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Why Tyson's Most Recent Divestiture Matters

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About: Tyson Foods, Inc. (TSN)
by: Kevin Mackie
Kevin Mackie
Value, long only
Summary

Tyson recently sold off a beef jerky asset acquired as part of the Hillshire Brands portfolio.

The sale of the unit is in spite of strong underlying economics for snack foods in general and beef jerky in particular.

Potential impairment of this asset, the likely use of proceeds, and overall implications for Tyson's financial situation.

It was announced on Thursday, January 9th, that Tyson foods (TSN) would be selling their Golden Island Jerky Co. brand to Jack Link's Beef Jerky. The sale was for an undisclosed amount, and the leased facility at which that jerky was processed is to be closed after running for two decades. Operations in fact ceased on December 13th 2019, but employees are being paid through February 10th. The intent of this article is to share my thoughts on why Tyson did this, what the implications are, and how that impacts investors who are considering taking a position in or against Tyson.

History

Golden Island came with Tyson's acquisition of Hillshire Farms in 2014. You may recall from my past articles that Tyson paid a hefty sum for the company. As I reported in September of last year, of the $8 billion they paid, $4.7 billion was attributed to goodwill. More than half of the purchase price was above and beyond the market quantifiable value of the entity. This tremendous amount was a result of a bidding war with Pilgrim's Pride (PPC) who was after Hillshire (in fact, Tyson had to pay $163 million in breakage costs alone for trumping the other party). Many independent parties thought the price was WAY too high, including Forbes who wrote in June of 2014:

We believe that in the heat of the bidding war, Tyson Foods has overpriced Hillshire Brands. Even if the company is able to realize anticipated cost synergies from the deal it could still find it difficult to justify the steep valuation in the long run.

.... according to our estimates, Tyson Foods would also have to grow Hillshire Brands’ sales revenue at an average annual rate of at least 4.5% apart from realizing cost savings in order to justify the price it plans to pay for the company. Just to give some perspective, Hillshire Brands’ average annual sales revenue growth rate has been just around 0.7% for the past 3 years.

I drag all this up again to make the point that all this over-paying for acquisitions is coming back to haunt Tyson by way of impairment. As I explained in my article mentioned above:

Tyson recently (June 2018) sold their "Sara Lee" holdings as well as "Van's Natural Foods". These brands came along with their 2014 purchase of Hillshire. The impairment charge attributed to goodwill between the two of these upon sale was $101 million. Essentially, they bought high and sold low, the exact opposite of what the ultimate aim of investing is. This begs the question, what other of their acquired brands are similarly impaired? Hillshire also came with brands like Jimmy Dean, Ball Park, Hillshire Farm, State Fair, Chef Pierre pies, as well as artisan brands Aidells, Gallo Salame, and Golden Island premium jerky. Is there impairment there?

More recently in the 2019 10K, Tyson listed a prepared foods unit as "held for sale" with an impairment tag of $41 million.

I floated the idea months ago, even mentioning Golden Island, that impairment may also be in the cards in the future. Are we soon to see it? I most certainly will be looking for impairment charges in the upcoming 10Q. I wouldn't be a bit surprised if Tyson couldn't get a good price for Golden Island, at least not good enough to not have impairment to record.

The Real Head Scratcher....

In explaining the sale of Golden Island, a spokesman for Tyson said:

“The decision to sell the business was a very difficult one. It’s important to know it was based on a combination of factors including our ability to generate profitable growth in the business and our need to focus on, and invest in, strategic growth priorities where we are competitively advantaged.”

I find this peculiar because beef jerky is actually a dang good business to be in nowadays. Within the broader meat category, which is growing at a moderate clip in and of itself, the jerky category is a standout. Data mentioned by NOSH.com spoke of a 9% CAGR for meat snacks in the past five years. Furthermore, jerky itself is projected to grow at a rate of 4.2% through 2022. This begs the question, why would Tyson sell a product with great economics, better in fact than some of its other product lines? This on top of the fact that Tyson has stated in the recent past that they are working on becoming a pure play protein company by divesting non-protein brands, while simultaneously focusing on their value-added lines because they have higher margins and aren't as exposed to commodity fluctuations. Check out these quotes:

...the primary focus is not either poultry or international, it's value-added foods.... We've made, obviously, most recently a number of acquisitions on the international side on poultry-based, but primary focus is going to be in value-added foods in growing that sector.

*From Q1 2019 conference call

With protein at the center of our strategy, we divested several non-protein businesses..."

*From Q4 2018 conference call

At Tyson Foods, we're creating a modern food company with a diverse portfolio of protein brands.

*From Q1 2018 conference call

So if their focus is on value-added protein, why would they sell a product line that checks both those boxes? Their behavior simply isn't matching up with their stated strategy.

My guess is that they are getting desperate in regards to their debt situation. I explained their debt load in detail in my last article on Tyson. In short, Tyson has $1.03 billion in long-term debt coming due this year on top of $3 billion in other contractual obligations (short-term borrowing, CAPEX, interest expense). They won't have nearly enough cash from operations to cover these expenses, unless they manage to increase cash from operations 40% over last year and 25% over their best cash generating year on record back in 2018. They are so desperate to cover their obligations that they are having to sell off otherwise good brands in order to meet their commitments. It remains to be seen what price they fetched.

This pattern may continue, of selling smaller business lines in order to satisfy their debt. Anyway you shake it, it's not good for Tyson. They took on too much debt to pay for assets that weren't worth what they paid, and now they are having to sell those same assets to pay that debt.

Conclusion

The more I learn about Tyson, the more compelling I find it to establish a short position. However, the situation with African Swine Flu is such a wild card that doing so would be inordinately risky, even for short selling. The fallout from ASF may might end up being a tremendous windfall for Tyson, as supply and demand imbalances allow their chicken segment to shine. I imagine Tyson is crossing their fingers that it happens. The less risky choice above short selling is to simply buy puts dated after their earnings call to mitigate losses if I am wrong (only lose the premium) but still be positively exposed to the downside if the stock falls. I remain undecided. In any case, I hope that people eye-balling Tyson will take these matters into deep consideration before establishing a position. A long position here will result in full exposure to a business that has a demonstrable track record of poor capital allocation and whose stock is trading near all time highs.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TSN over the next 72 hours. 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.