Following in P&G’s Footsteps, Heinz Deal Aims to Beat Taxes

The worldwide reshuffling of the packaged food industry moved into higher gear during June when major players pulled off two innovative deal structuring arrangements for transferring major brands without a cent of cash changing hands. The financial engineering served the dual purpose of advancing the game plans of four major food producers while allowing the divestors to avoid potentially huge tax bills. In one deal, H.J. Heinz Co. unloaded a bundle of mature, slow-growth product lines, including tuna fish, pet foods, baby foods, and broth, by dealing them to the much smaller Del Monte Foods Co. in a Morris Trust-type transaction to be executed via a spin-off and merger. In the second transaction, in effect a Morris Trust variation, Nestle SA sold its North American ice cream brands to Dreyer’s Grand Ice Cream Inc. in a $2.4 billion stock deal that gave Nestle 67% control of Dreyer’s. The agreement allows Dreyer’s to buy up the public’s remaining stake in 2006. Trailblazing in tax avoidance Heinz and Del Monte fit the paradigm developed last year when Procter & Gamble Co. dealt off its Crisco cooking oils and Jif peanut butter brands by spinning them off into a separate company, which then was acquired in a stock swap by J.M. Smucker Co. The pressure for such complex arrangements represents one of the great – and sometimes inexplicable – anomalies in m&a. Sellers such as P&G and Heinz have a multiplicity of brands, some of which they would like to cut loose either because they are growing too slowly or it is advisable for them to simplify their portfolios. To sell the brands for cash normally would trigger a large tax bill. The enigma is that the brands that are valued so highly for tax purposes are the poorest performers for their current owners. Even some experts on the question can’t account for the difference, although some say it usually results because the brands have been held for a long time and have appreciated in value over the years, even if recent performance is wanting Robert Willens, a managing director and corporate tax expert at Lehman Brothers, says that he expects stock-based deals, including the Morris Trust-type spin-off/acquisition schemes, to become more common as restructurings in food and other consumer-oriented industries pick up steam and tax avoidance represents a big issue. Willens reiterates a warning that the trick to escaping taxes in these deals is to make sure that the shareholders of the parent company initiating the transaction wind up owning a majority of the firm that does the second-step acquisition. Thus, P&G shareholders owned about 53% of Smucker at the completion of their transaction while Heinz shareholders will hold 74.5% of Del Monte stock when their deal is sealed. Strategically, the Heinz/Del Monte transaction could be viewed as a corporate version of the baseball trade that helps both sides. Heinz is turning over to Del Monte its StarKist tuna, a pet food business with such well known products as 9-Lives and Kibbles n Bits, Nature’s Goodness baby foods, and College Inn canned broth and Del Monte is picking up $1.1 billion in debt. Shifting brands to aid strategies Heinz says that freed of these slow growers, it can target annual earnings-per-share growth of 8% to 10% a year and sales growth of 3% to 4% after “transition year 2003” from its remaining lines. Del Monte more than doubles in size, with the newly acquired brands expected to represent nearly 60% of a projected $3.1 billion in annual sales and to extensively broaden its existing business, which is concentrated in canned foods. Moreover, despite Heinz’s willingness to shed them, several of the brands are among the biggest sellers in their categories, such as StarKist and Nature’s Goodness, which is No. 2 in baby foods. Ironically, Heinz tried to expand market share in both tuna fish and baby foods but ran into antitrust snags both times. Heinz tried to buy the Chicken of the Sea tuna line but the government opposed that deal as an anticompetitive expansion in the slow-growing field. It also sought to buy the third-ranked Beech-Nut baby food line but was fought by the Federal Trade Commission (FTC), which won a critical appeals court decision. Even though the combined business would have been a distant second to the Gerber brand, the court upheld the FTC’s argument that trimming the market from three players to two was anticompetitive. The big prize in the ice cream deal is the premium Hagen-Dazs brand, which will help propel Dreyer’s into a worldwide tie with Unilever for first place among ice cream producers. Added size and wider distribution are considered critical synergistic throw-offs in the hotly competitive industry, and Nestle estimates that Dreyer’s can save $170 million a year from efficiencies gained by consolidating plants and other functions. Before the transactions, Dreyer’s already was No. 1 in the U.S. with its Dreyer’s brand in the West and Edy’s brand elsewhere. It also has a number of smaller brands, such as Godiva, Starbucks, and Healthy Choice, and distributes ice cream products for other manufactures. Nestle previously owned a 23% stake in Dreyer’s. Goodwill Challenges To Divesting Firms Before it was finally completed in early July, the IPO divestiture of CIT Group Inc. by Tyco International Ltd. was riddled with problems, including a huge goodwill write-down for CIT. Although it was believed to be the first such goodwill reduction for a company in registration for a public offering, experts warn that it won’t be the last time the issue impacts corporate divestitures through either IPOs or sell-offs for cash or stock. The exact reason that CIT was hit with a $4.5 billion goodwill impairment, under orders from the Securities and Exchange Commis-sion (SEC), was not disclosed. However, expert sources suggest that Tyco was carrying CIT at too great a value, of more than $11 billion, on its books. That also indicates, they say, that Tyco may have overpaid for CIT, which was acquired for close to $10 billion in 2001. The broader implication of the CIT experience is that other restructuring companies seeking to divest business properties may have to reduce the goodwill entries of unwanted subsidiaries and divisions before parting with them. In fact, that could be a very common practice as corporate sell-offs and restructurings accelerate in the next several months, according to authoritative projections. This unusual possibility is one of the many unforeseen outcomes of the sweeping changes in merger accounting promulgated in 2001 by the Financial Accounting Standards Board (FASB). The key actions eliminated pooling-of-interest accounting for mergers and long-term amortization of goodwill while allowing companies to perform annual tests for impairment of goodwill. If impairment is found, the company is authorized to write off goodwill in one shot. The way the final decision on impairment, or lack of it, is made may figure in requirements that goodwill be reduced for subs and divisions on the block. The calculations are additive. The parent determines if its own goodwill is impaired or not impaired by collectively compiling results from its “reporting units,” or subs and divisions. That system may in fact hide impairments at the reporting unit level, experts say. As long as the sub or division stays with the parent, it may not make much difference. But if the reporting unit is set off separately in preparation for a sale, IPO, or spin-off, the company may have to go back and perform a focused impairment test on the unit. Although it slipped through the cracks during the layered approach, an impairment actually may be found when the spotlight is directly on the reporting unit. Ultimately, the parent will have to make an adjustment of its own when that happens. One of the key problems is that companies never have had to produce separate statements for many reporting units and could be shocked at the lengths they have to go to comply with the new accounting rules. It is too early to tell if goodwill write-downs will impact the prices paid in divestitures. Some authorities note that the write-offs will be most prominent at lackluster or poorly performing operations, which don’t face prospects for high prices. But the overall issue is complicated by the fact that goodwill write-offs are not cash items. In fact, many underperformers actually may be generating significant cash flows, and cash often helps spur pricing decisions. Ultimately, it’s the inevitable tension between growth and cash flow.