The H.J. Heinz Company (NYSE:HNZ) deal is complex, but the logic is simple.
As we age, we change. Warren Buffett is quite a different investor from his early days. His investing style has evolved. In his callow youth, Buffett started out investing in smaller, unloved, discarded companies: the so-called 'cigar butts' that his mentor Ben Graham was so keen on.
Later, he started to buy into companies that weren't cigar butts, but that appealed to his value and contrarian instincts. This was Buffett's 'golden age', when he churned out astonishing rates of return year after year.
More out of necessity than choice
But as Buffett turned Berkshire Hathaway from a dilapidated textile mill to the investing equivalent of the Sistine Chapel, the Oracle of Omaha was faced with a big difficulty. More out of necessity rather than choice, his investment style had to change.
When his investment funds numbered in the millions of dollars, he could basically invest as any private investor would. But when his investment funds numbered in the tens of billions, this was no longer possible. If you have $10 billion to shell out every year, there are only so many $100 million companies you can buy.
So when you get bigger, investing gets more difficult; potential opportunities are fewer and further between. I think this is one of the major reasons why Buffett's investment return over the past decade, although still decent, is less than half the average return he achieved throughout the length of his career.
Turning it around
So, onto Heinz (NYSE: HNZ.US) -- on the face of it, not a good deal. After all, why would the notoriously miserly Buffett splash out billions to buy a run-of-the-mill consumer goods company at a rather pricey P/E ratio of 21?
Well, it's quite simple really: he didn't. Out of the $13 billion he has paid for, $9 billion is in the form of preference shares, and only the remainder is in equity. It is thought Buffett will receive a yield of 9% from these preference shares, which outperforms the dividends paid by pretty much any high-yielding blue chip you can think of. In the next few years, Buffett will be banking the bulk of Heinz's profits. This is a deal that only someone with the financial muscle of a Berkshire Hathaway could pull off.
Quite simply, Buffett has figured out that while Berkshire Hathaway's size is a disadvantage as far as traditional value investing is concerned, he can draw on Berkshire's financial clout to get the best deals in terms of preference shares. He pulled off the trick with Goldman Sachs, Bank of America, and now Heinz.
Perhaps we should not be surprised to see that, with typical panache, Warren Buffett has turned his main disadvantage to a singular advantage.
Warren Buffett's ability to spot trends early, and to capitalise on them, and to coolly work out a company's potential and ignore the noise, has been the secret to his investing success.
It has also led him across the Atlantic to invest in a particular British company. Find out about 'The British Business That Warren Buffett Loves' in this free report.
> Prabhat owns none of the shares mentioned in this article.