In an article written last week I suggested that B&G Foods (BGS) agreement to acquire the New York Style® and Old London ® brands from Chipita America, Inc. could be a precursor to a dividend hike. The company typically makes acquisitions that are immediately accretive to earnings, generate incremental free cash flow, and then returns a portion of that cash to shareholders through dividend increases. In the earlier article it was also noted that CEO David Wenner had recently stated the company's leverage ratio had been reduced to 4x and that B&G was comfortable with leverage ratios of more than 5x. This comment was why I had expected the $62.5 million acquisition to be made using cash on hand and/or incremental debt, and why I expected a dividend increase.
However, on Monday B&G announced:
our intention to offer, subject to market and other conditions, 3,629,165 shares of our common stock, ... In connection with the offering, B&G Foods expects to grant the underwriters an option for a period of 30 days to purchase up to an additional 544,375 shares of common stock.
This is a total of up to 4,173,540 new shares of common stock. Although it seems like a relatively small offering, investors should realize that B&G "As of July 26, 2012, [B&G] had 48,387,225 shares of common stock, ... issued and outstanding." The new shares could add up to 8.6% new common shares, diluting the current owners' equity. The big question is why is there a new equity offering, and why is it so large?
In the past year B&G has increased the annual dividend rate twice, from $0.84 to $1.08. During that time the share price has doubled. The result,despite the increases, is that what had been a dividend yield of nearly 5.5% has declined to just under 3.5%. Consider the after-tax treatment of interest on debt - the government is funding nearly 40% of the interest expense - compared to the cost of dividends on equity. A year ago it made sense to fund most of the $325 million acquisition of Culver Specialty Brands from Unilever with debt. Today, on an after-tax basis, it's less expensive to use equity.
Next, examine the timeline of the recent events. B&G had announced the recent acquisition from Chipita on September 19th, and it was received very favorably, with the shares reaching an all-time intra-day high of $32.84 two days later. When the stock offering was announced prior to the market open on October 1st, the shares had retreated from that high, having closed at $30.31 the prior session. Assuming that the underwriters exercise the full option, at the $30.25 per share offering price, B&G should raise almost double (after underwriting fees) the $62.5 million needed for the acquisition. Clearly the company is raising far more than it needs for this acquisition.
I was first attracted to B&G by its high dividend. It was high not only in real terms, but also very high relative to its competitors. Now the relative advantage to its peer group has declined significantly. J. M. Smucker (SJM) is at 2.4%, General Mills (GIS) is at 3.3%, Kellogg (K) is at 3.4% and Pepsi (PEP) is at 3.0%.
The dividend is still attractive, but with the additional shares, it has also become more expensive for the company. My first reaction to the stock offering was the dividend increase I anticipated in Q4 could be in jeopardy. I still feel that way.
During a Mad Money clip on Monday, Jim Cramer discussed B&G and the acquisition and feels a bit different about the dividend. Not only does he like the new products and the acquisition for a number of reasons, but he also stated that Wenner "never overpaid for ANYTHING." Towards the end of the video, Cramer also stated, "more dividend boosts, they could be ahead."
B&G stock has reacted favorably to both the recent acquisition announcement and the new equity offering. The latter is somewhat surprising considering current shareholders are being diluted with the increase in the shares outstanding.
Here is a statement from the press release discussing the offering:
B&G Foods expects to use the net proceeds of the offering for general corporate purposes, which may include among other things, the payment of all or a portion of the purchase price and related transaction costs for the recently announced acquisition of the New York Style and Old London brands or any future acquisitions, and the repayment or retirement of a portion of B&G Foods' long-term debt.
Note the phrase in bold. The increase in EBITDA from the acquisition of the New York Style and Old London brands will reduce the B&G leverage, and combined with the incremental cash flow, increases the company's borrowing capacity. Combined with the excess cash from the recent stock offering certainly gives B&G more than enough resources to pursue additional acquisitions.
The stock market is a forward-looking, discounting mechanism. Could it be that the market is focusing on the anticipated increase in EBITDA from the acquisition, the extra cash raised by B&G, and already looking ahead to Wenner's next accretive acquisition?
Additional disclosure: I have no positions in any of the other companies mentioned in this article. I may add to my position in BGS at any time.