Producing a Great Acquisition

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Motley Fool Hidden Gems recommendation Fresh Del Monte Produce (NYSE: FDP) announced that it is purchasing the assets of Del Monte Foods Europe for $340 million. The acquisition is expected to be "modestly accretive" to earnings.

Del Monte Foods Europe was entangled in the bankruptcy of Italian canned produce company Cirio. Before you jump to the conclusion that Fresh Del Monte got assets on the cheap, consider that Del Monte Foods (NYSE: DLM), the company that owns the Del Monte name for canned goods in the U.S., was out of the bidding before the final round started.

One reason Del Monte Foods exited early may be its $1.4 billion in debt. Fresh Del Monte carried a minuscule $40 million total debt into the bidding.

Another reason Del Monte Foods exited is certainly price. Consider that Fresh Del Monte stock sells for 60% of sales. Chiquita Brands (NYSE: CQB) sells for 30%. Only broadly diversified food companies such as ConAgra (NYSE: CAG) sell for 100% -- and General Mills (NYSE: GIS) sells for 160%. The market treats commodity pricing risk like Wal-Mart (NYSE: WMT) -- lower everyday discounted price-to-sales ratios.

Del Monte Foods Europe, with sales of $370 million, is being purchased for a rich 92% of sales.

Fresh Del Monte paid that high price to gain the perpetual, royalty-free license to use the Del Monte(R) brand for processed and/or canned food products in more than 100 countries throughout Western, Central, and Eastern Europe, Africa, and the Middle East. This is a rarity. What is better than to profitably build a well-known quality brand name and then buy that name for 100 other countries?

While the press release talks about the expansion in "under-penetrated markets such as Russia," investing in assets that "have not been operating at full capacity," and reduced "earnings volatility" because of the more stable pricing environment in the canned produce business, investors should focus on this comment: "While we will be able to increase our future bottom-line performance, our pro forma leverage will approximate a modest 25 percent, and we expect to pay off the transaction debt quickly."

Ah, that payoff is what Motley Fool Hidden Gems investing is all about. Find companies that are growing, with great balance sheets and excellent free cash flow. That combination creates the best environment for organic growth. It also allows the company to acquire a fantastic strategic fit when that rarity is available -- and get that acquisition to produce (is there a pun here?) its own organic growth.

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Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.