Blackstone Group (NYSE:BX) brought Pinnacle Foods (NYSE:PF) to market March 28. The maker of Vlasic pickles and other well known brands saw its stock jump more than 11% in its first day of trading. Should investors buy its stock after the opening day success? The answer lies ahead. 

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History
Although some of Pinnacle Foods' brands date back to the 1800s, its modern history began in March 1998 when Campbell Soup (NYSE:CPB) spun-off its Vlasic pickles and Swanson frozen food businesses to shareholders under the name Vlasic Foods International. In 2001, with Vlasic's business operating under bankruptcy, the private equity firm Hicks, Muse, Tate & Furst acquired VFI's North American business for $370 million plus warrants to purchase 15% of Hicks, Muse common stock. Renamed Pinnacle Foods, the bid beat out an offer from Heinz (NYSE:HNZ).

Hicks, Muse turned around a little over two years later selling Pinnacle to JPMorgan Partners and C. Dean Metropoulos for $485 million. Pinnacle then merged its business with Aurora Foods, owner of Duncan Hines, and itself owned by private equity firm J.W. Childs. The three private equity firms contributed $85 million cash to the merger and it was operated by C. Dean Metropoulos until 2007 when the group sold Pinnacle to Blackstone for $2.2 billion including the assumption of $900 million in debt. 

The final piece to the pre-IPO puzzle is the acquisition of Birds Eye Foods in December 2009 for $1.34 billion. Pinnacle paid half in cash and the rest in debt. More importantly, the acquisition improved overall operating margins, added $1 billion in additional revenue and made it the fifth largest frozen food manufacturer in the U.S. Without the addition of Birds Eye, I wouldn't be spending any time considering Pinnacle stock.

SEE: Analyzing An Acquisition Announcement

IPO Valuation
If you include the underwriters' option to purchase an additional 4.35 million shares, Pinnacle Foods' market cap at its IPO pricing of $20 per share is $2.34 billion. That gives the food company an EV/EBITDA multiple of 10 based on an enterprise value of $4.24 billion and adjusted EBITDA of $426.1 million. The EBITDA is adjusted to account for plant closings in 2012 as well as some other one-time costs.

Product  #1 Market Share #2 Market Share
Frozen Vegetables  Birds Eye Green Giant
Frozen/Refrigerated Bagels Lender's Ray's New York/Michaels Foods
Shelf-stable Pickles Vlasic Claussen
Frozen Waffles/Pancakes Eggo Aunt Jemima
Cake/Brownie Mix Betty Crocker Duncan Hines



Of the non-Pinnacle brands listed above, there are three public companies: General Mills (NYSE:GIS) owns the Betty Crocker and Green Giant brands, Kellogg (NYSE:K) owns Eggo, and Kraft Foods Group (Nasdaq:KRFT) owns Claussen. The average enterprise value of the three companies is 12.59 times EBITDA, about 26% more expensive than Pinnacle Foods' 2012 adjusted EBITDA. However, the EV/EBITDA average multiple for the three hasn't added back one-time items. If I take out Pinnacle's one-time items, its EV/EBITDA multiple increases to 11 times, which is still better than all three. So, from a valuation perspective I don't think you're overpaying at $20 to $22 per share. The real question is whether it's got any growth left. 

SEE: IPO Basics

Future Growth
In terms of revenue there's very little opportunity without making acquisitions. Between 2008 and 2012, its leadership brands, which include Birds Eye, Vlasic and Duncan Hines, grew by 2% annually. The remaining brands, which Pinnacle refers to as its "foundation" brands, were flat. In addition, the gross margin from its leadership brands is 30% compared to 20% for its foundation brands. Interestingly, since it acquired Birds Eye in 2009, it's introduced new products (defined as those introduced within the last three years) at a much faster rate and now account for almost 10% of annual revenue. Clearly, Birds Eye is making a difference to its growth. Is it enough to matter has yet to be determined.

Verdict
The good news in Pinnacle Foods' IPO is that it's using all the proceeds to eliminate debt. The reduction of $612 million of its long-term debt will bring it down to $6 billion and less than five times adjusted EBITDA. Furthermore, although its growth isn't anything to write home about, it is growing free cash flow and that will only improve with the $600 million reduction in debt. In addition, it has $1 billion in net operating loss carryovers, which will do a good job limiting taxes for at least the next three years. Add to that the fact it's going to pay a quarterly dividend of $0.18 (annual yield of 3.2%) and Pinnacle Foods is looking like a reasonable investment.

The one thing you should keep in mind before pulling the trigger is whether you can live with its level of debt. Compared to General Mills, Kraft Foods Group or Kellogg, its debt-to-EBITDA is approximately 50% higher than its three major peers. It has much less room for error. 

Should that keep from investing? Not if you understand the company risk is higher.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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