Tyson’s purchase of Hillshire to create a global meat behemoth (Updated)

Tyson Foods is moving toward closing its acquisition of Hillshire Brands but has again had to extended its tender offer of $63 per share on the $8.55 billion deal from. Tyson Foods noted in a release Tuesday (Aug. 26) that it expects the deal to close by Sept. 27. Some 53% of shares have already been tendered. Analysts agree the deal will likely pass regulatory muster despite some concerns from the pork industry about lost production.

Tyson was notified Wednesday (Aug. 27) by the U.S. Department of Justice that it must divest Heinold Hog Markets, its sow purchasing business, in order to get DOJ approval. The department said that without the required divestiture the transaction would have combined companies that account for more than a third of sow purchases from U.S. farmers, likely reducing competition for purchases of sows from farmers.

State attorneys general from Illinois Iowa, and Missouri joined the department in the civil lawsuit filed today in the U.S. District Court for the District of Columbia to block the proposed transaction. At the same time, the department filed a proposed settlement that, if approved by the court, would resolve the competitive concerns alleged in the department’s lawsuit.

“Farmers are entitled to competitive markets for their products. Today’s proposed settlement will help ensure that hog breeders in the United States will continue to receive the benefits of vigorous competition when selling sows,” said Bill Baer, Assistant Attorney General in charge of the Antitrust Division. “Without the divestiture, the proposed acquisition would have eliminated a significant customer for farmers’ sows and likely would have resulted in less competition in this important agricultural market.”

Neither Tyson, nor Hillshire management, have disclosed what their combined operation will look like geographically and if there are plans to shutter or sell off any of their processing facilities spread across 11 states.

Hillshire's meat-related operations include:
• Kansas City, Mo., (sliced lunchmeat processing);
• St. Joseph, Mo., (sliced lunchmeat, hot dogs and links);
• Zeeland, Mich., (deli and breakfast bowls);
• Storm Lake, Iowa (Turkey production and processing);
• San Lorenzo, Calif., (Aidells Sausage and specialty meats);
• Rancho Cucamonga, Calif., (Golden Island Jerky);
• New London, Wisc. (sliced lunchmeat, smoked sausage and hot dogs);
• Newbern, Tenn., (sausage);
• Haltom City, Texas (corn dogs);
• Florence, Ala., (sausage);
• Claryville, Ky., (sliced lunchmeat, cocktail wienies and hot dogs).
• Rome, Ga., where Nature Valley Granola is manufactured;
• Vernon, Calif., Van's Natural Foods plant;
• Traverse City, Mich., Chef Pierre pie-manufacturing plant.;
• Tarboro, N.C., Sara Lee plant produces frozen cakes, croissants, muffins and cobblers.

Tyson recently announced the closure of three of its prepared foods manufacturing plants in Cherokee, Iowa; Buffalo, N.Y.; and Santa Teresa, N.M., citing the need for improved efficiencies as the plants tagged for closure were outdated. Tyson is shifting some of the production to more efficient plants. The Cherokee plant is slated for closure Sept. 27 and the other two are expected to wind down operations in the first half of 2015. An estimated 950 jobs are being eliminated with these closures.

BUSINESS TRANSFORMATION
The Springdale-based meat giant also sold its commodity businesses in Mexico and Brazil to competitor Pilgrim’s Pride, whose parent company JBS is based in Brazil.

“These recent moves by Tyson make sense,” said Steve Kay, publisher of Cattle Buyers Weekly. “The sale of the Latin American business simplifies things because they will have so much on their hands with this Hillshire acquisition. The plant closures of the underperforming sites is another way Tyson is getting ready for the transformation in their business. … They began preparing for this Hillshire deal more than year ago. Dipping their toe in the water with several small prepared foods acquisitions (Boscos Pizza, Don Julio Foods and Circle Foods) while they spent time reviewing Hillshire’s business,” Kay told The City Wire.

Aside from the plant closures already announced, Kay does not expect to see much manufacturing overlap when the merger is completed.

Wall Street analysts expect Tyson might sell off a few of the ancillary businesses within the Hillshire portfolio such as the confectionary Chef Pierre pie and the frozen Sara Lee brands. There is a plethora of merger and acquisition demand in the packaged food sector given cheap money and a thirst for market share. The companies themselves have not commented on these possibilities.

Not everyone is convinced that Tyson’s manufacturing footprint won’t need more tweaking once the deal is complete.

“We find it a bit disconcerting that the fiscal year 2015 plan hinges so heavily on the expectation that two Tyson divisions, Chicken and Prepared Foods, will deliver record results even though they just missed expectations in 3Q due to supply chain problems at antiquated production facilities. Manufacturing problems don't get solved overnight, and it sounds like the company needs to do some heavy lifting within their footprint to get back on track,” Credit Suisse analyst Robert Moskow noted in a July 28 report to investors.

