The food fight is finally over. Tyson Foods (TSN 0.66%) has reached an agreement to acquire Hillshire Brands (HSH +0.00%) after a back-and-forth battle.
The clear winners here are Hillshire Brands' shareholders. They will receive a huge premium for their shares. In fact, Tyson's $63-per-share offer is approximately 88% higher than Hillshire's share price at the start of the year.
A disturbing trend among corporate mergers is that there seems to be no price the acquiring company isn't willing to pay. After a bidding war with Pilgrim's Pride (PPC 1.49%), Tyson's buyout of Hillshire Brands seems to be an act of desperation rather than a sound business decision. On the other hand, it's a great day to be a Hillshire Brands shareholder.
Good fit strategically, financially not so much
It's certainly true that Tyson merging with Hillshire Brands makes sense from an operational perspective. Both companies hold similar product offerings, and together they will become a much larger entity with several well-known brands. As Tyson's size and scale increases as a result of absorbing Hillshire Brands, so will its competitive advantage. Tyson was already the largest meat processor in the United States and will now be even bigger.
Tyson's stable of meat products will be supplemented nicely by Hillshire's lineup of Jimmy Dean sausages and Ball Park hot dogs. In a conference call, Tyson's Chief Executive Officer Donnie Smith said, "Great brands like Hillshire, Jimmy Dean[,] and Ball Park just don't come available very often."
While that may be true, it's also true that many companies would make themselves available if the price tag were high enough. Pilgrim's Pride had offered $45 per share but wouldn't match Tyson. It determined it would not have been in its own shareholders' best interest. Considering how much Tyson is about to pay, Pilgrim's Pride shareholders should breathe a sigh of relief.
Including debt, Tyson's deal for Hillshire clocks in at $7.7 billion. The offer pegs an $8.55 billion valuation on Hillshire Brands.
At that valuation, Tyson is paying almost 35 times trailing earnings for Hillshire, a company that isn't generating much growth. Hillshire's sales actually declined in the most recent fiscal year and rose just 2% the year before that. In fact, Hillshire's sales actually fell over the five-year period of fiscal 2009 to 2013.
Justification is not all it's cracked up to be
Tyson's rationale for the deal should be concerning for its investors. According to Reuters, in a call with reporters, the CEO stated, "We want to buy this business for what it can become, not just for what it is now." That sentiment seems more appropriate coming from a technology company acquiring a high-growth start-up. It's not something you'd expect to hear from two meat companies getting together.
After all, there really doesn't seem to be very exciting growth potential, unless people suddenly start eating a huge amount of sausages and hot dogs, which doesn't seem likely. At its takeover valuation, Hillshire provides an earnings yield of just 2.8%, just slightly above the yield on the 10-year U.S. Treasury bond. As investors, it's customary to demand a risk premium to justify the higher risk of buying an individual company. It's not readily clear that Tyson is getting much of a margin of safety at such a lofty price.
Shares of Tyson fell 6.5% on the day of the announcement and another 4% the day after, which implies how little confidence investors have in the decision to acquire Hillshire Brands.
To be fair, Hillshire is a profitable company with several popular brands. Its products will fit well into Tyson's existing portfolio. There's little doubt the deal makes sense from a strategic perspective.
But financially speaking, it's an entirely different story. The simple fact that the food industry in the U.S. is fairly saturated is evident in Hillshire Brands' unimpressive growth profile. There simply doesn't seem to be enough potential for future growth to justify what a high price Tyson is paying.
