We Need to Be Less Efficient
As investors, we are trained to love productivity and efficiency. On the productivity front, a company that gets more output from its employees is typically a more profitable company. If you have one person doing the job of two, well, costs are lower, which means profits will be higher, right?
We might even think the productive company is just better — because it understands its market better or is better at managing its employees or has better systems or processes in place. And in terms of the economy, it's standard economic dogma that a productive economy is a better economy.
When it comes to efficiency, well, who doesn't want that? Better gas mileage, a washing machine that uses less water, light bulbs that use less electricity...
The Internet is obviously the big efficiency engine. The effect on worker productivity has long since worn off, but in terms of efficiency, it's still on the upswing. Just look at the increase in online shopping — every year, online retail grows by double digits as people save time and energy when they buy stuff online.
But what if efficiency and productivity aren't the twin holy grails we thought they were? What if it actually is better to have two people doing the work of two?
Warren Buffett Took Your Job
In 2013, Warren Buffett teamed up with a Brazilian private equity firm called 3G Capital to buy everybody's favorite ketchup maker, Heinz. Berkshire and 3G each put up $4.25 billion, and Berkshire added $8 billion for Heinz preferred stock that paid 9%. Heinz was valued at $28 billion at the time. The buyout was accomplished with $16.5 billion in cash, and the rest was loans.
A couple years later, Buffett and 3G Heinz set their sights on Kraft Foods. At the time that Heinz announced its intention to buy Kraft, the Heinz CEO said via press release:
Over the past two years, we have transformed Heinz into one of the most efficient and profitable food companies in the world while reinvesting behind our key brands and continuing our relentless commitment to quality and innovation.
And while it's true that profit margins did get better with the Heinz buyout and subsequent merger with Kraft, as this nifty Bloomberg chart shows...
It's not exactly due to reinvestment and a "relentless commitment to quality and innovation." It's more like firing people. 7,000 people, in fact.
When Heinz merged with Kraft, the total market cap came to $83 billion. The Heinz part of that total market cap amounted to $43 billion (according to Bloomberg's Matt Levine, who is a great read). So, Buffett and 3G put up a total of $16.5 billion to buy a $28 billion company, and two years later, that stake was worth $43 billion. So they more than doubled their money while 7,000 people lost their jobs.
Heinz estimated that it would save $1.5 billion a year once 7,000 people were canned. So basically, Buffett and 3G took the 10 years of salary for 7,000 people and put it in their pockets. They fired another 2,500 employees at Kraft once that merger was done.
Wow! Great! Productivity and efficiency!
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Do We Need Efficient Ketchup?
So, we're talking about ketchup, barbecue sauce, macaroni and cheese, and sandwich meat. And my question is: is it vital to the health of the U.S. economy and to the very notion of a free market that ketchup, barbecue sauce, macaroni and cheese, and sandwich meat companies run at absolute peak efficiency?
Again, investors always value productivity and efficiency. But in the bigger picture, is there any way to factor the fate of the 9,500 employees that were fired into the value equation?
I get the free market argument here. Capitalism is all about ownership. If you have the cash, you can buy whatever you want. And if you can make a company more efficient, then you make more money and get an edge on your competition. But firing people isn't exactly making the company more efficient, even though it does raise productivity because you're doing the same thing with fewer people.
There was a time when I though mergers and acquisitions were cool and kind of exciting. When a company wants to buy another one, you think, "Hey, this company must see opportunity to sell more stuff, and they must also think that corporate valuations are low enough to be attractive."
But clearly, that's not always what's going on. Sometimes it's as simple as one company saying, "Hey, there's a company where I can fire a bunch of people and make more money."
When InBev bought out Anheuser-Busch in 2008, 1,400 American employees got the axe...
When Anheuser-Busch bought out SABMiller, 5,550 employees were canned...
When Dow Chemical and DuPont merged last year, something like 5,900 employees were told their services were no longer needed...
At some point, simply firing people in order to make more money is a zero-sum game. You might save some money, but you are also slowly eroding your customer base.
I think it's high time that mergers and acquisitions take into account the impact on employees.
Joblessness and Wealth Inequality
I can't tell you that mergers and acquisitions are the reason there is a growing disparity between the haves and the have-nots in America today. But I guarantee you it is contributing. While I was writing this piece, I came across this article that has some pretty eye-opening statistics in it.
Here's one that sounds pretty good: Between early 2000 and late 2016, the estimated net worth of American households and nonprofit institutions more than doubled, from $44 trillion to $90 trillion.
But don't forget, the population has grown, and there's inflation. If you factor in the population growth, you get stats like these:
- Between 2000 and 2016, per-capita growth in GDP has averaged less than 1% a year.
- For every unemployed American man between 25 and 55 years of age, there are another three who are neither working nor looking for work.
- If our nation’s work rate today were back up to its start-of-the-century highs, well over 10 million more Americans would currently have paying jobs.
- In 2016, work rates for the “prime working age” group (25–54 years of age) were down almost four percentage points from their year-2000 highs. That is a jobs gap approaching 5 million for this group alone.
The main point of these observations is that, based on population, the United States has lost 10 million jobs over the last 16 years. 10 million.
There can be no doubt that mergers and acquisitions like the Heinz-Kraft deals are contributing to this dilemma. And unless it is addressed, the rich will get richer, the middle class will get smaller, and the anger of the American people will increase.
Until next time,
A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.
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