Heinz, Kraft to create world's No. 5 food company

In a jolt touching pantries across the globe, H.J. Heinz and Kraft Foods Group (KRFT) will merge into the world's fifth-largest food and beverage company — bent on cutting costs, growing internationally and evolving into a more consumer-focused company.

The massive merger, valued at about $36 billion, will allow Kraft "to move and grow faster than we could on our own," Kraft CEO John Cahill said. He would become vice-chairman of the newly-formed Kraft Heinz.

The news propelled Kraft shares nearly 36% — or $21 .83 per share — Wednesday to close at $83.15.

It's a bid "to create a Nestle of the USA," Nomura equity analyst David Hayes said. Others called it a New Era mega-deal that mixes sugar and spice — the sugar being the recent M&A popularity of food and beverage makers; and the spice being that Warren Buffett, through his Berkshire Hathaway, linked with Heinz operator 3G Capital to seal the deal with a combined injection of $10 billion in capital.

The companies had been unanimously approved by their boards of directors. The new firm will be headquartered in Pittsburgh, home of Heinz, and in the Chicago area (Kraft). There are no plans to close either operation.

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At issue is how the combined iconic but aging mega-brands will solve the overarching issue both companies face: evolving consumer taste trends that tend to favor foods perceived as fresh and natural over foods processed and packaged.

"These two companies are old school," said Lou Biscotti, global practice leader for WeiserMazars. "Both are stodgy, old brands that haven't kept up with the times in terms of shifting consumer appetites."

The new company will have revenue of approximately $28 billion and will hold a portfolio of brands, including Heinz, Kraft, Oscar Mayer, Ore-Ida and Philadelphia.

These are brands that still pack a wallop. A Kraft product of some kind is in 98% of American households, and Kraft ranks No. 1 or No. 2 in 17 core categories. Heinz, a more global food company, remains the world ketchup kingpin, and its various brands and products rank No. 1 or No. 2 in categories in 50 countries.

Officials said the merger of the two companies would result in $1.5 billion in cost savings by the end of 2017. In 2013, after acquiring Heinz, 3G aggressively cut costs there, axing 7,400 jobs in the process.

The key for the merged company, Biscotti said, will be to use the savings to acquire companies more closely aligned with emerging consumer trends. "If they don't do that, the deal won't be a success," he said.

"They should have started years ago," said Gary Stibel, CEO of New England Consulting Group. "They've both played lip service to better-for-you (food trends) for over a decade."

That may change sooner rather than later. "Our goal is to have industry-leading innovation," said Bernardo Hees, CEO of Heinz who will become CEO of Kraft Heinz. Alex Behring, chairman of Heinz and 3G Capital managing partner, will be the chairman,

Kraft shareholders will own a 49% stake in the combined company, and Heinz shareholders will own 51% on a fully diluted basis.

In addition to stock in the new company, Kraft shareholders will get a special cash dividend of $16.50 per share.

That $10 billion aggregate special dividend is funded with an equity contribution by Buffett's Berkshire Hathaway (BRK.A) and 3G Capital.

For Buffett, the deal seems as simple as pouring ketchup over macaroni and cheese. Berkshire is a longtime investor in Kraft. Buffett's passion is to place his investment bets on dominant consumer brands, such as Coca-Cola and Procter & Gamble, whose products millions of consumers know, understand and most importantly buy.

The deal comes as food companies of all kinds are merging — and splitting apart — seemingly at warp speed. Kraft Foods has been at the heart of it. In 2012, it split off its global snack business, named Mondelez International, maker of the Oreo brand, among others.

What's different this time? What makes Heinz a better fit than Kraft's former snack division?

Hees said Heinz is a "truly global player" with 60% of its sales outside North America. What's more, 25% of its sales are in emerging markets, which he said is "a number that has grown dramatically" over the past decade

"We have the infrastructure in place in those markets," Hees said.

Some doubt the deal is good for shareholders. "Kraft and HJ Heinz engaged in a convoluted merger," said Scott Rothbort, a business professor at Seton Hall University. "This sounds like both an overpriced deal, as well as a unique and crafty piece of financial engineering on the part of 3G and Warren Buffett,"

The deal, subject to approval by Kraft shareholders and regulatory approvals, is likely to close in the second half of 2015.