Craving for Food Firms Is Increasing : Takeover Binge Just Starting, Analysts Say
Managers and investors in the great food-processing companies of the Midwest are asking a question that would be familiar to executives in the oil industry: Who’s next?
The last year has brought four giant mergers to the companies that stock the nation’s pantries; all ranked among the largest non-oil mergers in history.
And like the market in 1983-84 for oil-patch stocks, every merger that seems to break the bank simply spurs more speculation about the next likely target.
Yet those may be the only similarities between the pirate’s war that reconstructed the oil industry and the comparatively sedate consolidation in the food industry.
For the acrimony that preceded Chevron’s acquisition of Gulf Oil has as much in common with the merger of Nabisco Brands into R. J. Reynolds and the proposed combination of General Foods and Philip Morris as an oil field manned by roustabouts does with a wheat field harvested by farmhands.
Consolidation Tendencies
Although there has been a tendency toward consolidation in the food industry for several years--among other deals, Nabisco merged with Standard Brands in 1981, Quaker Oats acquired Stokely-Van Camp in 1983, and Ralston Purina bought Continental Baking last year--most professionals regard the takeover wave as having begun in earnest with two multibillion-dollar acquisitions of mid-1984: the $2.7-billion merger of Esmark and Beatrice Foods, and the $3-billion purchase of Los Angeles-based Carnation Co. by Nestle, the Swiss confectioner.
Two much larger acquisitions followed this year: Nabisco’s purchase by R. J. Reynolds in June for $4.9 billion, and the $5.6-billion merger announced last week of General Foods into Philip Morris.
Many investment professionals say the merger vogue in the food industry is just now gathering steam. “You can look at anyone in the food industry as a potential buyer of anyone else,” said one investment banker familiar with the Philip Morris deal.
In fact, he said, any well-heeled company in an industry that prizes merchandising and distribution--the key management skills in the packaged foods business--is a likely bidder for such frequently mentioned targets as Sara Lee, Pillsbury, Quaker Oats, and Campbell Soup.
Among the potential buyers, investment bankers list such consumer-goods manufacturers as Pepsico, Coca-Cola Co., Seagram, Unilever and Procter & Gamble, which last week agreed to spend $1.2 billion for Richardson-Vicks.
Even Philip Morris has let it be known that once it begins applying its $1.5-billion-plus cash flow to pay down its acquisition debt it may return to the hunt. “Any company even remotely affiliated with this business is a candidate,” said one Wall Street deal maker.
That was an important consideration for Philip Morris, according to its chairman and chief executive, Hamish Maxwell.
“We thought the most responsible way to go was into a business compatible with our own experience,” he said in an interview. “We drew a distinction between a groceries company and a financial services or a chemical company.”
Conservative Philosophy
For the most part the buyers and the boughts also share a certain conservative business philosophy. As F. Ross Johnson, R. J. Reynolds’ president and chief operating officer, explained his company’s interest in Nabisco to securities analysts: “How we manage our businesses is practically identical. What we believe in--divesting bad businesses, tight control of the balance sheet, understanding cash flow--is pretty much the same.”
For all that, the packaged food industry boasts fundamental values that any industrialist could admire.
“They provide consistent earnings in any economy and they do have very strong balance sheets,” observed William Maguire, a food-industry analyst for Merrill Lynch & Co. The processors have been reaping the benefits of a depressed market for commodities, particularly for the grain and other agricultural products that are their raw materials; even a surge in commodity prices would scarcely cause a ripple in an industry thought to enjoy considerable flexibility in pricing. The grocery producers can pass costs on to consumers until the inflation rate reaches 13% or 14%, Maguire said.
More important, the best of the companies enjoy consumer loyalties that might be envied even by the makers of Tide or Ivory soap. “These brands have long life-cycles,” said Alan Greditor, an industry analyst for Drexel Burnham Lambert & Co. “It would take an awful lot of money to try to replicate the position of Kellogg in cereals or Purina in pet foods.”
Gratifying Profits
That means the manufacturers can accommodate low growth rates in some products--breakfast cereals, for example--because they reliably generate gratifying profits. “The food companies have never been given enough credit in the marketplace for the strength and value of established brand names,” said Mark Ziegler, an analyst for Tucker, Anthony & R. L. Day.
Companies on the prowl also appreciate the food processors’ healthy cash flow and low debt, features that enable buyers to finance their purchases with debt that can be swiftly repaid. Philip Morris’ Maxwell remarked that the entirely debt-financed General Foods acquisition will enable his company to accelerate its growth rate.
The industry’s cash flow looks especially majestic when compared with its capital needs. “The need for new (capital) facilities is just not there,” Maguire said.
