Pringles Is A Big Bite For Kellogg

By Stephen D. Simpson, CFA | February 21, 2012 AAA

Give credit where due; Procter & Gamble (NYSE:PG) lost no time moping about the disintegration of its deal with Diamond Foods (Nasdaq:DMND) to sell its Pringles business in a complicated $2.4 billion. In short order, P&G found a willing buyer and will be selling this iconic potato chip business to Kellogg (NYSE:K) for about $2.7 billion in cash.

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The Terms of the Deal
Unlike the convoluted reverse Morris Trust structure that Diamond and Procter & Gamble were going to use to save taxes for P&G, the Kellogg deal is much more straightforward. Kellogg will pay $2.7 billion in cash - actually a bit of a discount to what Kellogg would have had to pay to match the after-tax price that Diamond was originally offering.

Kellogg will raise about $2 billion in short-term debt to fund the purchase, and will make up the remainder with about $700 million in cash held overseas. Assuming smooth progress with the regulators (and there's no reason to assume otherwise at this point), the deal should close around mid-year. (To know more about acquisitions, read Analyzing An Acquisition Announcement.)

Kellogg Is Paying Up to Diversify
First, the good news - the Pringles deal will definitely expand and diversify Kellogg's business. Pringles garners about $1.5 billion in sales from 140 countries and only about 39% of those sales comes from North America.

That sounds great when it comes to expanding Kellogg's overseas business (you can even see a small store stocked with Pringles on the Altiplano in a Top Gear episode), but the reality is that the biggest markets for Pringles are the U.S., the U.K. and Germany; not exactly hot growth markets. Only 17% of Pringles sales come from Asia and Latin America, so the geographical benefits are somewhat limited.

That said, this does continue Kellogg's strategy of expanding away from the hyper-competitive cereal business where it goes head to head with General Mills (NYSE:GIS) and Post Holdings (NYSE:POST). With this deal, the company will be pretty much evenly balanced between cereal and snacks.

All of this comes at a cost. Although Kellogg expects some solid synergies in 2013 and 2014 (and there are definite prospects of improving Pringles' margins closer to the Kellogg company average), Kellogg is levering up and paying up 11 times trailing EBITDA. All of that for the pleasure of competing head-to-head with the very motivated snack businesses of post-split Kraft (NYSE:KFT) and PepsiCo (NYSE:PEP).

Opportunity Comes When It Comes
It's worth asking what this deal means for Kellogg's announced intentions to rebuild and reinvest in its businesses. Spending $2.7 billion on a business with about $1.5 billion in sales is going to shake things up, so there is the risk that it delays the process. By the same token, this was a scarce asset with high brand value and those deals don't go by every day.

The Bottom Line
This is an expensive deal for Kellogg, but a strategically sound one. Assuming that Kellogg management can get back to its former level of performance, this addition will likely look really good in three to five years' time.

For Procter & Gamble, it was probably the best deal they could get quickly. P&G isn't exactly selling this business for peanuts and it's hard to see that an open auction process would have garnered a significantly better deal. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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

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