Everybody knows the old expression, "If you can't beat 'em, join 'em". Apparently ConAgra (NYSE:CAG) is taking a different strategy - "if you can't beat 'em, quit and try something else". With ConAgra publicly making a bid for Ralcorp (NYSE:RAH), it would seem that this large Nebraskan packaged food company is content to cede the field to the likes of Kellogg (NYSE:K), Heinz (NYSE:HNZ), Kraft (NYSE:KFT) and General Mills (NYSE:GIS) in branded foods and focus much more closely on private label and value-oriented products.

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The Deal That May Be
A deal between ConAgra and Ralcorp has been running through the rumor mill for a little while now, with Ralcorp recently mentioning that it had declined an unsolicited proposal while also preannouncing better-than-expected quarterly results. Clearly there was a not-so-subtle message here - namely, "we're improving quite well on our own, thanks".

Nevertheless, ConAgra has decided to go public with an offer of $86 per share in cash for Ralcorp. Not only does that represent a 32% premium to the pre-speculation price of Ralcorp, it also represents a sweetening of $4 per share from ConAgra's prior offer.

If the deal somehow gets done, it would represent nearly $7.4 billion in total deal value, and ConAgra would need to raise a fair bit of cash through debt offerings. (For related reading, check out Con Agra Playing The Pricing Game Well.)

Ralcorp Should Probably Say Yes
Not surprisingly, Ralcorp management quickly declined this deal, and went a step further with a poison pill. Nevermind that they would be selling the company at a valuation close to that of branded companies like Kellogg, General Mills and Heinz. That would be a pretty noteworthy accomplishment, given Ralcorp has long lagged these rivals in terms of margins and returns on capital.

What's more, while management may feel (or at least say) that the deal price does not give full credit to the internal improvements underway at Ralcorp, the numbers say otherwise - maybe the deal is not 100% full value of what Ralcorp could be, but it absolutely de-risks the scenario for shareholders and captures quite a lot of that value.

ConAgra's Future Now Seems More Clear
For some time now, ConAgra has struggled with a portfolio of aging, lagging brands. In a supermarket world dominated by Wal-Mart (NYSE:WMT) and where #1 and #2 get a lot of attention and shelf space, being #3 makes it very hard to compete. As a result, ConAgra has needed to face up to the challenge of acquiring (or building) better brands or dramatically altering its strategy. (For related reading, see America's Biggest Food Companies.)

If ConAgra wants to compete in branded goods, the company should be thinking of names like Smucker (NYSE:SJM), Hostess Brands or perhaps even Sara Lee (NYSE:SLE) (though this would likely be too big). It does not look like the company is going that route, though.

A deal with Ralcorp would give the new ConAgra a nearly $4 billion a year private-label business. Private label isn't very sexy, and does not typically command premium valuations (TreeHouse Foods (NYSE:THS) not withstanding), but it can produce very solid cash flow and it is a business that rewards scale and operational efficiency. What's more, a private label strategy would mitigate some of the criticism ConAgra gets for its low overseas exposure.

The Bottom Line
With ConAgra now out with a public bid, this courtship of Ralcorp gets very interesting. Ralcorp shareholders would seem to be in line to get a good price, but it doesn't seem terribly likely that management will see things the same way; if management wanted to, they probably could have negotiated for that extra $4 privately. With Ralcorp digging in, it's a question whether ConAgra will keep pushing.

ConAgra shareholders should hope that their management exercises caution here. If ConAgra's future is in value-based packaged in goods, execution and margins will be more important than before and now would be a good time to show that discipline and attention to detail. A deal for Ralcorp below $90 could and should work out for both parties, but paying too much for Ralcorp would be a major mistake. (For more, see Big Money In Private Labels.)

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Tickers in this Article: CAG, RAH, THS, K, HNZ, KFT, GIS

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