Reason #4 why LNCE is unlikely to make $2 a share anytime soon: LNCE needs 9% margins just to get to $1.40, and both Lance and Snyder’s generated margins well below this as standalone companies in recent years. Below are the adjusted operating margins for Lance Foods from 1992-2010 (as far back as I can get data from Edgar) and for Snyder from FY2008-FY2010 (from the prospectus for the merger). I calculated adjusted operating profit by taking reported EBIT and adding back any non-cash impairment or gain/loss on sale charges recorded in cash flow from operations. In addition, for Lance Foods in 2010, I gave the Company credit for $49 million of add-backs related to merger and integration expenses. Lance Foods Snyder’s 1992: 12.5% 1993: 10.2% 1994: 8.7% 1995: 3.9% 1996: 7.7% 1997: 9.3% 1998: 8.4% 1999: 7.8% 2000: 6.4% 2001: 6.9% 2002: 6.6% 2003: 6.8% 2004: 6.4% 2005: 4.5% 2006: 4.4% 2007: 5.2% FYE 3/30/08: 6.1% 2008: 3.5% FYE 3/29/09: 6.0% 2009: 6.4% FYE 3/28/10: 7.8% 2010: 6.3%
If LNCE is unlikely to achieve $1.40 in synergized EPS (let alone $2), then it trades at pricy multiples. For 2011, the first full year as a combined Company, LNCE is likely to generate around $0.75 in adjusted EPS, between $90-$100 million in adjusted EBIT, and between $145-$155 million in adjusted EBITDA. Based on these figures and the recent $22.57 stock price and $1.8 billion enterprise value, LNCE trades at 30x EPS, 18-20x EBIT, and around 11.5-12.5x EBITDA. Based on these multiples, it’s clear the market is pricing in some significant improvements in profitability.
Let’s say the Company does achieve the high end of management guidance for synergies and in the next year or two gets to $1.40 in EPS, $160 million in EBIT, and $220 million in EBITDA. Even at these levels, LNCE at its current price would trade at 16x EPS, 11x EBIT, and 8x EBITDA. While these are more reasonable levels, I wouldn’t call them obviously cheap. And more importantly, for all the reasons listed above, I think these profitability levels are very unlikely to be achieved anytime soon.
These valuation multiples look even steeper when you realize that LNCE has historically been a very low growth company. Below are the adjusted operating profits for Lance Foods from 1992-2010 (as far back as I can get data from Edgar) and for Snyder from FY2008-FY2010 (based on the prospectus for the merger). Lance Foods Snyder’s 1992: $58 million 1993: $48 1994: $43 1995: $19 1996: $37 1997: $45 1998: $41 1999: $41 2000: $37 2001: $40 2002: $36 2003: $38 2004: $38 2005: $30 2006: $32 2007: $39 FYE 3/30/08: $36 2008: $30 FYE 3/29/09: $40 2009: $59 FYE 3/28/10: $53 2010: $62
Note also that Lance Foods made $54 million of acquisitions in 1999, $44 million in 2004, $55 million in 2008, and $24 million in 2009, so what little growth there has been is at least partly due to acquisitions rather than just organic growth. Snyder’s looks a bit more promising, but its operating profit was boosted somewhat by $58 million of acquisitions made in FY 2008. Snyder’s fiscal year ended 3/28/10 does look pretty good (as does Lance Foods’ 2009), but I’d point out that 2009 was actually a very good year to be in the snacks business, as the benefits of dramatic declines in ingredient costs more than offset any volume declines from the weak economy.
My point here is that neither Lance Foods nor Snyder’s demonstrated remarkable growth prospects as stand-alone companies, so I don’t think the combined company is worthy of premium valuation multiples.
The biggest risk to shorting LNCE is that the Company could get bought out… As Mario Gabelli notes, LNCE could be an acquisition target, particularly for Kraft Foods after it completes the spinoff of its global snacks business (targeted to be officially spun off by the end of 2012). According to Kraft, their snack business will be “focused largely on capitalizing on global consumer snacking trends, building its strength in fast-growing developing markets and in instant consumption channels.” Like LNCE, Kraft’s snacks business uses a direct-store-delivery model, so there is some logic in combining the two companies. Although LNCE wouldn’t help Kraft much in its ambition to expand in foreign markets, LNCE would help Kraft expand in U.S. “instant consumption channels” such as convenience stores. Although I’m of the opinion that LNCE’s attractiveness as an acquisition target might be overrated (especially since LNCE doesn’t have remarkable growth prospects), we certainly can’t rule out the possibility here, especially since food companies tend to be acquisitive.
If LNCE is acquired at some point, what is the downside to a short position? Most transactions in the snack food space involve the purchase of private companies, so rarely are profitability figures for the target disclosed. The best comp I can think of is Diamond Foods’ 2010 purchase of Kettle Foods for 11.6x EBITDA. Diamond was rumored to have outbid several other players (including Frito-Lay and Lance, among others) so I don’t think Diamond got a bargain price here. Suppose LNCE is successful in achieving synergized EBITDA of $220 million (this would be the EBITDA level commensurate with 9% EBIT margins and $1.75 billion in revenue), and the Company is bought for 11.6x. This would mean a total purchase price of about $2.55 billion. If we subtract out ~$270 million of net debt and divide by 69 million shares, then the implied share price is about $33, or about a 45% premium to the current price. So yes, there is potential downside to shorting LNCE.
But such an acquisition is unlikely to occur anytime in 2012. Although this is the big risk to shorting LNCE, I’m still comfortable with the trade because even if LNCE is bought, I don’t think such a transaction is likely to take place in 2012. LNCE is still busy integrating its merger (integration efforts are expected to last at least through the first half of 2012), and I would expect that any potential acquirer would want to see the Snyder’s-Lance integration efforts complete before making an offer. Moreover, LNCE probably doesn’t want to entertain any efforts until they’ve made progress on realizing the synergies that they promised. Also, Kraft (the most logical suitor) will be dealing with its own spinoff issues through most of 2012, so Kraft would likely to prefer to make such a deal after the snacks spinoff has been finalized. If the end of 2012 nears and LNCE has completed its integration efforts and has made significant progress towards achieving the synergies it’s promised, I would recommend closing any short positions in LNCE. But I believe that the stock is likely to trade down before the end of 2012 as expectations for synergized EPS are ratcheted down.