Indeed, for most of the industry the principal business expense is marketing and advertising, items that are booked as current expenses and thus can be adjusted annually as income rises or falls. That gives a food processor financial flexibility nonexistent in an industry--auto manufacture or airlines, for example--that must build or buy capital facilities and pay for them over time no matter how earnings perform.
Still, merchandising expenses often reach as high as 8% or 9% of sales. Quaker’s marketing budget for its current fiscal year, analyst Greditor said, is almost equal to its shareholders’ equity of $787 million, or more than 22% of sales. Recent increases of as much as 20% at some companies to introduce such new products as granola bars (a particular hit for Quaker Oats) and to buy a little more shelf life for old ones are beginning to stir concerns about overspending.
“We have greatly increased our promotional spending in the past year, because with relatively low commodity costs people are fighting for market position,” said Roger Hedrick, chief financial officer of Pillsbury. “One of the ways you keep market position is to spend for it.”
Those that concentrated on food-related acquisitions have done much better. Pillsbury has spent heavily on restaurant chains such as Burger King and small food processors such as Haagen-Dazs and Green Giant. “We wanted to stick with what we knew best,” said Hedrick, “and we felt the opportunities we had in the businesses we knew were better.”
Undergoing Change
Meanwhile, the conservative financial practices that made the industry’s balance sheet so strong are undergoing change: The food processors have discovered the heady qualities of debt, and a few--notably Ralston Purina, the Saint Bernard of pet-food companies--have plunged into the credit markets with the enthusiasm of fresh converts.
Three of the largest companies--Purina, Kellogg, and Quaker Oats--have implemented major share repurchases largely financed with debt, a financial restructuring last seen in the oil and broadcast industries. These repurchases, of course, tend to boost earnings per share, an effect aimed at keeping shareholders happy enough to turn away an unfriendly tender offer.
This restructuring trend was started in 1982, and continues to be exemplified, by Ralston Purina. The St. Louis-based company first moved to pare its underperforming acquisitions, something investment professionals say is long overdue throughout the industry.
To some extent, this represented a new regime casting off the mistakes of its predecessors; among the divested units were a mushroom-growing facility, the Green Thumb chain of plant stores, and the St. Louis Blues professional hockey team.
Purina hardly got out of the acquisition game: In October, 1984, it spent $475 million for Continental Baking Co., the maker of Twinkies and Wonder Bread. At the same time, the company’s balance sheet was undergoing a dual transformation. The company was buying back huge amounts of its stock--34.9 million shares, or 30%, at market prices--and it was taking on a flood of debt.
Highly Leveraged
Over the last 2 1/2 years Purina has metamorphosed from a typically debt-light food company to the most highly leveraged in the business: In the nine months ended June 30, long-term debt nearly quadrupled to $899.5 million from $242.7 million on Sept. 30, 1984. The debt is more than 50% of Purina’s total capitalization. Still, Purina executives say the company’s cash flow of more than $420 million a year is sufficient to cover the debt generously; some Wall Street professionals believe that Purina may even have the money to resume its repurchases.
Many food industry followers warn that predicting the course of takeover interest in this industry is scarcely safer than predicting weather on the Great Plains. For one thing, there may be a real oversupply of targets. As many as a dozen companies have the fundamental qualities to attract a bidder, although speculation focuses on Sara Lee, Pillsbury, Quaker Oats and one or two others.
At the same time, acquisition prices have been rising as if the supply and demand rule is mythical--a signal that the crest may be near, if not past. “We’ve seen a dramatic escalation in the multiples paid (that is, ratio of price to earnings per share), from Carnation to Nabisco Brands to General Foods,” said Drexel’s Greditor.
The cheapest acquisitions, he noted, have been those of share-repurchase programs: The 20% of its stock that Kellogg repurchased last November from the W. K. Kellogg Trust cost it $37.50 a share, or less than nine times its projected earnings for 1985. Philip Morris is paying double that multiple for General Foods.
This trend is pricing many of the most attractive targets out of the market. Now that two major tobacco companies are sated with their prizes, investment professionals are hard-pressed to think of many companies with the resources to pay a premium over the current market value of Pillsbury ($2.5 billion), Quaker Oats ($2.2 billion), or Sara Lee ($2.4 billion).
HOW THE FOOD INDUSTRY HAS CONSOLIDATED RECENT MAJOR ACQUISITIONS Esmark (by Beatrice) $2.7 billion announced May, 1984 Carnation (by Nestle) $2.9 billion announced September, 1984 Nabisco Brands (by R.J. Reynolds) $4.9 billion announced June, 1985 General Foods (by Philip Morris) $5.6 billion announced September, 1985 RECENT MAJOR STOCK REPURCHASES Kellogg Co. 14.52 million shares (20%) November, 1984 Quaker Oats 3 million shares (7.5%) March-October 1985 Ralston Purina 34.9 million shares (20%) January, 1982-October, 1985 Los Angeles Times
