ConAgra Wins Ralcorp After A Long Chase

By Stephen D. Simpson, CFA | November 26, 2012 AAA

With Wall Street's quarter-to-quarter obsession, it's often thought that corporate America no longer has the luxury of thinking and planning for the long term. ConAgra's (NYSE:CAG) eventual success in winning over Ralcorp (NYSE:RAH) to a friendly bid shows, though, that patience can still play a significant role in business. Although ConAgra is not getting a great bargain here, this should be a value-additive deal for the company over the long term.

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Terms of the Deal
ConAgra is going to be acquiring Ralcorp for $90 a share, or a roughly 28% premium to Monday's close. At that price, the total enterprise value (EV) of the deal comes in at about $6.8 billion. That, in turn, works out to a roughly 11 times EV/EBITDA premium which places this deal value above the average industry valuation (which is around 10.5 times), as well as ahead of the current multiple for ConAgra itself, not to mention General Mills (NYSE:GIS) and Kraft Foods (Nasdaq:KRFT).

So How Did ConAgra Get to "Yes?"
One of the first things that jumped out to me about this deal is that it was just $4 higher (or about 5%) than the last publicly acknowledged bid from ConAgra back in 2011 - a bid that Ralcorp apparently thought, at the time, didn't even merit further discussion. So what changed?

Well, it hasn't been a great year for Ralcorp. Although shoppers have increasingly turned to private label brands, that hasn't translated into demonstrably better organic growth for companies like Ralcorp or Treehouse Foods (NYSE:THS). In fact, Ralcorp's fiscal fourth quarter earnings (which were released in conjunction with this merger announcement) saw another 2% decline in organic revenue, with a 6% decline in volume. What's more, Ralcorp has coupled that disappointing revenue growth with unexpectedly high costs and disappointing margins over the last 18 months.

All in all, without wishing to cast aspersions on Ralcorp management, I would say the light bulb went on in the boardroom and they collectively realized that this $90 per share bid from ConAgra was the best chance they had of seeing $90 in the foreseeable future.

SEE: Evaluating A Company's Management

A Focused, Quality Deal for ConAgra
Although Ralcorp's recent financial performance hasn't been great, I still believe that this deal makes solid sense for ConAgra. Specifically, it more than quadruples ConAgra's private label business, and adds No.1 leadership positions in sizable categories like ready-to-eat cereal, crackers, pasta and peanut butter, and significant market share in categories like cookies. Said differently, about 70% of Ralcorp's sales come from market-leading products, with another 15% from products in the No.2 slot.

But I believe ConAgra should benefit from more than just the acquisition of market-leading products. Integrating Ralcorp should allow for a variety of synergies and more efficient sourcing. The deal also makes ConAgra a top-five supplier for many major retailers, and that sort of leverage matters more than some investors realize.

Will Other Deals Follow?
Given the debt that ConAgra will take on to fund this deal, I'd say they are out of the running for deals for companies like Hillshire Brands (NYSE:HSH) or Treehouse (assuming there's even any reality to the rumors that they are on the block). In fact, I wonder if ConAgra will look to sell some branded food lines now that it has Ralcorp in hand. ConAgra has long struggled with a portfolio of lagging brands, and selling some of them could help defray the cost of this deal. I don't expect any major moves in this direction, but there have been enough small-scale deals in the industry lately to make me believe it is plausible.

SEE: Analyzing An Acquisition Announcement

The Bottom Line
I've generally been a skeptic on ConAgra, but I have to give credit where it's due - over the past 12 to 18 months, management has shown evidence that its turnaround plan is cogent and worthwhile. If ConAgra can extend those benefits to Ralcorp once the deal closes, it will only enhance the value of the transaction.

When I last looked at ConAgra in September, I thought the stock's price made it a decent hold, but not an especially compelling buy. With the premium being paid for Ralcorp and the timeline for recognizing synergies and improved free cash flow from the deal, I'm inclined to stick to that view. I do think the Ralcorp deal helps ConAgra for the long term, but I don't see the stock as a major bargain today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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