Takeover speculation for Kellogg has led to company's shares rising more than 8% since April, bestowing company with a US$25B market value

Nevin Barich

NEW YORK , June 3, 2014 (The New York Times Co.) – Kellogg looks like someone wants to eat it for breakfast.

Takeover speculation has helped the company’s shares rise more than 8 percent since April, bestowing it with a $25 billion market value. Kellogg may be too big for a Hillshire-like takeover battle, and it carries too much debt to make a traditional leveraged buyout palatable. But a deal like the one Warren E. Buffett and a group of Brazilian financiers struck last year for the ketchup maker Heinz might work.

Kellogg’s $7.4 billion of net debt limits how much a buyer could borrow to juice returns in a straight leveraged buyout. A deal struck at a 20 percent premium to Kellogg’s current market cap, funded with 30 percent equity, would burden it with net debt of more than nine times earnings before interest, tax, depreciation and amortization. That’s too high for comfort.

Heinz shows a more digestible solution. Mr. Buffett and his Brazilian partner 3G financed their $28 billion acquisition with around $8.2 billion of equity and $8 billion of preferred shares. A similar move would value Kellogg at an enterprise value of about $37 billion. Net debt would be 5.4 times Ebitda, a bit lower than the leverage for Heinz. Interest cover would be tight at 1.5 times Ebitda, including the cost of preferred dividends. But Mr. Buffett and friends left Heinz similarly stretched.

Such a deal would still present challenges, requiring a huge equity check and the same long-term approach to returns that Mr. Buffett and 3G took. These partners might double their money on Heinz, but it will take 10 years and require that sales grow 4.5 percent a year and margins jump by a third, Breakingviews calculated at the time.

Mimicking that at Kellogg would be harder. Low cereal sales in the United States mean that analysts do not expect revenue growth to top 3 percent before 2018, according to Thomson Reuters data. And fierce competition in the breakfast aisle may limit gains from cost cuts.

Still, if Kellogg could coax out 5 percent Ebitda growth, investors could feasibly make a 12 percent return on their equity investment, excluding the 9 percent return on the preferred shares. If the Sage of Omaha wants to do a Heinz with Kellogg, he would need a solid operating partner – and a lot of patience.

Kevin Allison is a columnist at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.

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