Goodwill impairment is likely to be on the rise.
When Warren Buffett’s Berkshire Hathaway bought H.J. Heinz Co. in 2013, the prevailing view was the company was undervalued in the market given its potential for worldwide growth. In 2015, when Buffett led the merger of Heinz and Kraft Foods Group, Inc., he predicted a food manufacturing powerhouse with the best brands, “uniting two world class organizations and delivering shareholder value.”(1)
In February, Kraft Heinz Co. (KHC) announced $15.4 billion in write downs due to goodwill impairment. Goodwill is the difference between the price paid by an acquirer and the target’s fair market value. Usually, companies engage in a complex process of purchase price allocation in order to determine how much goodwill can be ascribed to intangible assets (such as brand names, customer lists, and other assets that can’t be included in property plant & equipment).
The key factors leading to KHC’s goodwill write down are instructive:
- Expected synergies did not come to fruition
- After massive cost cuts, the company failed to pivot toward growth.
- Grocery store chains resisted KHC’s price increases, resulting in an erosion of distribution channel relationships and 1-2% annual revenue declines since 2016.(2)
- The brands Heinz purchased were not as valuable as expected.
- The Kraft and Oscar Mayer brands under performed due to consumer tastes shifting away from processed foods.
- KHC’s price increases caused grocery stores and consumers to turn to other, often cheaper, products.
Over the last five years, global M&A deal value has averaged $4 trillion annually. During this time, acquirers have paid up to 12.0x-14.0x EBITDA for targets. These are historically high valuation multiples, even when compared to frothiest years in the run up to the Great Recession.
KHC’s experience may be a harbinger of things to come, as other companies fail to achieve expected merger synergies. As a result of overpaying, both strategic and financial buyers may end up taking significant goodwill impairment charges in the near future.