty enduring,” he said in a telephone call to the business news channel CNBC.

Still, the early plans outlined by Kraft and Heinz executives in a conference call Wednesday focused largely on the savings that would be achieved through the deal, rather than the potential for sales growth in North America.

They said they expect to save US$1.5 billion through moves such as combining manufacturing and distribution networks.

James Angel, an associate professor of finance at Georgetown University’s McDonough School of Business, said that would probably result in job losses.

“Even though it is painful for the people involved, those resources will be freed up for other, potentially more productive, uses,” he said.

The boards of both companies unanimously approved the deal, which still needs a nod from regulators and shareholders of Kraft Foods Group Inc. The companies say they expect the deal to close in the second half of the year.

READ: The rise of discounters

If the agreement goes through, Kraft is expected to undergo cost cutting under the management of 3G Capital, which is known for running tight ships.

John Cahill, who took over as CEO of Kraft late last year, noted that the new management would drive a “much leaner organization,” as was the case when 3G took over Heinz. He said 3G can “make this happen deeper and faster.”

“What we have not been thrilled about is some of our execution,” Cahill said.

The two companies also see potential in pushing their products more aggressively overseas. Since splitting from Mondelez in 2012, Kraft’s business has been primarily concentrated in North America.

But executives noted that Kraft’s brands are well known in major markets around the world, including the United Kingdom, Mexico, China and Brazil.

Already, Heinz gets 61 per cent of sales from outside North America, said Bernardo Hees, the CEO of Heinz and a partner at 3G Capital who will become head of the newly created company.

The deal came together rapidly, Buffett said, having been in the works for only about four weeks.

VIEW: A cathedral of food

The new company will be co-headquartered in Pittsburgh, where Heinz is based, and the Chicago area, home of Kraft, and will have annual revenue of about US$28 billion.

Eight of its brands have annual sales of $1 billion or more and five others log sales between $500 million and $1 billon every year.

Shares of Kraft jumped nearly 35 per cent, to $82.72, in Wednesday afternoon trading.

The total value of the deal is difficult to gauge because Heinz is privately held. But Kraft shareholders will receive stock in the combined company and a special cash dividend of approximately $10 billion, or $16.50 per share. Each share of Kraft will be converted into one share of Kraft Heinz.

Current Heinz shareholders will own 51 per cent of the combined company, with Kraft shareholders owning a 49 per cent stake.

The Kraft Heinz board will include six directors from the current Heinz board. Those six directors will include three members from Berkshire Hathaway and three members from 3G Capital. The current Kraft board will appoint five directors to the combined company’s board.

Kraft Heinz plans to keep Kraft’s current dividend once the transaction closes. Kraft has no plans to change its dividend before the deal is complete.

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