There is no doubt that Ralcorp (NYSE:RAH) is getting creative in its efforts to get value for its assets. Still not willing to agree to ConAgra's (NYSE:CAG) bid, Ralcorp apparently believes that separating the company may be its best chance at guaranteeing greater value for its shareholder base.
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First, a Warning
Ralcorp led off its Thursday night announcements with a warning on fiscal third quarter results. Citing weak volumes in cereal and some difficulty in getting better pricing through, Ralcorp lowered its guidance for the third quarter to a range of $1.13 to $1.18 - well below the $1.37 average estimate. Just as a point of reference, investors should also note that the lowest published estimate was $1.28, so this was indeed a meaningful miss.
It is odd, though, that analysts hadn't been moving their numbers down before this announcement. Kellogg (NYSE:K) seems to be only company seeing much momentum in cereal, and both Ralcorp and General Mills (NYSE:GIS) are seeing some volume issues. What's more, the only other publicly-traded private label food company of note, Treehouse Foods (NYSE:THS), has also mentioned difficulties with price realizations. So even though this announcement will likely be positioned as a surprise and the magnitude is a little startling, it is not exactly a stunning development.
And Then the Break-Up
Ralcorp also announced that it has decided to break up the company by spinning off the Post Cereal business and leaving Ralcorp to continue on as a dedicated private label food company. The spin-off, which the company estimates will take four to six months to complete, will be a tax-free event for shareholders and management expects to list the Post business on the NYSE. As part of the transaction, Ralcorp will lever up Post - issuing over $1 billion in debt through that business and paying back the proceeds to Ralcorp.
There is some logic to this move. While Ralcorp bought Post from Kraft (NYSE:KFT) back in 2008, Ralcorp never seemed to be able to do a lot with it; it was not an albatross by any means, but it was not a major help either. Moreover, it has been clear for a while now that Ralcorp wants to focus on its potential as a consolidator in the large, but highly fragmented, private label food business. Given the popularity of private label offerings on the shelves of Wal-Mart (NYSE:WMT), Target (NYSE:TGT) and even Whole Foods (NYSE:WFM), this does not seem like a bad decision.
More Obvious Value?
Spinning off Post also seems to lay in a credible floor for the stock. Ralcorp gave a fair bit of financial information with this announcement and that makes it easier to calculate some fair values based on different premises. Looking at comparables, then, it seems like this anticipated split would establish a floor valuation in the high $70s or low $80s. That makes ConAgra's bid of $86 seem less impressive, and perhaps this proposed spin-off will give ConAgra the incentive to make a better, stronger offer for Ralcorp.
Assuming that Ralcorp shareholders should share in the synergies and value that ConAgra could get from an acquisition, it is not so unreasonable to think a bid in the $90s will be what it takes to get a deal done.
That gives ConAgra an interesting set of choices. Should the company contemplate a deal for a smaller company like Snyder's-Lance (Nasdaq:LNCE) or Diamond Foods (Nasdaq:DMND), or some other smaller branded food company in the hopes of adding some more valuable brands? Should the company leave Ralcorp to its fate and make a play for Treehouse? Or how about forgetting a headline-grabbing deal and instead focusing on making consolidating acquisitions in the private label space and essentially competing with Ralcorp in a bid to be a dominant private label food company?
Ultimately, Ralcorp stock could be something of a bargain here, though it would hard to see the company getting a bid above the mid-$90s. ConAgra and Ralcorp need each other more than either company wants to admit, and that usually argues for a reasonable bid coming before it's all over. Nevertheless, investors should be prepared for the possibility of Ralcorp going ahead with this split - a move that could ultimately be the beginning of an interesting phase of Ralcorp's corporate life as a consolidator and large private label pure play. (For related reading, also check out Cashing In On Corporate Restructuring.)
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