Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

A tie-up between Pinnacle Foods Inc. and Conagra Brands Inc. won't be as hated as their past attempts at megamergers. It's still an expensive and uninspiring idea.

Conagra reportedly approached Pinnacle Foods at some point over the past few weeks about a takeover. The two sides are certainly familiar with one another: Conagra CEO Sean Connolly tried to buy Pinnacle in 2014 while he was leading Hillshire Brands Co. Pinnacle's slow growth and the heavy debt load that deal would have entailed left shareholders with a bad taste in their mouths and Hillshire subsequently dropped the deal after receiving a takeover offer from Tyson Foods Inc. Connolly then joined Conagra, where he's had to try to unravel the hideous mess that was the $7 billion Ralcorp Holdings Inc. purchase.

Shares of both Conagra and Pinnacle rose on the news, with the would-be buyer jumping as much as 4 percent. Investors may want to temper their enthusiasm a bit.

This latest proposed combination does have a stronger rationale than some of those prior deal situations. The Ralcorp purchase went wrong in part because its grocery-store label products didn't mesh with Conagra's branded goods; in contrast, both Conagra and Pinnacle sell household names like Orville Redenbacher's popcorn, Vlasic pickles and Mrs. Butterworth's syrup. There are some clear overlaps in condiments and frozen foods that should create sales and cost benefits. And since the Hillshire offer collapsed, Pinnacle has used the acquisitions of Garden Protein International and Glutino cracker-maker Boulder Brands to add health-conscious, faster-growing food options to its roster.

Going, Going, Sold?
Pinnacle has gotten more expensive as time has gone by
Source: Bloomberg

But there are also some reasons for caution, the biggest being just how expensive Pinnacle Foods is. Even before this week's takeover speculation, the company was trading at a record $62 a share, earning a valuation of about 15 times its anticipated 2017 Ebitda. That's before adding on a premium, with analysts targeting an appropriate takeover bid in the $70 to $75 range.

It's worth recalling that Pinnacle Foods' 2016 purchase of Boulder Brands valued the company at about 14 times its projected year-ahead Ebitda. In other words, Conagra would be paying a higher multiple for Pinnacle than Pinnacle paid for what is arguably the most attractive and valuable part of Pinnacle. That doesn't make a lot of sense.

Conagra could use a transformational deal to arrest its revenue declines and give it new cost-cutting opportunities after reaping most of what it could from its own business, but I'm not sure this is a great long-term solution. First of all, at this kind of price, it's not clear that the earnings boost is strong enough to make this a "must do," says JPMorgan Chase & Co. analyst Ken Goldman, who estimates 13 percent accretion to Conagra's EPS with a bid at about $75. And then what comes after the synergies?

Underwhelmed
Pinnacle's revenue growth is respectable in a declining packaged-food industry, but it's far from spectacular
Source: Bloomberg
Note: The spike in growth in 2016 correlates with the closing of Pinnacle's acquisition of Boulder Brands, which had about $500 million in revenue.

Pinnacle is certainly growing faster than Conagra, but it's not going gangbusters. As my colleague Tara Lachapelle has noted, a lot of its brands are still boring, slow-growth, center-of-the-grocery-store products. There's a reason why Kraft Heinz Co. switched up its M&A playbook and why other consumer goods companies are thinking outside of the box.

Conagra will want to think carefully before jumping into another massive deal. Analyses from UBS Group AG and Jefferies estimate a takeover would boost the company's pro-forma net debt-to-Ebitda leverage to about 5 times, undoing a lot of its work over the past few years to improve its balance sheet and potentially hampering its ability to compete for other more attractive food deals for a while. A Pinnacle takeover would have been a lot more financially attractive a year ago when it was 55 percent cheaper, but Connolly was too busy trying to undo the damage wrought by his predecessor with the Ralcorp deal.

It would be wise to not make the same mistake again.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net