Two weeks ago PepsiCo started the ball rolling by offering $103 per share for Quaker Oats, maker of cereals, oatmeal, and hot property Gatorade. Quaker rejected that deal, and has since seen later prospective buyers bid and then retract as the price has gotten too high. Quaker is still very much in play, but the company's shares have risen 80% in the last eight months. The shareholders of purchasing companies really don't seem to be able to stomach much of a greater premium on top of this recent growth.
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Quaker Oats (NYSE: OAT) -- maker of all things oat-related as well as such brands as Gatorade and Cap'n Crunch -- has been playing fair maiden to all of the gentleman callers at its door over the last three weeks. Quaker's stock has risen and fallen on the expectation that one of these suitors would agree to wed. But in a bizarre course of events, PepsiCo (NYSE: PEP), Coca-Cola (NYSE: KO), and most recently French food conglomerate Groupe Danone (NYSE: DA) have each played Quaker's Prince Charming, storming loudly through the front door and then slinking back out, claiming lack of interest. In each case there are some real plusses for the deal, but the minuses -- or at least the questions -- have won out. After each spurning, Quaker's share price has sulked back downward. Quaker has fallen more than 12% since Danone retreated. And yet today Quaker's share price is rising once again on the hope that a buyout partner is going to step up. The primary candidate? Once again it is the original suitor, boy-next-door PepsiCo, whose original offer was rejected by Quaker. In addition, Switzerland-based Nestlé stepped up and voiced some interest as well when its CEO spoke glowingly of the job Quaker's management has done, and also confirming that it was monitoring the situation. Nestlé's CEO also made what were perhaps the clearest comments yet as to why a company with brands as strong as Quaker's has not been immediately snapped up. Peter Brabeck-Letmathe stated that when each potential buyer for Quaker has seen its share price hit to the tune of 10% when a deal looked imminent, perhaps that is the market's way of saying that the purchase price is just too expensive. This means that if Nestlé were in fact going to put in a bid for Quaker, its premium over the current market price would be minimal. Pepsi's original bid was for $103 per share, pricing the company at $13.7 billion. Coca-Cola's trumping bid came in at $113 per share, but Coke's board, led by Berkshire Hathaway (NYSE: BRK.A) Chairman Warren Buffett, rejected the deal. It was actually surprising to some (including me) that Coke bid for Quaker at all, seeing as the prize of the deal, Gatorade, would have come under strict antitrust scrutiny: Coke holds the #2 sports drink brand, while Gatorade is tops with nearly 80% of the market. At Quaker Oats' current share price of $87.75, Pepsi's original bid would represent a premium of 17%. What is really interesting is the timing of these deals. Quaker could have been had for a song in March but has since gone on a rampage, climbing more than 80% in price on sales that have grown at only 10% per year. Whether the company was undervalued then or overvalued now is debatable, but it seems odd that the current suitors, all of which are flush with cash, would not have taken advantage of market conditions when they were less ebullient for food stocks. The Fool's Jeff Fischer, who covers food and beverage stocks in our upcoming Industry Focus 2001, has a rational way of valuing food stocks, using a ratio between the free cash flow and enterprise value of the company (for a description, see this recent article). In the case of Quaker, it has a ratio of 32 at current prices, just shy of the industry average. Were Quaker to be bought at $103, the ratio would increase to 69, far above industry norms. Now that Quaker is in play, it seems likely that its absorption into a larger company is fait accompli. Given the power of some of its brands, the company that picks it up will be getting a strong boost to its bottom line. But the market is not willing to bear just any price to get the deal done. In the end, this penalty may keep the premium granted to Quaker shareholders lower than they expect.
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