Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message| ()  

Investors in Sysco (SYY) are very enthusiastic about the announced deal to acquire U.S. Foods, in a deal which increases its annual revenues by nearly half.

The deal seems very reasonable and investors bid up shares on the back of synergy estimates and the increase in leverage. I applaud management for making a great deal as investors have more potential going forward.

The Deal

Sysco announced that it has entered into a merger agreement with U.S. Foods, creating a world-class foodservice company.

While the press release names the deal a merger, it is really an acquisition by Sysco. The company will pay $3.5 billion for the equity in U.S. Foods, to be financed with $3 billion in stock and $500 million in cash. Sysco will furthermore assume $4.7 billion in debt, valuing U.S. Foods at $8.2 billion.

The deal brings two complementary companies together and allows for sizable efficiencies, notably in the supply chain functions, merchandising and general and administrative activities.

CEO Bill DeLaney commented on the rationale behind the deal, "As we continue on our transformational journey at Sysco, this transaction will position U.S. to significantly accelerate our progress in achieving the vision we have for our company: to be our customers' most valued and trusted business partner."

Following the deal, the "new Sysco" will have annual revenues of $65 billion. The $8.2 billion price tag values U.S. Foods at 9.9 times trailing EBITDA of $826 million. On top of this, Sysco sees annual synergies reach at least $600 million per annum in three or four years time.

As such, the deal is immediately accretive to earnings, not factoring in transaction related expenses and amortization of intangible assets.

The deal has already been approved by the board of directors of both companies. Sysco's CEO DeLaney will continue to lead the company. The deal is expected to close in the third quarter of next year, and is subject to normal closing conditions, including regulatory approval.

Valuation

Back in November, Sysco released its first quarter results for the fiscal year of 2014. The company ended the quarter with $359.5 million in cash and equivalents. Total debt stands at $3.13 billion, resulting in a net debt position of $2.77 billion. Add to that $5.2 billion in cash and debt, used to buy U.S. Foods and the net debt position will increase towards $8 billion.

The company secured a fully committed bring loan to finance the deal, and expects to issue long term debt over time to repay the bridge loan.

Full year revenues for Sysco's fiscal 2013 came in at $44.4 billion, up 4.8% on the year before. Net earnings fell by 11.5% to $992 million.

Before Monday's jump, shares traded around $34 per share, valuing equity in the firm at $20 billion. This values the stand-alone Sysco at 0.45 times annual revenues and roughly 20 times annual earnings.

Sysco's quarterly dividend of $0.28 per share, provides investor with an annual dividend yield of 3.3% before the deal has been announced. The company notes that it remains committed to its dividend despite the deal.

Some Historical Perspective

Long term investors have seen their shares trade within a wider trading range. Over the past decade, shares have traded in a $20-$40 range, with the latest news sending shares to the high end of the range.

Shares traded in a $32-$36 range for most of this year, and sparked higher on the news of the deal. At the start of the session, shares spiked towards $43 per share, and they are currently trading around $38.50 per share.

Sysco has seen solid growth in revenues over the past few years, even as earnings growth stagnated.

Investment Thesis

The market is very enthusiastic about the deal sending shares some 13% higher halfway during Monday's trading session, thereby boosting the valuation of the firm by some $2.5 billion. At Monday's highs of $43 per share, the market boosted the valuation of the firm by almost $6 billion.

The $8.2 billion deal will add roughly $20 billion in sales, valuing the enterprise at around 0.4 times annual revenues, a slight discount to Sysco's own valuation. Sysco's own valuation on an enterprise basis was around $23 billion before the deal, at around 10 times annual EBITDA of $2.2 billion. In this light, the 9.9 times trailing EBITDA multiple for U.S. Foods seems fair.

So while the multiples are the same, investors are very happy, obviously being attracted to annual synergies estimated at $600 million per annum in three year's time. Such sizable estimates can easily explain the $2.5 billion market capitalization jump.

Following the deal, the new Sysco will have annual revenues of $65 billion. Annual EBITDA is seen around $3.2 billion, while earnings could come in around $1.4 billion on a pre-synergy basis. After synergies, earnings could increase towards $1.8 billion after tax.

After the jump towards $38.50 per share, Sysco is being valued at $22.4 billion. Add to that $3 billion in fresh equity, and equity is valued around $25.4 billion. The entire enterprise is valued at $33 billion, when including the net debt position of the combination. The equity in the new entity is valued at 0.4 times annual revenues, 17 times current earnings and 13 times earnings when factoring in full synergies.

As such I can only congratulate shareholders with a great deal which Sysco's management has arranged. The company used its strong balance sheet to increase leverage and use that capital to make high returning investments. The leverage increase to $8 billion is high, but the debt position of 2.5 times EBITDA remains manageable.

As such, investors are right to applaud management for making such a deal. The jump to highs of $43 at the start of the trading session seems overdone for the short term, but current levels in the high thirties result in an appealing valuation going forwards. I see a $50 price target for next year as a very realistic target, especially if the deal progress remains on track.

Source: Sysco - U.S. Foods' Synergies Will Drive Shares Higher