Middleby Launches A Viking Raid

By Stephen D. Simpson, CFA | January 03, 2013 AAA

Middleby (Nasdaq:MIDD) is a pretty remarkable company (and stock) by most standards. Blending internal product development with a steady stream of acquisitions, the company has built itself into a major restaurant equipment player. Along the way, revenue has grown at an average rate of nearly 16% over the past decade, while the stock is up more than 18,000% from 1992. This is not a cheap stock, though, and investors may have reason to ask whether this latest deal doesn't carry more risk than past tuck-ins.

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Viking the Latest Collection
Most of Middleby's deals have been for companies that the average investor has never heard of, at least not unless they have a lot of experience or knowledge in the food service industry. Monday's deal for Viking Range is different, though, as Viking is pretty well known as a provider of high-end residential cooking equipment and kitchen appliances.

Middleby is paying $380 million in cash for Viking, and funding the deal with debt. For that $380 million, Middleby is buying a business with about $200 million in revenue and EBITDA margins in the low teens (10 to 12% according to management). As it stands, paying almost two times revenue is a bit steep for this industry, to say nothing of about 17 times EBITDA.

To be fair, Viking has been hammered by the recession and the housing bubble. Consumers are no longer paying top dollar to renovate kitchens, and taking out a personal or home equity loan to fund such improvements has been a lot more challenging (and expensive). To that end, it's worth noting that Viking's revenue has dropped about half from its peak, while EBITDA margins have fallen by about a third.

SEE: Analyzing An Acquisition Announcement

A Risky Move for Middleby?
While the cooking nerd in me is a fan of Viking's products, I'm not such a fan of this deal for Middleby. Middleby has done very well competing against the likes of Illinois Tool Works (NYSE:ITW), Manitowoc (NYSE:MTW), Dover (NYSE:DOV) and Standex (NYSE:SXI) in the commercial food service market, but the residential market (particularly the high-end segment) is a very different kettle of fish. Suffice it to say, customers have different expectations when they pay $3,000 to $8,000 for a Viking range, as opposed to $500 at Home Depot (NYSE:HD) for a run-of-the-mill model, and any marketing or product performance missteps will be punished harshly.

In its presentation for the deal, Middleby management talked about the potential of using Viking's brand and products as a means of introducing multiple Middleby technologies (like speed cooking, induction and truvection) into the consumer market. Fair enough; I think there's certainly ample opportunity to introduce more advanced cooking technologies to the home kitchen (particularly sous vide). At the same time, this is an intensely competitive market (just ask General Electric (NYSE:GE) or Electrolux (OTC:ELUXY, OTC:ELUXF)) and the market dynamics (what motivates a sale, for instance) are different.

That said, I do believe there is a potential to reap some synergies from de-duplicating management overhead and bringing Viking into Middleby's supply chain. What's more, buying Viking after the recession-related crushing may in fact be de-risking the deal substantially. Still, with this deal representing about 15% of Middleby's market cap and 20% of its revenue, I would not just wave away the potential risks of Middleby taking a sizable step outside of its comfort zone (and its established zone of competence).

SEE: Biggest Merger and Acquisition Disasters

The Bottom Line
Middleby remains a stock that I love from a distance. Even though I'm willing to project nearly 10% long-term revenue growth and steady (albeit not spectacular) free cash flow (FCF) margin improvements to and through the mid-teens, the resulting implied FCF growth of 10 to 12% doesn't quite cut it. While Middleby would be worth something close to $140 a share without its debt, that debt pushes the fair value down by more than $25 a share.

While Middleby is a fixture on my watch list and a good stock to consider on a pullback, the shares seem too expensive to me today, particularly with what I now believe is a higher risk profile to the story.

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

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