Pinnacle Foods: Stay Away From This Overvalued, Overleveraged Public Offering

| About: Pinnacle Foods (PF)

Pinnacle Foods (NYSE:PF) made its public debut on March 28th. Shares of the manufacturer, marketer and distributor of quality foods, ended their first trading day with gains of 11.0% at $22.21 per share. Shares extended their gains in Monday's trading session, exchanging hands around $23.20 at the close of the trading day.

The Public Offering

Pinnacle Foods is a leading manufacturer of high-quality branded foods. The company owns a portfolio of US iconic brands with leading positions in its product categories in which Pinnacle competes. Some of Pinnacle's well known brands are Birds Eye, Duncan Hines, Mrs. Paul's, Hungry Man, Log Cabin and Celeste, among others.

Pinnacle Foods sold 29.0 million shares for $20.00 apiece. The company raised $580 million in gross proceeds in the offering process, valuing the equity of the company at $2.24 billion. All shares were offered by the company, with no shares being offered by selling shareholders.

The offering was a modest success. The offer price was set at the high end of the preliminary $18.00-$20.00 price range set by the firm and its bankers. On top of that came the favorable price returns on the opening day followed by a decent performance on Monday.

Some 26% of the total shares outstanding were offered in the public offering. At Monday's closing price of $23.20, the firm is valued at $2.62 billion.

The major banks that brought the company public were Barclays, Credit Suisse, Goldman Sachs, Morgan Stanley, UBS and Bank of America/Merrill Lynch, among others.


Pinnacle Foods was taken private by well-known private equity firm Blackstone Group LP (NYSE:BX) in 2007. From that point in time, Blackstone has been able to increase sales, raise margins, and consequently increase Pinnacle's operating profits. In 2009, Pinnacle acquired Birds Eye Foods, which at the time was the 5th largest frozen food manufacturer of the US. That deal valued Birds Eye at $1.34 billion.

The company stresses that products in Pinnacle's strong and diverse market leading portfolio of brands can be found in over 85% of the US households.

For the year of 2012, Pinnacle Foods generated annual revenues of $2.48 billion, up just 0.4% compared to 2011. The company reported a net profit of $52.6 million for the year, compared to a loss of $46.9 million in the year before, when the company took almost $123 million in goodwill impairment charges.

As a result of being owned by a private-equity firm, Pinnacle operates with a lot of debt. The company spend $198.5 million on interest payments for the whole year of 2012.

Pinnacle Foods raised $580 million in gross proceeds in the offering process. As such net proceeds are expected to come in around $550 million. The company operates with $92.3 million in cash and equivalents and $2.61 billion in short and long-term debt. Consequently, Pinnacle will operate with approximately $2.0 billion in net debt, following the offering.

Based on Monday's valuation of $2.62 billion, the market values the company's equity at 1.05 times annual revenues and 56 times annual earnings.

Investment Thesis

As noted above, the public offering of Pinnacle Foods has been a modest success. Shares were offered some 5.3% above the midpoint of the preliminary offering range and are currently trading some 22.1% above that level.

The company plans to use the proceeds of the IPO to repay $465 million in senior notes which carry a 9.25% interest rate and mature in 2015. As such the public offering could boost net income by some $25 to $30 million per year, assuming statutory tax rates.

Back in April of 2007, Blackstone Group LP took Pinnacle Foods public in a $2.16 billion all-cash deal. The private equity firm saddled the company with some $3 billion in debt, of which little over 10% has been paid back at the moment. The offering will lower the net debt position towards $2.0 billion and increase earnings towards the $80 million mark.

Something which is not common in re-capitalizations executed by private equity firms, is that Blackstone actually made large investments in the business. Most notable, is the sizable $1.34 billion acquisition of Birds Eye in 2009.

The total debt position is not the largest risk related to this offering, given the very stable and diversified cash flow streams generated by the portfolio of brands. While Pinnacle is subject to a range of normal risks related to operating any business, it is interesting to see that Pinnacle points out that the consolidation in the supermarket industry is a key risk.

The reduction in leverage will boost the bottom line to an estimated $80 million in 2013, assuming operating profits are unchanged compared to 2012. While the revenue multiple is fair, the earnings multiple will still be rather high at 32-33 times estimated annual earnings. A reduction in leverage could further boost the bottom line, given that the company paid an average of 7.5% in interest over its debt over the past year.

A key comforting fact is that the company already proposed a quarterly dividend payout of $0.18 per share, for a decent annual dividend yield of 3.1%. Furthermore, Blackstone Group LP will continue to hold a 71% stake in the business, while management holds an almost 4% stake as well, which is key for a good alignment of incentives.

Yet I decide to remain on the sidelines. While the diversified portfolio of brands and the dividend yield are appealing, the earnings valuation is too high and the company carries along a sizable debt position.

The combination of an elevated price-earnings ratio, the sizable debt position and the low to non-existing revenue growth are enough reasons why retail investors should pass on this latest public offering.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.