We've read in the financial press or heard on the business news channels that experts are enthused about the ConAgra Foods (CAG) pending purchase of Ralcorp Holding (RAH). I don't share in the enthusiasm -- perhaps it is my cautious, conservative nature. The experts may very well be correct and be well-rewarded; however, I remain skeptical and have a contrarian view based on three points:
- ConAgra is financing the $5 billion purchase price (plus debt) in a deal valued at $6.8 billion with almost 100% borrowed money, by taking on $6 billion in new debt -- I wonder how they hope to service the debt.
- ConAgra may have overpaid for this purchase by offering a hefty 28% premium after the stock had already had a nice run-up.
- The much-touted synergies that we are told will make the acquisition a success and be accretive to earnings may be difficult to achieve if history serves as an example.
Let me be clear that both ConAgra Foods and Ralcorp are fine companies with excellent products and have long records of success. I am just not convinced they are better together -- not at the price paid and under the terms of the deal.
ConAgra is making the purchase with borrowed money. Couldn't this have been a part cash/part stock purchase? ConAgra will take on $6 billion in new dept on top of its $3.31 billion long-term debt already on the books. I know money is cheap in this environment, but ConAgra will triple its long-term debt with the purchase making it imperative that the acquisition goes perfectly according to plan.
The following three tables help illustrate my concerns:
Current ConAgra LT debt
New debt for RAH purchase
Total debt going forward
Source for ConAgra LT debt: Yahoo Finance.
ConAgra's annual income less dividend.
ConAgra's current cash on hand:
ConAgra Shares outstanding
Annual per-share dividend
Net annual income (TTM)
Less annual dividend payout
Cash after paying dividend
Current cash on hand (MRQ 8/26/12)
TTM = trailing 12 months
MRQ = most recent quarter
Combined CAG and RAH net income -- Is this enough to service debt?
CAG Net Income
Less dividend payments
Plus RAH net income
Total debt combined company
Time will tell whether ConAgra overpaid for Ralcorp. But a 28% premium seems stiff if one considers that the stock price had already moved 18% from $59 on July 31, 2012, to $70 immediately before the purchase announcement was made on Nov. 27, 2012. The current price (closing Nov. 29, 2012) is $89.84. The one year chart of Ralcorp illustrates the price movement, available here. In addition, investors need to remember that Ralcorp had already sold off its interest in Post Holdings (POST), its branded cereal business.
In most acquisitions the concept and claim is the purchaser will "unlock synergies" that will result in more dollars flowing to the bottom line. In order to leverage synergies, the acquiring company must bring expertise and an ability to outperform the way the selling company had performed. Often significant savings results from workforce reduction of overlapping personnel. With this purchase personnel savings isn't at the forefront.
So what are the potential synergies with this acquisition? The following is from the ConAgra press release announcing the purchase:
ConAgra Foods intends to use its strong infrastructure and productivity capabilities to drive significant cost synergies from this transaction, primarily in the areas of supply chain and procurement efficiencies. It expects to achieve approximately $225 million of cost synergies on an annual basis by the fourth full fiscal year after closing.
But the stock listings are flush with acquisitions that failed because synergies didn't materialize:
- The current developing story of the huge Hewlett-Packard (HPQ) acquisition of Autonomy.
- Quaker's 1994 purchase of Snapple for $1.7 billion and the sale just 27 months later for $300 million.
- America Online and Time Warner -- In 2001, America Online acquired Time Warner in a megamerger for $165 billion -- the largest business combination up until that time.
- Sprint acquired Nextel Communications in a $35 billion deal in 2005 with the idea of cross-selling each other's customers. By 2008 Sprint took a $30 billion writeoff impairment charge.
- Hewlett-Packard acquired Palm for $1.8 billion with a 23% premium paid and ends up taking a $3.3 billion impairment and restructuring charge after one year and seven months.
- Microsoft's (MSFT) 2007 purchase of aQuantive for $5.9 billion -- an 85% premium -- resulted five years later in a restructuring charge of $6.2 billion.
Also from the press release: The acquisition of Ralcorp will add to ConAgra Foods' existing private label business of approximately $950 million to create the largest private label packaged food business in North America, with approximately $4.5 billion in combined annual private label sales. This scale will create new opportunities to potentially obtain the private label business at Costco (COST) and other big box, high volume businesses.
ConAgra is counting on private label business to continue to grow. In the same press release Gary Rodkin, chief executive officer of ConAgra Foods, added, "Clearly, consumer dynamics have changed since the recession and we expect growth in private label food to continue to outpace growth in branded food."
Private label growth may or may not happen. That remains to be seen over time. Perhaps as the economy grows and improves consumers will once again embrace national brand foods at the expense of private label packages. Plus, the separation in terms of price at the retail level is shrinking as both private label store brands and national brands face increasing input costs driving up the retail price of both. National brands may be more successful at raising prices to account for increased costs. Private label store brand margins may be squeezed.
This may be one of those acquisitions where the stars line up and everything works out perfectly. The cultures of the two companies may come together nicely, all hoped-for synergies may be accomplished, and private label growth may continue. I hope this is the case. But rather than be carried away by the excitement and enthusiasm expressed in the press release and by many in the financial community, this investor will simply wait and see.