Given 3G Capital's industry focus, its background of partners and track-record, the next big takeover target for the co-owner of Heinz is almost certainly a legacy branded business in the FMCG world. But which companies other than PepsiCo and Campbell Soup Co. could or should be on that big-ticket target list? We tip Kellogg and, lower-hanging in terms of rationale, General Mills.

General hunting-ground of Heinz adjacency…

Looking in particular at deal track-record (Burger King in 2010, HJ Heinz in 2013), but also taking into account the group's partners' profiles, 3G's next acquisition target will include a strong, household name brand, in the developed world, in food and beverage, foodservice or retail. 

We can also be sure that, given 3G's track-record of public-to-private deals, the target will be a big public company, with a large free -float, rather than a privately -held one.

We can exclude foodservice and retail, because we learn both from general sources and from discussions with insiders, that 3G wants to treat Heinz as a platform for acquisitions in adjacent, grocery food categories, above all in the US.

… plus investment rationale of cost cutting …

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The key question is: what was the investment rationale behind the HJ Heinz acquisition? Understanding that will take us a long way to unlocking the case for which company might be next on 3G's acquisition trajectory in US branded grocery foods. 

Heinz was a decentralised business, with too many factories (upwards of 20 in Europe, to the constant chagrin of senior management) and too many brands (as many as 15 power brands accounting for only two-thirds of the group's sales). It was a clear candidate for streamlining, rationalising, centralising. 

Now, eighteen months or so after the acquisition, 3G's restructuring and productivity initiatives are already bearing fruit, with Heinz's adjusted EBITDA up by 30% in the third quarter of 2014 year-on-year. Functions have been centralised or regionalised, product lines have been terminated, three factories have been closed.

… but focus now must be on growth through acquisition

Although Heinz's EBITDA increased in the third quarter, for the first time in several years its top-line failed to grow in that period and in fact volumes declined. It's hard to see how that will be reversed organically given 3G's model includes reducing costs in commercial functions, and centralising marketing across broader geographies.

If Heinz does not start to grow again, then it risks milking itself to death over time. That's a classic scenario of a group that needs to grow through the acquisition of businesses in overlapping or adjacent product categories and geographies.

PepsiCo and Campbell have already been rumoured as takeover targets but which other companies could or should be on the list? We would contend Kellogg and, in particular General Mills, both meet the investment criteria and acquisition trajectory that's been outlined above.

PepsiCo simply too big and distant…

Speculation and activist shareholders has spoken of a split of PepsiCo's beverages and snacks businesses, in order to increase value, for some time. Although the case for that might be strong, it seems unlikely it would be affected by 3G taking over the group first.

Just think of the sheer scale of such a transaction. PepsiCo is the second-largest food and beverages group in the world, with sales revenue of US$66bn. That makes it more than five times as big as Heinz. Sure, 3G might be looking to make a bigger bang with its next acquisition, but maybe a company twice the size is the limit.

Plus the portfolios of Heinz and PepsiCo are relatively far apart, in that grocery products are very different from impulse-based soft drinks and extruded snacks, from a sales and marketing perspective. It makes more sense for 3G to target a primarily grocery business. 

…with Campbell more likely…

From a portfolio perspective, there's no business more adjacent to Heinz than Campbell, with its status as the world's leading soup maker, and 60% market share in US wet soups.

On the other hand, Campbell's performance is looking quite rosy, with net sales up by 4%, and adjusted EBIT 9%, in the first quarter of its 2014/2015 financial year, so shareholders are unlikely to be overly nervous about earnings. Plus the group is relatively small, with annual turnover of around US$8bn. 

Kellogg according to insiders…

We admit Kellogg's candidacy was mentioned to us by a source very close to Heinz (one of the victims of 3G's restructuring there). However, looking at Kellogg's recent financial performance, it's not difficult to see why the cereal-to-snacks group should be on the radar.

In both the third quarter and the first nine months of 2014, Kellogg's top-line and underlying operating profit were both slightly down compared with the prior year. Indeed, underlying operating profit in particular has been almost stagnant over the last five years. Kellogg's portfolio is also very much adjacent to Heinz in terms of shelf -space (morning foods, snacks).

On the other hand, the group's decline has been mostly due to problems in the highly-competitive North American market. Elsewhere things are more positive; in the third quarter, Kellogg reported earnings growth in Europe, Asia Pacific and especially Latin America (up by 20%). Kellogg also has a relatively focused portfolio and brand structure, which limits the opportunity for rationalisation. 

Overall therefore, although Kellogg's ticks some of the boxes as a takeover candidate for 3G, there is we believe a lower-hanging behemoth in the same space, that we would tip more (if 3G can raise the capital).

…but General Mills ticks more of the boxes

General Mills, the third-largest consumer foods group in the US, booked flat sales and declining earnings numbers in the second quarter of its 2014/2015 financial year. In that context, a series of restructuring measures have been announced.

There's a lot to streamline, rationalise and centralise. For a start, the group has about 40 production locations in the US alone. As for its portfolio, General Mills has no single flagship brand, like Heinz or Kellogg do. However, with a range of over 40 brands, there's huge potential for brand migration and consolidation in its various business segments, with attendant savings in marketing costs etc.

Should General Mills' shareholders entrust the restructuring plan to encumbent management, or is there more value-creation certainty in merging with a Heinz that has over a year of successful restructuring to its credit, as well as bringing all the goodies of cost synergies and portfolio adjacencies?

At 12x EBITDA, our valuation for General Mills comes in at slightly below the Heinz number, from an EV/EBITDA perspective because, in our view, General Mills does not have quite the brand equity of Heinz, in our view. At an enterprise value of US$42bn, a takeover of General Mills would be 50% bigger than the Heinz deal.

Size (€ mln) 36000
Sector grocery products
Asset Quality US no.3 group branded
Seller large plc
Buyer private equity
P/S 2,4
P/Ebitda 12,0
Type enterprise value estimate