Sanderson Farms: An M&A Opportunity

Summary

• Sanderson Farms is being acquired by Cargill and Continental Grain.
• The terms look straightforward, but it carries certain antitrust risks.
• The spread between today’s price and the $203 close represents a decent return.
• If the deal fails, Sanderson Farms should do well as a standalone investment.
• Investors beware: investing in mergers like this is inherently risky.

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Introduction

Sanderson Farms (NASDAQ:SAFM) is being acquired by Cargill and Continental Grain Company (Conti) for $203 per share cash. The deal was announced in August, is expected to close later this year or early next, and will merge the operations of Sanderson Farms with Wayne Farms (a Conti subsidiary). The transaction appears straightforward but is subject to regulatory approval and carries certain antitrust risks.

For full disclosure, I have a position in SAFM at $187.10. This position was taken because the spread is relatively wide, the transaction is clean, and the runway for Sanderson looks good if the deal fails.

This is my first M&A-related investment in the agri-food space since Bayer (OTCPK:BAYRY, OTCPK:BAYZF) acquired Monsanto in 2018, and is the first M&A investment I've written about publicly since Guyana Goldfields was bought by Zijin Mining Group (OTCPK:ZIJMF, OTCPK:ZIJMY) in 2020. It is, however, one of five merger-related investments currently in my portfolio. The other four are Ferro Corporation (FOE), Marlin Business Services Corp (MRLN), Sunnyside Bancorp (OTCPK:SNNY), and Shaw Communications (SJR). Though I am comfortable with merger-related investing, those new to the topic should study deeply before getting overly involved as it carries considerable risk and is akin to collecting pennies in front of a steamroller. Buyer beware!

Agreement Background and Terms

The buyout was first announced on August 9, 2021, but followed months of speculation regarding a potential tie-up. According to the terms of the deal, SAFM owners will receive $203 per share cash, which is equal to a total equity value of $4.53 billion. The purchase price represents a 30.3% premium to the pre-merger-speculation stock price. Upon completion, Cargill, Conti's Wayne Farms subsidiary, and Sanderson Farms will form a new privately-owned poultry company.

According to the press release and subsequent filings with the Securities and Exchange Commission, the deal has committed equity and debt financing in place. Committed financing is often important, and without it, the odds of the amalgamation falling apart would be higher. While the parties hope to finish the business combination later this year or early next, the soft outside date is May 8, 2022, which then automatically extends until August 8, 2022. In other words, there is a lot of time to get this done.

Digging further into the details, Sanderson Farms can continue to pay quarterly dividends so long as those distributions do not exceed "past practices" - i.e., $0.44 per share. The board of directors also received a fair value assessment from a third party (Centerview Partners LLC). Getting an independent assessment like the one provided here by Centerview Partners LLC is an important step, but sometimes companies do overlook it, which can then invite litigation from disgruntled shareholders.

The Securities and Exchange Commission filing contains fairly standard language around fiduciary duty if a superior bid emerges. There are termination fees in place as well, which cut both ways. The buyers will pay Sanderson $300 million if the deal falls apart for certain reasons (i.e., reasons deemed to be more or less within their control), and alternatively, Sanderson will pay the buyers $158 million if it falls apart for reasons that would, roughly speaking, be deemed within its control. These are hefty breakup fees, and there are also debt financing and anti-trust termination fees on top of that, which is uncommon in my experience. Having termination fees that cut both ways is important, as it incentivizes both parties to get this done and stay at the table - especially when the fees are so large at $100 million plus.

Going forward, a stockholder vote is scheduled for October 21, 2021, and the parties involved await regulatory approval.

Risks and Ownership Rationale

The regulatory approval process appears to be the largest risk for Sanderson. Iowa Senator Ruck Grassley, for example, has publicly expressed concern about the proposed buyout, and the Biden Administration is worried that meatpacker consolidation is causing higher food prices. This all plays into the antitrust review. The regulatory review is likely to compare the post-merger operations of Sanderson Farms and Wayne Farms to peers like Tyson Foods (TSN), Pilgrim's Pride (PPC), and other large poultry producers. Though this proposed tie-up could hit a regulatory tripwire on the basis of competition, I don't think that should happen based on the current market share of America's top 10 poultry producers. As the chart below suggests, the post-merger market share of Sanderson Farms and Wayne Farms will be 14.6%. This means the new entity will still have lower market share than Tyson Foods and Pilgrim's Pride at 20.4% and 16.4% respectively.

Source: Sanderson Farm's Corporate Presentation - May 18, 2021.

In my estimation, the regulatory antitrust risk is an acceptable one given the spread between today's current price and the $203 close. Moreover, the ownership rationale is clear as the deal is straightforward, and the terms of the transactions include termination fees, funding commitments, and a third-party fair value assessment.

Finally, I do not mind owning SAFM if the deal fails, and this gives me greater confidence purchasing SAFM compared to many other merger situations. The corporation is a good play on higher food prices and inflation. These tailwinds are already showing up in its income and cash flow statements, and the odds that trend continues are good in my opinion. The balance sheet is also debt-free, its current assets exceed all liabilities, and the stock outstanding has held stable over the past decade at about 22.5 million shares.

Source: Seeking Alpha's valuation table for Sanderson Farms.

Behind the scenes, the valuations appear decent and insiders own 5.36% according to their 2021 Proxy Statement. As well, Sanderson's current CEO and Chairman is the grandson of its founder. While some investors may consider this nepotism, and family operations can result in ruin, some of the best-run companies are family affairs too.

Conclusion

Sanderson Farms is being acquired by Cargill and Conti for $203 per share cash. The merger is expected to close later this year or early next, and the terms of the deal are straightforward. The agreement's fine print checks many important boxes too - financing commitments are in place, fair value assessments have been rendered, and there are heavy termination fees to incentivize all parties involved to get this finished. That said, the buyout does carry antitrust risk, which could derail the transaction. If the business combination fails, however, it is likely I would continue to hold my stake in the name given its business outlook, balance sheet strength, and valuations. While I am comfortable with M&A investing of this nature, it is important to reiterate that this type of investing is akin to collecting pennies in front of a steamroller, and investors interested in SAFM (or other companies being bought out) should proceed with caution.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SAFM, FOE, MRLN, SNNY, SJR either through stock ownership, options, or other derivatives. 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.

Disclaimer: The opinions expressed - imperfect and often subject to change - are not intended nor should be taken as advice or guidance. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.