3G LBO of Burger King

3G's $3.3B ($4.17B total transaction value) LBO of Burger King is one of the most high-profile LBOs of 2010. This LBO is interesting for a number of reasons. For one, the acquirer, investment fund 3G (funded by a small group of Latin American billionaires), is not a part of the usual suspects one would expect to see on a deal of this magnitude. Also different from most LBOs, 3G has stated it is buying Burger King for the long-haul and is willing to wait 10 years before exiting.

The choice of Burger King is also a strange one. When BK was bought out by Bain, GS, and TPG in 2002, Burger King was an insignificant and unappreciated holding of the food and beverage behemoth Diageo, allowing the sponsors to acquire BK at a very favorable valuation. But the Burger King of today is much different. Eight years of sponsor ownership have turned BK into a lean company with few easily realized cost reductions. Furthermore, from a strategic point of view, BK has fallen far behind its rival McDonald's and requires massive amounts of capital expenditures to compete (estimated in a recent Bloomberg article to be as high as $3 billion). For more on the challenges facing 3G, go here. Perhaps most surprising is the valuation. 3G did not pick up BKC on the cheap, paying 9.4x LTM EBITDA and 8x LTM net income.

My model of the LBO is posted below. I suggest you do not try to look at it on Scribd but instead go here, and download the excel file. My analysis shows that using conservative growth assumptions and moderate cost cutting assumptions, the Burger King LBO could return 16% annually if 3G exits in five years at the same valuation (9.4x EV/EBITDA) at which it entered.

However, this return is very sensitive to Burger King's ability to cut costs, which is questionable given the rising costs in the industry as well as BKC's previous ownership (Management also expects SG&A to increase by 3% in 2011). If one assumes Burger King has to boost capex to 10% of sales and SG&A as a % of sales increases by 3%, the 15% IRR quickly disappears, even with above trend top-line growth.

That being said, I actually think this deal was a good idea for 3G if 3G manages to leverage its experience in Latin America to grow Burger King quickly in emerging markets. As Burger King grows internationally, its operating leverage from its restaurant ownership will deliver larger margins and significantly increase Burger King's valuation. But overall, like most recent LBOs, the success of the BKC LBO is heavily dependent on exogenous forces. 3G is blessed to have patient investors. It's longer term investment horizon will allow it to wait for an opportune time to exit -- which can make all the difference.

Burger King LBO Model

Going forward...

As I've learned more about finance over the last few years, I've started to shift my focus from markets and asset prices to transactions and operations. On this blog, I've written mostly on macro, geopolitical, and policy issues. Going forward, I expect to have little to say on these subjects. For one, I (regrettably) no longer have time to read as I once did (I recently graduated from school and am working full-time in finance). But more importantly, I've become increasingly interested in the details of operations, capital structure, and M&A. Perhaps the greatest reason behind this shift is that I've found I really like the way investors can influence returns by making financial or operating changes, while in macro investments an investor is merely a spectator, (though exciting as that may be in interesting times such as these the lack of control can be frustrating).

So what I've decided to do is use this blog as a forum to discuss recent M&A deals (trends, valuation, etc.), focusing mostly on LBOs and private equity activity. I'll usually build a model to back up my analysis which I will post on Scribd. The first LBO I will discuss is 3G's recent buyout of Burger King.

My Thesis: Pricing of LBOs from 1999-2009

I finally finished my honors thesis. I wrote about LBO pricing from 1999 to 2009. LBO prices (valuation multiples) rose dramatically as the amount of capital committed to private equity surged almost 10-fold after 2001. I argue that mega-buyouts, such as TXU Corp., HCA, First Data, and Freescale, were designed to avoid the increasing prices of LBOs by acquiring companies other private equity firms could not buy. My results support this hypothesis and show that after an LBO exceeds around $10 billion in Enterprise Value, the valuation of the deal becomes more favorable. After bypassing this threshold, EV/EBITDA decreases .1-.2 for every $1 billion increase in transaction value. This result is statistically significant at the .05 level.

If you are not interested in the results of my statistical analysis, you might still be interested in the first half of my paper. Section 1 gives a thorough history of private equity activity since 1980 and illustrates how the space has changed over the last 10 years. Section 2 reviews academic research on LBO performance and pricing.

LBOs From 1999 to 2009

A Shift in American Conservatism

Over the last decade, the Republican party has not lived up to its conservative values regarding fiscal issues. Until recently, the far right-wing focused increasingly on social issues. Consider, for example, Bush's gaping budget deficits. Or better yet, the rise of politicians such as Huckabee or Palin, both of whom's appeal is their social conservatism. Both can be described as either uninformed, undistinguished, or both in the fiscal realm. Given recent developments in GOP politics, it seems this trend has finally reversed, though ironically this reversal may not be as good for the deficit as one might expect.

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Grantham on Bubbles

Jeremy Grantham of GMO has made some interesting comments recently on bubbles. In this FTfm interview, Grantham argues there is nothing more damaging to an economy than a breaking asset bubble. In his Q1 2010 quarterly letter, Grantham identifies bubbles in US equities, emerging nation equities, and commodities. Grantham also recommends continued allocation to these assets, a strange recommendation considering Grantham is a value investor, who traditionally shy away from overpriced assets.

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Kraft-Cadbury Was a Good Deal Despite Recent News

Much ado has been made about the Kraft-Cadbury deal. The consensus seems to be (especially after the overlooked pension shortfall) that Kraft overpaid for Cadbury and, even worse, used its own undervalued stock to do so. Recently, Kraft revealed CEO Irene Rosenfeld's compensation for 2009 was $26.3 million, up 41% from 2008. The compensation committee "heavily weighted the significant effort and the ultimate acquisition of Cadbury" to determine the payment. To some, the Kraft-Cadbury deal is the perfect example of empire building, suggesting that Rosenfeld executed the Cadbury deal to increase revenue (which generally determines CEO compensation) without much attention to the price. This criticism reflects the common conception that most M&A destroys value and is driven by ego and compensation. In my opinion, this view is misguided, both for M&A generally and Kraft specifically.

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A Few Words on the SEC's Suit Against Goldman

Reading the SEC's allegations against Goldman (available here), I was reminded of the case against Bear Stearns hedge fund managers Cioffi and Tannin. From the excerpts of emails given by the prosecution during this case, it seemed that Cioffi and Tannin clearly deceived investors. However, the defense argued that the prosecution's damning quotations had been taken out of context and did not reflect the concrete views of the defendants. Furthermore, it was difficult to link these discussions to actually proving that the managers mislead investors. Cioffi and Tannin were acquitted of any criminal wrongdoing.

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