PROCESSING HICCUPS
Moskow is concerned about the non-recurring items mentioned in the recent quarter restricting the company’s chicken margin by 1.5% to 2%.

“There were a few things that happened in the quarter at manufacturing facilities that contributed to lower volume. The company suffered a fire in one of its fully cooked processing plants in February. The damage was more extensive than the company thought and it impaired their ability to provide adequate supply. Management said the repairs have been completed and the plant is back on line. In addition, a second fully cooked processing plant had some operational issues related to outdated equipment. This also significantly impacted volumes. Management said the new equipment has been ordered and the they expect to return to full production volume by first quarter of 2015,” Moskow said.

Tyson has agreed to buy meat on the open market at expensive prices to fill its customers’ orders. Tyson execs said this strategy will continue going forward.

“The supply chain issues coupled with the higher input prices amount to a chicken margin impact of 1.5% to 2% in the back half of the year,” Moskow notes.

FUTURE GAINS
Tyson and Hillshire Brands will create the biggest meat company in the world with some $40 billion in combined annual revenue once the deal is completed.

Kay said Tyson bet the farm on a deal that has the potential to radically transform its business model from the fresh meat business into a higher margin retail packaged food company like Hormel. He said the deal can be summed up in three words: Brands, breakfast and margins.

Tyson reported that the combination of assets will accelerate its growth in the coveted $1 billion breakfast-food category, the fastest growing segment in the food sector. Tyson CEO Donnie Smith said combining the brand strengths of Wright Brand bacon and Jimmy Dean sausage make for a blissful marriage and growing market share. Aside from having a lock on breakfast meats, the Hillshire portfolio also expands Tyson’s reach into the cereal, gluten-free and granola markets with the Nature Valley brand and the recently acquired Van’s Foods.

Smith said the combined brands include four that are worth $1 billion or more. He said the combined companies will be the No. 2 player in the frozen retail category with $3.7 billion in annual sales, leap frogging over ConAgra Foods at $3.3 billion.

The biggest reason Tyson is eager to complete the Hillshire deal is the promise of higher operating margins, Kay said.

“In fiscal 2013, Hillshire had a net margin of 4.7 % versus 2.3% for Tyson. On an operating basis, Hillshire’s retail business had an 11.4% operating margin and its foodservice business a 7.3% margin,” Kay said.

Compare that Tyson’s overall operating margin of 4% in 2013 and Kay said it’s easy to see the attraction.

“Hillshire’s $404 million in operating income in 2013, and what will most likely be a larger number in fiscal 2014, obviously appealed a lot to Tyson,” he said.

RISK ASSESSMENT
Tyson’s eagerness to get this mega deal done is not without risks that the company publicly disclosed in an Aug. 7 filing with the Securities and Exchange Commission.

Tyson execs note that while they plan to achieve targeted benefits with the Hillshire acquisition, they realize that will depend largely on their ability to integrate the two different businesses.

“The necessity of coordinating geographically separated organizations, systems and facilities and addressing possible differences in business backgrounds, corporate cultures and management philosophies may increase the difficulties of integration. We and Hillshire Brands operate numerous systems, including those involving management information, purchasing, accounting and finance, sales, billing, employee benefits, payroll and regulatory compliance. Moreover, the integration of our respective operations will require the dedication of significant management resources, which is likely to distract management’s attention from day-to-day operations. Employee uncertainty and lack of focus during the integration process may also disrupt our business and result in undesired employee attrition. An inability of management to successfully integrate the operations of the two companies could have a material adverse effect on the business, results of operations and financial condition of the combined businesses.” Tyson noted in the filing.

Tyson also warned that cost savings and synergies could differ materially from earlier estimates and investors should not place undue reliance on those estimated cost-savings, which are $500 million over three years.

With respect to executive management, Tyson notes the accelerated vesting of equity-based awards and payment of “change in control” benefits to some members of Hillshire Brands’ management could result in increased difficulty or cost in retaining Hillshire Brands’ officers and employees.

EARNINGS OUTLOOK
Despite the the risks, Tyson management recently provided upbeat earnings guidance for fiscal 2015 with chicken margins of at least 10%, Hillshire synergies of $225 million in the first year and $500 million by year three, with $575 million in proceeds from the sale of the Latin American poultry segment.

On that note, Moskow raised his fiscal 2015 earnings guidance to $3.22 per share, still somewhat below the consensus $3.40 per share.

The target price for Tyson shares according to Moskow is $38. Shares of Tyson Foods closed Tuesday (Aug. 26) at $37.22, for 24 cents. Wall Street’s consensus target price is $46.13. During the past 52 weeks the share price has ranged from a $27.33 low to a $44.24 high.