Source: Pinnacle Foods
May 27 was not a good day to own shares in Pinnacle Foods (NYSE: PF). After rival Pilgrim's Pride (PPC 0.77%) announced that it would be willing to buy Hillshire Brands (HSH.DL) in a transaction valued at $5.5 billion, shares of Pinnacle Foods fell 5% because of the stipulation that the deal would mean Hillshire must not follow through with the purchase of the company.
Two days later, on May 29, Pinnacle Foods' investors saw even more bad news hit when Tyson Foods (TSN 0.49%) announced that it too was putting in a bid for Hillshire valuing the firm at $6.1 billion. But, with shares of Pinnacle Foods trading at a 16% discount to its acquisition price (excluding the premium price at which Tyson Foods is willing to buy Hillshire at), is now a Foolish time to jump into the company's stock?
A little background goes a long way!
On May 12, Hillshire and Pinnacle Foods agreed to a deal whereby the former would buy out the latter in a cash and stock transaction. According to the terms of the agreement, Hillshire will give shareholders in Pinnacle Foods $18 per share in cash as well as 0.50 shares of its business for every share in Pinnacle Foods. Given the closing price of Hillshire's shares on May 23, this acquisition placed a per-share value on Pinnacle Foods of $36.51 for a total price of almost $4.3 billion.
Source: Pinnacle Foods
The deal, if consummated, will create a food giant with sales of $6.6 billion and forecasted net income of $416.1 million. However, the downside for shareholders is that, with cash on hand of just $389 million, Hillshire would have to take on a significant amount of debt (as much as $2.1 billion) to make its dream of assimilating the business a reality.
Pilgrim's Pride and Tyson Foods both swoop in!
Seeing opportunity, Pilgrim's Pride decided to step into the picture. The company, which has a current market cap of $6.6 billion and annual revenue of $8.4 billion, make an unsolicited offer to buy up Hillshire for $45 per share. In response to this offer, shares of the company soared 22% to close at $45.19, which could indicate that investors anticipate a higher bid coming from another market participant.
Source: Hillshire
Apparently, Pilgrim's Pride wasn't the only company keeping an eye on Hillshire. Believing that the firm would be a valuable addition to its operations, Tyson Foods topped Pilgrim's Pride's proposal by placing a buyout price on the company's stock at $50 per share. With a market cap of $15 billion and annual sales of $34.4 billion, the acquisition would not mean as much to the shareholders of Tyson Foods but its shares still managed to climb 6% on the buyout.
As part of either deal, Hillshire would be required to axe its proposed merger with Pinnacle Foods. Even though this would leave shareholders of Pinnacle Foods shortchanged, they would be compensated to some extent by a $163 million termination fee that Hillshire would be obligated to pay.
Does this leave an amazing opportunity to buy Pinnacle Foods on the cheap?
Whenever a merger or acquisition falls through, shareholders of the company that will no longer be bought end up seeing their shares fall in price. With the thought that Pinnacle Foods might no longer be purchased by Hillshire, Mr. Market discounted the company's stock accordingly but may have gone overboard.
Prior to its agreement to be acquired, shares of Pinnacle Foods were trading at $30.45 apiece. With the company's stock now trading at $31.48, the downside should its deal with Hillshire fall through is likely limited. In fact, if you assume that the business was trading at fair value before Hillshire's offer and you factor in the $163 million termination fee it will receive if its acquirer accepts Tyson Foods' invitation, then the business would actually be undervalued by almost 5%. This suggests an overreaction by Mr. Market.
Foolish takeaway
Given Hillshire's current share price of $52.76, it appears that Mr. Market expects the company to receive an even higher offer (possibly from Pilgrim's Pride). For this reason alone, shares of Hillshire appear to have priced in another bid that may not arise, but shares of Pinnacle Foods appear to be fully discounted. This points to a very interesting opportunity for the Foolish investor.
Using forecasted profits, shares of Pinnacle Foods are trading at about 18 times earnings. While this is far from cheap, it's lower than Hillshire's 26 times and the 20 times exhibite by Tyson Foods, but above Pilgrim's Pride's 14 times. For this reason alone, it's unlikely that the company's downside moving forward is significant, which could make the business a nice long-term prospect moving forward.
On top of this, there is the added benefit that its huge discount to acquisition price could mean a great deal of upside if Hillshire rejects either offer and decides to move forward with its purchase of Pinnacle Foods. However, the Foolish investor should see the company's price and future prospects as the main catalyst to invest in the firm while maintaining that this acquisition possibility is just a nice little bonus that may or may not materialize.
