3G Capital is a Brazilian investment firm. They formed the world's largest beer maker AB InBev, partnered with Warren Buffett to acquire Kraft-Heinz, and own large franchisors like Burger King and Popeyes.
One of 3G’s founders has a saying, “Expenses are like fingernails, you always need to be cutting them.”
3G’s model is built on using leverage to buy a business, slashing operating expenses, and then deploying cash flow to make a larger acquisition. Their deployment of internal cash flows to acquire other businesses is of use to anyone building a HoldCo. 3G’s successes and mistakes are worth studying.
Driving efficiency through cost-cutting speaks to me, as I believe a projection of lowering expenses is more predictable than one of rapidly rising sales. We have all seen the hockey stick growth predictions when looking at acquisition targets. It is hard for me to believe that owners have simply been too lazy or unwilling to take advantage of such easy growth hacks; that as soon as we buy the business this growth will miraculously occur. I do not think growth is that easy and I do not have a high enough estimation of my abilities to believe I can easily unlock it.
This brings us back to cutting expenses. If we can maintain sales post-acquisition, but focus on making the operation more efficient, we can achieve a similar increase in profits. The extra cash flow is then used to deleverage at a faster rate and acquire new businesses. The underlying business has steady sales, and increased profits, while the HoldCo is free to use the cash to buy new businesses. Thus, the HoldCo grows in large leaps whenever a transaction occurs. This was the 3G model and it was our initial strategy at AH.
There is a caveat with this approach, and it happened to 3G Capital. Too much focus on cost-cutting can lead to a complete lack of investment for growth. The underlying companies can suffer as customer experience dips. This can lead to an impairment in sales which cannot be fixed by simply cutting more expenses. This happened to 3G at Kraft-Heinz. Their product development became stale, and the sales began to suffer. As 3G got larger, making it more difficult to fuel growth through larger acquisitions, their strategy began to falter.
After reading about the difficulties the strategy had faced, we adjusted our plan. We continue to forecast zero growth when making an acquisition. Our investment thesis does not depend on growth. We still look for efficiencies post-acquisition while also encouraging CEOs to bring us plans for organic growth. A larger portion of our free cash flow is now reinvested in our underlying companies than previously. While this slows the pace of acquisitions, it also protects the vitality of our underlying operating businesses.