Tyson Foods May Have Served Shareholders A Raw Deal By Overpaying Hillshire Brands

Jun.27.14 | About: Tyson Foods (TSN)

Summary

It may be challenging for future operations that the less valuable and efficient Tyson Foods is acquiring the more valuable and efficient Hillshire Brands.

Tyson Foods is overpaying Hillshire Brands, and the downward adjustment in Tyson Foods' stock price reflects the overvaluation.

Hillshire Brands may not perform as well as Tyson Foods is hoping for.

Combining Tyson Foods and Hillshire Brands may lead to a less competitive market for prepared meat products.

While it's understandable that Tyson Foods (NYSE:TSN) would like to get into the higher-margin prepared foods business, it may be challenging for the raw meat producer to digest Hillshire Brands' (NYSE:HSH) rich operations of multi-line meat-centric products. On the other hand, Hillshire Brands would do fine without joining Tyson Foods and might be able to create more value for its shareholders in the long run, instead of selling itself now for some quick gains. The deal between Tyson Foods and Hillshire Brands may not serve the best interest of either company's shareholders. It surely looks a raw deal for Tyson Foods shareholders, who are losing considerable value from this high-premium acquisition.

Traditional mergers and acquisitions often are value based, meaning that an acquirer would pick up an undervalued target company and try to improve its performance. But this is not the case with Tyson Foods' proposed acquisition of Hillshire Brands. Compared to Tyson Foods, Hillshire Brands has always been a higher-valued company. Its predecessor, Sara Lee, was trading at about 6 times equity book value in the period before the spinning-off of its coffee and tea business in June 2012.

The remaining company, renamed Hillshire Brands and left with a more concentrated meat operation, has seen even higher valuation, trading at about 9 times equity book value just before bidding activities from Pilgrim's Pride and Tyson Foods. All the while, Tyson Foods has had a relatively low valuation, currently trading at only 2 times its equity book value. Here it seems that the target company has a more efficient operation than the acquiring company, potentially making it more challenging to merge the two operations.

Tyson Foods' proposed acquisition price of $63 per share is more than 15 times Hillshire Brands' equity book value, representing an almost 80 percent premium over Hillshire Brands' already relatively high valuation. The overvaluation of Hillshire Brands causes a loss of value for existing Tyson Foods shareholders at least for the moment, as it's difficult to be certain if Hillshire Brands' different operations could be well plugged into what Tyson Foods traditionally does and create the expected synergistic value.

Over the bidding period, shares of Tyson Foods have traded lower from the stock's five-year high of around $42 right before the company made its initial offer to buy Hillshire Brands, to the current range of between $35 and $36 after the company raised its offer and won the bid. The drop in the price of Tyson Foods' stock is seemingly an adjustment by investors to the potential equity losses incurred by current Tyson Foods shareholders as a result of the company's overvaluing Hillshire Brands' assets, reflecting a sentiment that Tyson Foods may be overpaying Hillshire Brands.

About one tenth the size of Tyson Foods in annual revenue and having no real revenue growth in recent years, Hillshire Brands is unlikely to make a large impact on the combined earnings immediately, even with its better operating margin that currently is just over 60 percent higher than that of Tyson Foods. Hillshire Brands has seen equity losses over the past five years, partly because of wide swings in operating income. The weak showing of Hillshire Brands' ability in earnings and equity accumulations may prolong Tyson Foods shareholders' future recovery of their equity losses from the acquisition.

Based on the amount of recent decline of about $6 in Tyson Foods' stock price, in connection with the overvaluation of Hillshire Brands, and the number of 344 million outstanding common shares for the stock, the implied amount of overpayment would be around $2 billion. At Hillshire Brands' current level of annual operating income of $297 million, it would take close to 7 years to equalize Tyson Foods shareholders' acquisition losses.

Not only the acquisition of Hillshire Brands appears not very promising in financial terms, but combining the two companies may also lead to something less desirable on the business side. If left independent, Hillshire Brands would most likely continue to better structure its lines of packaged meat offerings amid increased competition from companies like Tyson Foods coming into the prepared foods market. By the same token, relying on organic growth, Tyson Foods would also want to do a better job with its own brands of packaged meat products when having to compete with the more established Hillshire Brands and the like.

By joining forces, neither company would have to worry about competitions from the other side. But this may not bode well for a healthier growth of the prepared meat market in general if the combined company becomes less motivated to bring out new products to a less competitive market. If such issues catch the attention of the Federal Trade Commission, the proposed deal could even be in question for a potential blockage.

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