Bob Evans Farms Makes Sense as Pilgrim's Next Target

Having started the food fight over Hillshire Brands last month by launching an unsolicited $5.5 billion takeover bid, poultry producer Pilgrim's Pride (NASDAQ: PPC  ) was left with egg on its face when rival processor Tyson Foods placed a winning offer of $7.7 billion.

Pilgrim's, though, might still come out on top here, as any number of analysts think its rival may have overpaid for the privilege of purchasing the packaged meats company. With little debt and a number of acquisition possibilities still to choose from, Pilgrim's could do itself proud by buying up a smaller operator. Bob Evans Farms  (NASDAQ: BOBE  )  might be just the ticket for Pilgrim's Pride.

Bob Evans is a full-service restaurant operator, owning 562 family restaurants across 19 states, mostly in the Midwest, mid-Atlantic, and Southeast. It also owns BEF Foods, a leading producer and distributor of pork sausage products, along with a variety of complementary homestyle refrigerated side dishes and frozen food items under the Bob Evans, Owens, and Country Creek brand names. BEF represented nearly 30% of Bob Evans' $1 billion in revenue in the third fiscal quarter, a 2% increase year over year.

The impetus behind Pilgrim's pursuit of Hillshire was the desire of its parent company, Brazilian meat processor JBS, to diversify itself away from providing supermarkets with generic-brand meats. While that is a good business, branded products carry higher premiums. Bob Evans' packaged-foods division could provide that mix.

BEF Foods, however, has been having operating difficulties and last quarter identified plant start-up inefficiencies, high sow costs, and a dispute with one of its suppliers impact per-share earnings by $0.17. It shaved off $0.06 from the full-year guidance it updated in January.

As a result, activist shareholders have sought to split the company in two. Last September, Sandell Asset Management charged that shares of Bob Evans Farms were suffering from the effects of a "conglomerate discount" due to the divergent nature of the two businesses, which despite some of benefit receives from the vertical integration isn't enough to justify it other than for the sake of its own "empire" building. The stock, which jumped nearly 20% in the aftermath of Sandell's agitation, has since fallen back to its prior level and is now essentially flat. 

Sandell said a spun-off food business could trade at 10 times its EBITDA, similar to other packaged foods companies such as Campbell SoupConAgra, and Hormel. However, if it were sold instead, it could garner an even higher premium in light of the merger and acquisition environment at the time, which continues today.

While the average food industry multiple is nine times EBITDA, ConAgra bought Ralcorp for 12.5 times EBITDA and Berkshire Hathaway took Heinz private at 14.3 times EBITDA. Tyson's winning offer for Hillshire, however, values the packaged meats company at more than 17 times earnings before interest, taxes, and depreciation.

Between Bob Evans' own internal estimates of its enterprise value as a multiple of its EBITDA and those of analysts, the restaurant operator should trade around eight times this year's earnings, meaning an offer from Pilgrim wouldn't have to approach the nosebleed valuations Tyson is offering to realize a significant premium for shareholders.

Pilgrim's Pride has shown that even with a fairly clean balance sheet it's not willing to go off the deep end in buying a company. It could achieve the same goals it had with Hillshire, perhaps more cheaply, by buying Bob Evans Farms. JBS could then provide the necessary infrastructure support that Bob Evans' struggling packaged foods division needs. 

Unlike Tyson's hefty bill for Hillshire, Pilgrim's Pride can win for losing and can put a chicken in the pot of its own investors, as well as those of Bob Evans Farms.

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