Even if Hillshire deal is dashed, Pinnacle Foods remains appetizing

Pinnacle Foods Inc. CEO Bob Gamgort and company executives ring the opening bell, in celebration of the company's IPO at the New York Stock Exchange in this file photo

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Pinnacle Foods Inc. CEO Bob Gamgort (C) and company executives ring the opening bell, in celebration of the company's IPO at the New York Stock Exchange in this file photo from March 28, 2013. REUTERS/Brendan McDermid/Files

The market is assuming Pinnacle Foods Inc. (PF) will be orphaned after its intended acquirer Hillshire Brands Co. (HSH) received an uninvited $5.5 billion takeover bid from Pilgrim’s Pride Corp. (PPC).

The offer by chicken processor Pilgrim’s is contingent on Hillshire dropping its weeks-old $4.2 billion deal to buy Pinnacle, owner of grocery brands including Birds Eye and Duncan Hines. Investors have repriced the shares of all three companies as if Hillshire is very likely to set aside the Pinnacle deal, pay them a steep breakup fee and take Pilgrim’s cash. Yet Pinnacle is not without options, and its financially shrewd backers will no doubt keep working to generate greater value for themselves and fellow investors.

Hillshire shares jumped as much as 23% to $45.55 on Tuesday, above Pilgrim’s $45 formal offer price, as traders built in some chance that a negotiated purchase by Pilgrim’s could happen at a higher price, or that a rival meat company could enter a bidding battle. Pilgrim’s stock also edged higher on enthusiasm for the potential efficiencies of a deal. Indeed, the entire meatpacking sector got a lift, with Tyson Foods Inc. (TSN) and Sanderson Farms Inc. (SAFM) climbing on enthusiasm for industry rationalization.

Pinnacle, meantime, has dropped to just above $31, less than a dollar more than where the stock closed the day before its agreement with Hillshire was announced.

The evaporation of virtually the entire takeover premium in Pinnacle’s shares probably makes some sense in the immediate term, as Hillshire said it will seriously consider Pilgrim’s offer. Hillshire's shareholders are required to vote on the Pinnacle acquisition because it would require the issuance of new stock, so its management could advise investors to vote “no” to doom the Pinnacle transaction and perhaps take Pilgrim’s cash.

A fat consolation prize

Yet Pinnacle would collect a nice cash consolation prize, as its agreement with Hillshire explicitly included a higher breakup fee if the merger were dropped because Hillshire itself became takeover quarry. The $163 million breakup fee in this scenario is roughly equal to Pinnacle’s 2013 net income.

Pinnacle also still has a highly capable and motivated private-equity sponsor in Blackstone Group (BX), which owns 51% of the company after taking part of it public last year. It’s fair to say that, having agreed once to sell Pinnacle, Blackstone will remain alert to other such prospects in the constantly consolidating food business.

It now appears Pilgrim’s Pride made an overture toward Hillshire months ago, which both explains the enhanced breakup-fee clause and implies that Blackstone has always been aware  a plan B might be necessary.

Todd Munn of Water Island Capital, a portfolio manager of the Arbitrage Event-Driven Fund (AEDNX), says it's clear Hillshire sought to buy Pinnacle as "a defensive transaction," and could drag out the process to pull in higher bids for itself. Pinnacle, for its part, has steady but lower-than-average profit margins that could be squeezed higher through productivity measures. In addition, "with Blackstone being there, they want out," and at some price Pinnacle "is for sale," Munn says.

So Pinnacle's tack from here could simply be to operate the business well, expand profit margins, make tuck-in acquisitions and pare down its debt load over time. Or, it could mean entertaining other suitors. 

Jim Cramer of and CNBC weighed in to say the selloff in Pinnacle shares looks like a buying opportunity.

Pinnacle’s non-executive chairman is Roger Deromedi, a Blackstone advisor who served as Kraft Foods CEO from 2003 to 2006 and has been in the packaged-food industry for more than 35 years. The food industry is seen as ripe for realignment, as companies try to better compete in a slow-growth economy and a grocery industry increasingly dominated by Wal-Mart Stores Inc. (WMT) and other mega-chains. Unilever (UL) this month sold its Ragu and related sauce brands to Mizkan Group for more than $2 billion. Pork processor Smithfield Foods sold out to a Chinese counterpart last year, and ConAgra Foods Inc. (CAG) bought private-label packaged-food maker Ralcorp Holdings.

Hillshire’s stated logic for picking up Pinnacle was to diversify from meats into a broader assortment of branded products featured in the baking and frozen food aisles of the supermarket. Hillshire CEO Sean Connolly extolled this strategy in announcing the deal. If Connolly and Hillshire shareholders find it impossible to resist Pilgrim's fat offer, a similar rationale could animate interest in Pinnacle from the likes of Hormel Foods Corp. (HRL), ConAgra or an even larger, global branded-food player.

It never makes sense to invest solely on the hope that a company will be acquired. But in the case of Pinnacle, the demonstrated attractiveness of its brands and willingness to entertain offers should lend support to the stock even if the Hillshire deal fails.

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