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Summary

  • After news reports hit the wires last week, a rumored deal has finally become reality.
  • The $3.1 billion acquisition of WILD Flavors is the biggest deal in the company's history.
  • Long term appeal relies on the achievement of aggressive capital efficiency targets.

A much-rumored deal has finally become reality with Archer Daniel Midlands announcing the acquisition of Switzerland based WILD Flavors in the biggest deal in the company's history.

The deal makes strategic sense as it improves ADM's growth profile while dampening the earnings volatility of the firm. Yet the price is a bit high and (revenue) synergies seem ambitious in my eyes.

With the company being focused to improve capital efficiency and returns in the medium to long term, shares offer very long term appeal. Yet the company has a long way to go and trades at premium multiples based on today's performances in a still volatile environment.

The Deal Highlights

Archer Daniels Midland (NYSE:ADM) announced the acquisition of WILD Flavors GmbH. The company previously owned by Hans-Peter Wild and KKR allows Archer Daniels to capitalize on the large and growing trend for natural flavors and ingredients.

WILD Flavors is the leading provider of these suppliers to the wider food and beverage industry. The company has about 3,000 customers and is expected to post net revenues of about Euro 1 billion this year.

Under terms of the deal, Archer Daniels will pay Euro 2.2 billion in cash for the company, while assuming roughly Euro 100 million in debt. This puts the total price tag at Euro 2.3 billion, the equivalent of $3.1 billion.

The deal is anticipated to close by the end of the year.

Strategic Rationale

WILD Flavors offers flavor and ingredient solutions which it calls flavor systems. Examples of these are juice concentrates, blends, flavors, sweetening systems, seasonings, specialty ingredients, taste modifiers and fermentation technologies.

According to the deal presentation WILD Flavors generates 60% of its sales in Europe, the Middle East and Africa, thereby adding significantly to ADM's operations in the continent. The company employs a total of 2,300 workers of which 418 are scientists.

The highly specialist offerings make the company very appealing as WILD Flavors has strong market positions in niche markets. Combined with Archer Daniels' operations in this area, the company would become a leading flavor and specialty ingredient company with current sales of $2.5 billion and significant growth potential.

The wider range of products in its portfolio allows ADM to serve more customers and leverage its platform in this high margin business. The deal is furthermore complementary to the long term strategy to diversify from the main business of crops processing.

This relatively steady business should furthermore reduce the overall volatility of the earnings, while improving the overall growth profile.

Financial Implications

The $3.1 billion deal, values WILD Flavors at 2.3 times sales based on projected revenues of $1.35 billion. Note that the company anticipates to realize anticipated cost and revenue synergies which total approximately $135 million per annum by year three.

Interesting enough, two thirds of these anticipated synergies are expected to result from an increase in revenues, with just a third of synergies related to cost savings.

According to the deal presentation, ADM pays about 14.1 times estimated EBITDA for 2015. It is unknown what current depreciation charges are for the business, yet interest payments are low given the low-debt capital structure while. Of course, Suisse statutory tax rates are low as well. The multiple reported implies that EBITDA is seen at roughly $220 million, which values the company at roughly 8.7 times EBITDA after factoring in the full synergies.

The announced synergies appear to be rather ambitious, set around 10% of annual sales, and rely largely on sales improvements as discussed above. As such the deal is accretive to earnings per share, although the company does not quantify this statement.

Positive is the low earnings volatility, high cash flow conversion and high single digit anticipated revenue growth.

All Part Of The Strategy

The deal adds stability and growth prospects to the volatile current earnings profile of Archer Daniels. The global agricultural giant derives about 80% of operating earnings from oilseeds and corn processing which are volatile and low-margin businesses.

Besides moving into operations which higher and more stable margins, Archer Daniels will improve its global operations, as it is still being overrepresented within the US.

Traditionally, Archer Daniels has been very strong at the upstream segment which focuses on sourcing, transportation and processing. These activities have been relatively volatile and carry lower margins, being the opposite of the global oil and gas industry for instance. More value is to be added in the more stable downstream tasks of transformation, distribution and sales.

While the deal will add to the ¨downstream¨ business, it will of course reinforce the entire system around Archer Daniels operations.

Which Is Showing Early Results

Back in May, COO Juan Luciano confirmed that the company's strategy to increase shareholder value is starting to pay off.

Trailing adjusted returns on capital rose to 6.9% in the first quarter, being up 30 basis points on a quarterly sequential basis, and up 140 basis points compared to the year before. The company remains committed to returns of 200 basis points above the long-term weighted average cost of capital which currently stands around 8%. This results in a current long term target to return 10% on its capital.

Luciano confirmed that the company has achieved $200 million in annual cost savings so far, which is roughly six months ahead of schedule. As such cost savings are now seen at $400 million by the end of the year.

Valuation

Back in April, Archer Daniels reported its first quarter results. The company ended the quarter with $2.07 billion in cash, equivalents and marketable securities. Total debt of $5.67 billion results in a net debt position of about $3.6 billion.

On a trailing basis, Archer Daniels posted revenues of $88.8 billion on which it net earned $1.34 billion. At $46 per share, equity is valued at roughly $30 billion, valuing operations at 0.3 times sales and roughly 22-23 times annual earnings.

Archer Daniels currently pays a quarterly dividend of $0.24 per share, for a dividend yield of 2.1%.

Historical And Future Perspective

Over the past decade, Archer Daniels has grown its business from $36 billion in sales by 2005 to nearly $90 billion last year. Earnings have been volatile and margins have been low, with net earnings coming in between $1 and $2 billion.

The current performance is at the low to medium end of this range amidst non-favorable operating conditions and a modest performance. The 10% return on capital target should allow ADM to return to the high end of the earnings range again. Combined with improved market conditions, this might allow the firm to post earnings above $2 billion in the future.

Final Takeaway

The announced deal fits perfect within the company's strategic, but does not come cheap. It will still work out fine, if the company can meet its ambitious synergy targets. The transaction was anticipated with rumors about a potential deal circulating around long before the deal has been announced.

The deal will probably work out in the long run, with Archer Daniels itself being well positioned as well to benefit from the growing world population. Yet shares have risen by a third already over the past year, creating a premium valuation. This is as investors are already discounting the future anticipated improvements on the back of solid execution on the current cost savings plans.

This has resulted in a premium valuation on today's multiple,s but rather appealing valuation if the company can meet its return on capital targets of 10%, while displaying less earnings volatility. With much of the good news already having priced in, I will pass on the stock at current levels.

Source: Archer Daniels Midland - A Much Rumored Deal Has Finally Become Reality