Two food industry giants may be joining forces soon -- Sysco Corp. (NYSE:SYY) has offered to buy U.S. Foods for $3.5 billion, payable in cash and stock. The addition of U.S. Foods is expected to increase Sysco's annual sales by about 46% to $65 billion. Investors applauded the move, and Sysco shares rose 9.7% to $37.62 on Dec. 9.
Sysco will pay for the deal with $500 million in cash and $3 billion in common stock. Sysco will also assume $4.7 billion in debt from U.S. Foods, giving the deal a total value of $8.2 billion. The significant amount of debt assumed by Sysco has prompted Moody's Investors Service to consider a possible downgrade of the company's credit rating .
The combined companies are expected to generate $2 billion in operating cash flows. The acquisition should help Sysco grow its case sales volume -- in its fiscal 2014 first quarter report, sales grew 5.7% to $11.7 billion but net earnings decreased 0.4% to $285.6 million. Diluted earnings per share was down 2% to $0.48 per share. Sysco's EPS during the first fiscal quarter of 2013 was $0.49 per share .
The deal should close in 2014's third quarter. It is expected to boost the company's profits for 2014, after accounting for transaction and amortization related expenses. On a three to four year time-frame, Sysco expects to realize annual cost savings of at least $600 million from "supply chain efficiencies, merchandising activities, and overlapping general and administrative functions ."
Deal will reduce competition and could raise antitrust concerns
The purchase of U.S. Foods by Sysco creates the largest and the only national food and restaurant supplier in the country. Sysco expects this acquisition to increase its market share from 18% to 25%.
Antitrust regulators are expected to analyze the deal with a fine-tooth comb. If it fails to get approval, it could cost Sysco $300 million in breakup fees. Sysco may also need to part with $2 billion worth of its business if regulators require it.
The Wall Street Journal reported that attorneys who are familiar with the matter believe it's all a matter of how the SEC views the role of the newly combined company within the industry and its impact on market competition, which varies by geographic area. In an April 2013 filing with the SEC, U.S. Foods explained to investors that it faced intense competition in the industry from several "smaller, regional, local and specialty distributors ." While most of the attention has been directed at the proposed Sysco merger, other food distributors have recently made their own acquisitions.
The Chefs Warehouse expands its business in Chicago
One of Sysco's smaller competitors, The Chefs' Warehouse (NASDAQ:CHEF) has been doing some shopping of its own. On Dec. 11, the company announced that it was acquiring a major stake in Allen Brothers, a purveyor of premium quality meats to almost 400 restaurants, hotels, and other hospitality related businesses. Allen Brothers also sells its meat products directly to consumers through its direct mail and e-commerce channels.
In addition to the new growth opportunities offered by the deal, Chefs Warehouse is looking at the potential to build upon the Allen Brothers' e-commerce platform and offer Chefs' Warehouse products for sale directly to consumers. Chicago-based Allen Brothers will also make it easier for Chefs' Warehouse to build its business in Chicago, an area with significant long-term growth prospects . In its latest earnings report for the third quarter of 2013, the company attributed the rise in sales to its acquisitions of Queensgate Foodservice, Qzina Specialty Foods, and Michael's Finer Meats. The acquisitions increased quarterly net sales by $35.6 million .
Organic food supplier United Natural Foods adds a new subsidiary
Another of Sysco's competitors looking to increase its market share is United Natural Foods (NASDAQ:UNFI). Uited Natural Foods offers more than 65,000 products to natural, organic, and specialty food retailers. The company has over 27,000 customers throughout the U.S. and Canada.
In late Sept. 2013, the company acquired privately-owned Trudeau Foods, a Minnesota-based food distributor which sold products similar to those sold by United Natural Foods. Financial details for the transaction were not released. The majority of Trudeau's 600 customers are grocers, wholesalers, and meat markets located in Minnesota, North Dakota, Wisconsin, and Michigan .
Once the buyout is finalized, Trudeau Foods will be run as a wholly owned subsidiary of United Natural Foods. In its most recent earnings report, United Natural Foods showed off strong results for the first quarter of fiscal 2014 and reported a net sales increase of 13.6% to $1.6 billion. The company earned $1.4 billion last year. Its adjusted diluted EPS grew 21.7% versus the same period last year .
My Foolish conclusion
The hunt for market share is on in the food service sector. It will be interesting to see how food retail and food service buyers react to the Sysco-U.S. Foods merger and the possibility of higher prices down the road. While national and regional customers may find it difficult to switch to another distributor, smaller businesses may be willing to give more of their business to Sysco's smaller, local rivals.
Eileen Rojas has no position in any stocks mentioned. The Motley Fool recommends Sysco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.