Tyson Foods Inc. – A perfect case of winner’s curse

Last week, Tyson Foods Inc. (TSN) won an auction to acquire Hillshire Brands Co. (HSH), the biggest maker of hotdogs and breakfast sausages. Hillshire, the longtime maker of Jimmy Dean sausages and Ball Park hot dogs, got caught up into a bidding war between two of the country’s biggest meat producers – Tyson Foods Inc. (TSN) and Pilgrim’s Pride Corporation (PPC).  On May 27th, Pilgrim’s Pride bid for Hillshire for $45 per share. Tyson Foods upped the ante by increasing the bid price by $5 to $50 per share. In first week of June, Pilgrim’s Pride further increased the bid price to $55 per share.

SECRET BID AUCTION:

The Hillshire’s advisers at Centerview Partners and Goldman Sachs devised an unusual auction structure with a very fast timeline. Both the bidders – Pilgrim’s Pride and Tyson were each to have submitted offers by Sunday afternoon (June 7th). But the winning bid had to be at least $2.50 a share higher than the other bid. If not, the two bidders would have had to continue to submit offers until that requirement was met, with the necessary margin of victory to shrink over time. The goal was to get each to put its best offer on the table as quickly as possible, with the process hopefully wrapping up within hours.

The setup in this type of auction is uncommon where each participant is unaware of the action (bid price) of its opponent. Each participant tucks a price into an envelope, trying to guess the dollar amount it needs to be on top. Pilgrim’s pride (PPC) participated in the auction with the same price it offered last week i.e. $55 per share. As per the auction rules, Tyson Foods need to bid only $2.5 above the bid price of Pilgrim’s to win the auction. However, to play safe, Tyson Foods put a $63 per share for Hillshire and eventually ended up winning the bid. $63 per share valued Hillshire Brands Co. at $7.7 billion, 70% above the stock price from where the bidding started. This is a perfect case of “Winner’s Curse” where the bidder even though wins the auction, eventually ends up paying way more than the fair price of the asset. Shareholders of Tyson Foods and Pilgrim’s rightly punished their respective stocks sending the stock price down by 6.5% and 6.7% respectively on Monday 9th of June.

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Figure 1: TSN stock price and volume for time period 06/07/14 – 06/12/14

Source: Capital IQ 

TOO MANY RED FLAGS TO IGNORE:

Tyson Food’s management team arranged a management conference call on June 9th to address any questions related to possible (I will explain below why the acquisition is still a possibility) acquisition of Hillshire Brand Co.

  • Hillshire’s deal to acquire Pinnacle Foods (PF):

    A month before the auction for Hillshire started, Hillshire signed an agreement to buy Pinnacle Foods. This deal is mutually incompatible with the Tyson’s deal for Hillshire. Hillshire by no means can quit the Pinnacle deal unilaterally. It has to gain its shareholder’s approval or the deal has to be mutually cancelled out between the two parties (Hillshire and Pinnacle). Termination fee for agreement is $163 million, which will go out from the pocket of Hillshire’s shareholders. Tyson and Hillshire have signed no M&A agreement even after Tyson won the auction. So right at this moment, the deal can go either of the three ways –

    1. Hillshire acquires Pinnacle and rejects the Tyson Food’s offer. Even though the possibility of this option is highly unlikely (given the huge premium Tyson has accepted to pay to Hillshire’s shareholders), this possibility still exists.

    2. Pilgrim’s Pride decides to increase its bid above $63 per share to buy the Hillshire. Hillshire can again reject the Tyson’s bid and go ahead with this new bid from Pilgrim.

    3. Deal works in favor of Tyson Foods and it acquires Hillshire. Not to forget it will end up paying a huge premium for this deal.

  •  Synergy cost:

Mr. Donald J. Smith, President and CEO of Tyson Foods, came up with this fancy number of $300 million of annual savings in synergies. Time and again in past M&A deals we have seen that most of the CEOs have used synergy savings as one of the major reason to justify the cost of acquisition. As an investor one should be extremely careful about such acquisitions.

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Figure 2: Tyson Foods management conference transcript

Source: FACTSET

When an analyst asked Mr. Donald to classify his synergy savings (what percent are they coming from head count reduction, higher profit margin, or other) of his $300 million, below was his response.  I believe any person with a reasonable amount of business knowledge could have given this generic response as given by the CEO.

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Figure 3: Tyson Foods management conference transcript

Source: FACTSET

When grilled further on how he came up with this $300 million target for synergy. Did he go through the books to determine the value? And the response was even more astonishing.

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Figure 4: Tyson Foods management conference transcript

Source: FACTSET

  • Repayment of Debt:

One of the analysts questioned – “How much of equity company is planning to raise to repay the debt?” and CEO was not sure about it as of now. It’s not quite surprising now when we look at the history of M&A deals of past and why most of them do not add much value to the acquirer and it shareholders. $7.7 billion deal and CEO has no definitive plan of repayment of debt.

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Figure 5: Tyson Foods management conference transcript

 Source: FACTSET

  •  RETURN ON INVESTED CAPITAL (ROIC):

Mr. Donald mentioned in the conference call that company is aiming for ROIC of 20% in next five years. Current earnings per share (EPS) of Hillshire is $1.73 and the price that Tyson has offered is $63 per share. So the current yield on the investment is 2.74%. To reach to the target of 20%, company will have to earn $12.62 per share i.e. 700% more than what Hillshire is currently earning. How feasible is that? Time will tell the answer.

CONCLUSION:

Time and again we have seen in most of the M&A deals bidders overpay for the synergies. Tyson has strategic reasons to acquire Hillshire Brands. Hillshire will give Tyson a larger presence in branded foods, which offer higher profit margins than the Tyson’s products. May be the strategic reasoning explains the casual attitude of Mr. Donald towards the financial viability of the deal. He seemed to have no clear breakdown on $300 million synergy – what percent of that synergy would be coming from revenue and from cost. He vaguely explained about the sources of increase in profit margins expected from the acquisition of new business.  Mr. Smith repeatedly declared, “We think the cultures are very complementary, and we think that will go a long way into making for a really smooth integration.” He clearly missed mentioning which cultural traits these two firms have in common.

One thing is for sure that the combined firm will be second biggest in the industry and will see substantial upsurge in the revenues. However it would be interesting to see in future if the price paid to acquire the firm was justifiable.

REFERENCES:

http://www.sec.gov/Archives/edgar/data/23666/000010049314000073/transcript994.htm

http://www.bloombergview.com/articles/2014-06-10/tyson-s-sausage-deal-is-not-yet-fully-cooked

 

Akhil Parekh is a Research Associate for the Rotman Asset Management Association. He will be graduating from the MBA program at the Rotman School of Management in 2015. Akhil can be reached at Akhil.Parekh15@rotman.utoronto.ca
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