The Big Read 3G Capital Inc

The lean and mean approach of 3G Capital

Founding partner Alex Behring talks about the strategy transforming the beer and food industries

MAY 8, 2017 by Scheherazade Daneshkhu, Lindsay Whipp and James Fontanella-Khan

When Rod Miller found out that Warren Buffett was involved in Heinzs $62bn acquisition of Kraft, he joked with colleagues that the
billionaire investor would spare his job and the factory where he had worked for more than 30 years in Pennsylvanias Lehigh Valley.

Deep down, however, the 61-year-old night shift worker in the Italian and Russian salad dressings department knew Buffett was just
like any other businessman. Moreover, 3G Capital, Mr Buffetts fellow investors, had a reputation for aggressively cutting costs and
jobs.

We knew there was always a risk of job cuts and even factory closure, says Mr Miller. But given the strategic location of the plant,
we thought we would be saved. We were wrong.

Since 2013, more than 10,000 people one-fifth of the workforce have been laid off from Kraft and Heinz, with seven plants shut,
highlighting the human cost and upheaval involved in producing the highest profit margins in the food industry. The founders of 3G
have transformed the beer, fast food and food manufacturing industries with bold acquisitions, which are quickly followed by a brutal
but disciplined attack on costs, a surge in profitability and high returns to shareholders.

Warren Buett of Berkshire Hathaway Bloomberg

After 3G bought Heinz in 2013 with Mr Buffett, profit margins rocketed by a remarkable 58 per cent within two years to 28 per cent.
Such levels, once thought unobtainable by industry executives, are revolutionary in the words of Peter Brabeck-Letmathe, until last
month chairman of Nestl, the worlds biggest food group. The average margin in the food industry today is 16 per cent, according to
Bernstein Research.

These achievements have earned 3G the respect of investors and the fear of rivals. 3G has been a big wake-up call for the industry,
said Will Hayllar, partner at OC&C, a global consulting firm. Lots of questions are being asked of incumbent management teams as to
whether they really are managing the business as effectively as they could.
Two years after buying Kraft and merging it with Heinz, 3G was expected this year to embark on a big acquisition. But when in
February Kraft Heinz and Mr Buffetts Berkshire Hathaway group made a bold $143bn takeover offer for Unilever, it flopped. Kraft
Heinz had to beat an embarrassing retreat within 48 hours after fierce resistance from the Anglo-Dutch groups board.

The Unilever failure was a rare setback for 3G, which is known for its meticulous planning and steely determination. And it has left the
industry wondering where 3Gs next target lies.

3G executives persistently decline to talk to the press. But in a rare interview, Alex Behring, one of 3Gs founding partners and Kraft
Heinz chairman, tells the Financial Times, there is no necessity for another deal.

Kraft Heinz doesnt need another acquisition to drive profitable growth for the long term, he says. As always, we will evaluate any
opportunity that makes strategic sense, with the objective of growing for the long term, whether in the US or internationally.

However, serial acquisitions are one way to increase revenues at a time when processed food manufacturers are being roiled by
changes in consumer tastes and feeble sales growth. Even if Mr Behring insists 3G is not dependent on M&A, investors are placing
bets on more deals. Valuations of companies in the sector, including Mondelez, General Mills and Kellogg, have risen on expectations
that Kraft Heinz is biding its time before striking again, analysts say.

***

3G takes its name from the three Brazilians who once owned Garantia, an investment bank sold in 1998 to Credit Suisse. It was at
Garantia that Jorge Paulo Lemann, Brazils richest man, and his partners, Marcel Telles and Carlos Alberto Sicupira, hit upon the
formula that is shaking up consumer industries today. They bought Brahma, a domestic brewer, in 1989 and used it as a platform to
assemble what would become the worlds biggest beer company Anheuser-Busch InBev through a series of bold acquisitions over
more than two decades.
 Carlos Alberto Sicupira, Jorge Paulo Lemann and Marcel Telles
The three men set up 3G Capital as a vehicle to invest in US companies in 2004 along with Mr Behring and Roberto Thompson Motta.

With each deal they applied the same tactics: a rapier-like approach to costs, swift promotion for high-performing young talent and
transparent annual goals for each employee. The result has been stellar returns to shareholders.

3Gs favoured approach to cost-cutting is zero-based budgeting: giving managers control of their budget and able to query every cost
from scratch. As Mr Sicupira once said: Costs are like fingernails: they always have to be cut.

Mr Buffett, widely regarded as the worlds most successful investor, is an admirer. He helped finance 3Gs $13.3bn acquisition in 2014
of Tim Hortons, the doughnut chain, and invested alongside 3G in Heinz, then Kraft, through his Berkshire Hathaway investment
group.

But while 3G has proved that it can make companies more profitable, it has been less successful at delivering sales growth, especially
at Kraft Heinz. Sceptics say the heavy cost-cutting comes at the expense of brand-building, and that food is a more complicated
business than beer.

***

In February Mr Behring approached Unilever, hoping to strike a deal. It was a move that Paul Polman, its chief executive, called a
near-death experience and he quickly sought to halt the advances.

Mr Behring told the FT that our intention was to proceed on a friendly basis only. As it became clear that Unilever did not wish to
pursue a transaction, we withdrew the offer.

In the past, 3G founders did not give up so easily: InBevs $52bn bid for Anheuser-Busch in 2008 was strongly opposed at first by the
US brewers board. However, Mr Buffett, who has always favoured friendly acquisitions, was not involved in that deal.

The Unilever debacle raises questions about possible tension between the partners. Without Mr Buffetts support, 3Gs firepower
could be more limited.
Mr Buffett has faced persistent questions about his involvement with 3G. He was asked at the Berkshire Hathaway shareholder
meeting at the weekend about the political risks of his association with a group known for cutting jobs.

