With the deal Danone will achieve strategic objectives to expand into North America and improve the overall growth profile of the business. Given that Danone is already very strong in milk and yoghurts, the acquisition of WhiteWave is a logical mix from both a product and geographical perspective.
The price is pretty steep but can probably be justified in this crazy zero-interest rate world. If you take into account anticipated synergies and very low financing costs in Europe, the deal could probably make sense for Danone in some crazy way. That said, I am not focused on Danone itself, which actually is quite leveraged following the deal.
I must applaud investors in WhiteWave for receiving a premium price. I can see that the deal has a real impact on the wider natural and organic food complex in North America. While I am not chasing the obvious trade to move into Hain Celestial (NASDAQ:HAIN), I see more potential in the natural and organic supermarket business. Danone's deal shows that food manufacturers certainly take the natural and organic food segment very seriously.
The Deal & Importance To Danone
Investors in WhiteWave stand to receive $56.25 in cash for each share, which they currently own. That is equivalent to an 18% premium compared to the close on the day before the deal has been announced. The deal marks a 60% premium from lows in the mid thirties, levels at which shares traded during the tumultuous period in February. While these premiums look very healthy, I also recognize that shares actually did trade in the $50s in the summer of 2015.
The all-cash deal will be completely financed with debt by Danone. Including WhiteWave's net debt position, the French value the company at $12.5 billion.
While this is very steep price given the current revenue and profit base of WhiteWave, Danone has two main financial reasons to justify a deal. For starters is the fact that borrowing costs for large multinationals are very low in Europe, in part resulting from the central bank bond-buying program. The other reason is the expectation to realize $300 million in synergies over time, although a quarter of that number estimate is comprised out of revenue synergies.
For Danone, the deal has the potential to boost the overall organic growth profile of its business. Its core businesses are growing at just a couple of percentage points per year, while WhiteWave's growth comes in around 10%. With the deal, Danone will grow its business by roughly 15%, adding roughly 1-2 percentage points to its organic growth profile.
The greater presence in the US has defensive benefits as well. Danone was underrepresented in this geographical area while it reduces the exposure to volatile emerging markets as well.
The Deal, Taking Place At Steep Multiples.
The $12.5 billion deal tag is pretty elevated, if you ask me. The number represents a 3.1 times sales multiple based on the trailing revenue base of $4.0 billion. EBITDA, by using the adjusted method and excluding losses in China, came in little above $500 million in 2015. That translates into a very high multiple of 25 times.
Actual operating profits come in at $350 million on a trailing basis, for margins of 9%. Given that WhiteWave itself employed quite some leverage, net earnings came in at just $170 million on a trailing basis. That gave the somewhat leveraged business a near 60 times earnings multiple.
Danone itself has an enterprise valuation of roughly $50 billion, equivalent to 2 times its annual revenues. While revenue growth has been uninspiring, Danone's margins are pretty low as well. Operating margins of 10% exceed those of WhiteWave, but given the much larger scale, one would expect higher margins. This is certainly the case if you benchmark Danone against major food peers.
If we assume that Danone could borrow the roughly $10 billion cash component to pay for WhiteWave's equity at 2%, it would incur additional financing charges of $200 million. With WhiteWave now contribution $350 million in EBIT, the after-tax accretion to earnings per share would come in at roughly $100 million. That adds roughly 7% to Danone's earnings of $1.4 billion a year which is relatively little. This is certainly the case, as leverage will increase from a net debt load of $8 billion towards roughly $20 billion overnight. With leverage ratios ranging at 4-5 times EBITDA, I find that leverage risks are on the increase, with relatively little earnings accretion to show for it.
If we take into account $300 million in projected synergies, EBIT accretion comes in at $650 million, or at $450 million after applying the additional interest expenses. Assuming a 35% tax rate for Danone's earnings, after-tax earnings might increase by roughly $300 million over time. If these synergies were to be achieved, and WhiteWave continues to boost the growth profile of Danone, the deal might be worth it for the French in the long haul.
Investors Made A Killing
WhiteWave's investors should be very happy with the deal. The company has been very aggressive with dealmaking, already operating with a 4 times leverage ratio. This has pretty much limited the potential for WhiteWave to pursue other major deals in order to accelerate growth even further without diluting the shareholder base.
The $10 billion equity valuation at which Danone is now valuing WhiteWave is pretty steep as well. Note that earnings came in at just $170 million on a trailing basis, for a +50 times earnings multiple.
All in all, investors should be applauding the sale of the business, giving instant monetary rewards. This is the case unless they were planning on staying a shareholder for decades to come, betting that WhiteWave would become a $100 billion business in the long haul by dominating this category.
Remember that WhiteWave only became public in 2012 following a spin-off from Dean Foods (DF). It instantly became an acquisition target in the eyes of the investment community. Its parent has an enterprise valuation of just $2.5 billion, roughly 5 times as little as WhiteWave. Following the spin, WhiteWave has embarked on an acquisition spree including the purchase of Earthbound Farms, Horizon Organic, Silk and Alpro, among others.
These deals and a solid organic performance have resulted in shares increasing by a factor of 3-4 times from the levels in the mid-teens at which the stock was trading in 2013.
What about The Investment implications?
This deal has major implications for many players in the wider natural and organic field. The first name, which comes to mind is Hain Celestial (HAIN), which probably should see a boost in its valuation following the news.
Hain does not have a similar focus on plant-based foods and soy milk as WhiteWave but actually focuses on organic and natural snacks, tea, meat and general grocery products. Hain has an enterprise valuation of roughly $6 billion at $50 per share, which implies that it is valued at little over 2 times annual revenues of $2.9 billion.
Its operating margins of 10% are healthy with shares trading at just 24-25 times trailing earnings, while leverage ratios are much lower compared to WhiteWave. Based on sales and earnings metrics, Hain's is trading at a 30-50% discount compared to WhiteWave's deal price. The reason for that stems from the fact that Hain is much more established already, its products can be found at mainstream supermarket chains, as organic growth is not that impressive at all. US sales grew by just 2.7% year on year in the most recent third quarter.
Organic supermarket chains like Whole Foods Market (WFM) might see products of WhiteWave end up in more supermarket chains, as Danone will probably try to make use of its strong channel relations. This could potentially pressure some of their business as customers can find their beloved brands in more stores going forwards.
Alternatively, the deal once more demonstrates the growth of organic and natural food, potentially putting Whole Foods and smaller competitors in the picture amidst a consolidating grocery landscape. The one clear loser from the deal is Mead Johnson (MJN), which was often rumored to be sold to Danone. Danone bought baby-food producer Numico in 2007 in order to build a big presence in baby food. The WhiteWave deal pretty much rules out Danone bidding for the US company for many years to come.
The deal will keep the rumors going for some time as organic and natural food producers and stores will probably be in demand. That being said, I would urge you to be very selective with your investments in this area.
The flight to safety into consumer names amidst the global uncertainty and low rate environment has already made the entire sector very pricey. While further M&A action might certainly attract interest into the category, one has to consider the investment risks given the potential for significant valuation multiple compression across the industry.
For all these reasons, I continue to stick with a modest long position in Whole Foods Market based on somewhat moderate valuations and a strong leadership position.
Disclosure: I am/we are long WFM.
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.
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