The 3G people...are very good at making a business productive with fewer people than operated before, but we have been doing that
in every industry, whether it is steel or cars, you name it, and thats why we live as well as we do, he said.

He also emphasised that 3G does not just cut costs but also invests in new products. In the past he has said: Ive never seen anybody
any better about marketing and product development.

That runs counter to the industry view that 3G starves its brands of investment, a charge Mr Behring rejects. We build brands. We
aggressively reinvest in our product innovation, expansion into global white spaces and brand health, he says.

He points to Burger King as proof. Mr Behring says its growth in sales per US restaurant reached more than $1.3m in 2016, from
$1.1m in 2011, equivalent to a doubling of operating profit per restaurant for RBI franchisees.

The growth, he says, was driven by new products at Burger King, such as chicken fries, and creative marketing that won the chain a
Marketer of the Year award at the Cannes Lions International Festival of Creativity.

Kraft Heinzs retail sales in the US have increased 12 per cent since 2014, he says, thanks to product introductions such as a barbecue
sauce range and a mustard for retail customers. New products this year include a selection of fresh foods in a tie-up with Oprah
Winfrey and Weight Watchers.

Kraft Heinz, along with the rest of the packaged food industry, is battling with big shifts in demand. Consumers want healthier, less
processed food, which is often produced by independent companies. Supermarkets are giving more space to fresh food at the expense
of tinned and packaged food.

Mr Hayllar says Kraft Heinzs sales growth has performed in line with its US rivals but it has been weaker than that of Nestl and
Unilever, which have bigger operations in emerging markets.

Ulf Mark Schneider, Nestls chief executive, did not mention 3G by name at last months annual meeting but told his shareholders:
Many companies are focusing on radical cost-cutting to deliver higher profits in the short term. This approach is not sustainable.

***
For all the industrys protestations, 3G can claim to have won the battle if not the war about the long-term viability of its business
model because a rising number of companies in the sector are adopting some of its practices.

Seeking Alpha, the US stock market analysis website, calculates that in 2013, when 3G had just bought Heinz, 14 companies
mentioned ZBB short for zero-based budgeting on their earnings calls. That rose to 90 in 2015.

This trend could limit the potential M&A gains to 3G, says Julian Birkinshaw, a professor at London Business School. The
opportunities for 3G to come in and do the same as before lessens compared to when the companies were sleepy and traditionally
managed, he says.

The big question is whether 3Gs serial M&A model is destined to fall apart once the pool of targets dries up.

What happens when you can't make any more deals? That will happen at some point. It's inevitable, says a founding partner at one
of New Yorks largest hedge funds. Unless they change tactic and start to aggressively invest in research and development and new
growth-generating products, their business is not going to be sustainable in the long run.

In beer, AB InBev has reached that limit in terms of big deals. Having swallowed the London-listed SABMiller last year in a 79bn
takeover, it now sells one in four beers worldwide and reaps 45 per cent of the industrys profits, according to Bernstein. Analysts say
the company could diversify into a big soft drinks acquisition by targeting Coca-Cola or PepsiCo.

There is still plenty of room for deals in food but the choice of Unilever Kraft Heinzs first attempt outside North America
suggests 3G aims to diversify geographically and by business line: most of Unilevers sales are in emerging markets and nearly 60 per
cent of its sales are of personal care brands.

Mr Hayllar says that, even if the M&A finally stops, it doesnt necessarily mean those businesses are unsustainable but it does become
much harder for them to generate significant returns. They will have to play the same old challenging organic growth game that
everybody else is having to play.

Mr Behring disputes the portrayal of 3G as ignoring the human toll of its drive towards efficiency. Burger Kings international push
has created more than 105,000 jobs, he says.
But for workers who are losing theirs it feels very different.

If I go to another job I have to start from the beginning again, says Juan Perez, who has worked for nearly two decades at Krafts
Oscar Mayer factory in Madison, Wisconsin. Its like wasting 18 years.

Additional reporting by Eric Platt in Omaha

Brewing expansion: 3Gs journey from Brazilian niche to a global empire

1989 - 1999

Jorge Paulo Lemann and his Garantia fund partners acquire Brahma, a Brazilian brewer, that will become the firstplatform used by
the billionaire investors to build a beverages empire. In that decade Brahma rolled up more than 20 brewers in Latin America and
Europe.

2000

Brahma merges with Companhia Antarctica Paulista creating a new Latin American beer group with sales worth more than $5bn
annually. The company is called AmBev.

2004

Belgiums Interbrew agrees to merge with AmBev, creating a $16bn brewer big enough to compete with Anheuser- Busch of the US.
The new company is called InBev. Lemann and his partners establish 3G Capital in New York.

2008

InBev decides to acquire Anheuser-Busch for $52bn, a deal that will create the largest brewer in the world, including brands such as
Budweiser, Stella and Leffe. The company is called Anheuser-Busch InBev, or AB InBev.

2010

Lemanns 3G partners Warren Buffett of Berkshire Hathaway to acquire Burger King. This creates its second platform to carry out
deals in the fast-food restaurant sector.

2013

3G and Buffett team up again to acquire Heinz for $27.5bn, creating a third platform in consumer food.

2014

Burger King buys Canadas Tim Hortons for $13.3bn. The holding company is called Restaurant Brands International (RBI).

2015

Heinz buys Kraft Foods for $62.6bn. The new company is called Kraft Heinz.

2016

AB InBev acquires SABMiller for 79bn in what is likely to be the last big beer deal for 3G, as further acquisitions in the sector would
risk being blocked by antitrust regulators.

2017