BANGALORE Investors in Ralcorp Holdings RAH.N, who have pushed up the stock price on hopes of a deal, may have overreached as twice-rebuffed suitor ConAgra Foods (CAG.N) looks increasingly unlikely to sweeten its $86 a share takeover bid.
Ralcorp is instead expected to go ahead and spin off its Post cereals business in a move some shareholders and analysts say is worth a lot less, relatively, than selling the whole company.
The spin-off plan for the No.3 U.S. cereal brand, announced last month, was seen by some as a tactic by Ralcorp to force ConAgra to raise its offer or tease out other bids for a company that primarily serves up cheaper pasta and cereals for stores to brand as their own.
If that was the plan, it hasn't worked, yet.
A source familiar with the situation said ConAgra, whose brands include Hunt's ketchup, Chef Boyardee pasta and Pam cooking spray, was not keen to raise its $4.9 billion offer and no higher bid was imminent. The source declined to be identified due to the sensitivity of the matter.
Ralcorp shares, which have risen by nearly a quarter since ConAgra's interest was first reported, now trade at around $78, some way below ConAgra's $86-a-share offer. They have lost about $9 this week.
Cambiar Investors LLC sold its 1.8 million-share stake in Ralcorp in May, reckoning Ralcorp management would not pursue a sale of the company, and would in any case not manage to get a substantially higher price than its current trading levels.
"We got the impression they weren't going to go quietly ... that they wanted to hang on and they like life as it is for them," Cambiar President Brian Barish said.
ADMISSION OF DEFEAT
Post's proposed spin-off, less than four years after Ralcorp bought the business for $1.65 billion, seems like an admission by the company that the acquisition didn't quite fit with its core private label business.
Another source familiar with the situation, who also asked not to be named, said Ralcorp's board knew within 9 months of buying Post that the market was pricing its stock at a discount.
The board considered alternatives, but ruled out a Post sale due to the massive tax liability involved, and decided a spin-off was the most feasible option to unlock value, the source said.
"The Post acquisition will ultimately prove to be a value-destroying investment for Ralcorp shareholders," said Morningstar analyst Erin Lash.
"For shareholders to break even on the deal, Post would need to garner 9.5 times adjusted EBITDA, which seems rich for a third-tier brand in a highly competitive category," Lash said.
Edward Jones analyst Jack Russo estimates that Post rivals Kellogg's (K.N) and General Mills (GIS.N) trade at around 9 times EV/EBITDA, and believes Post should sell at a discount as it has surrendered market share and has less brand power.
Wall Street is divided on how much value a Post spin-off can unlock, even in the long term.
"The market applies a discount to Ralcorp due to execution risks related to the Post business," said Scot Harrison, senior analyst at Argent Capital Management LLC, which holds Ralcorp shares. "A split would take that risk out."
Harrison said Post would be attractive to a company that can spend more on marketing to drive sales, as the business has healthy margins and strong cash flow.
However, in the short term, he still expects Ralcorp shares to fall to the high $60s-low $70s, in the absence of a deal.
Michael Goodman, senior analyst at Corbyn Investment Management, another Ralcorp investor, agreed that Post and the private label business, either together or separately, are not worth more than the mid-$70s a share, based on industry projections.
Last month, Ralcorp cut its annual earnings outlook, as it can't push through price cuts big enough to offset rising input costs, echoing comments by rival Treehouse Foods (THS.N).
In June, ConAgra also said its quarterly profit would be hurt by rising costs.
Still, BB&T Capital Markets analyst Heather Jones said a split should attract additional bidders, who may only be interested in either the private label or branded businesses, separately.
Jones estimates the private label part of Ralcorp can fetch an estimated 9-9.5 times EBITDA, and Post about 8 times, suggesting a total post-split value of $85-$90 a share.
Post could interest private equity. Last November, a group led by Kohlberg Kravis Roberts & Co (KKR.N) snapped up Del Monte Foods Co, which makes Meow Mix cat food, in a deal worth about $4 billion.
Ralcorp is due to report its April-June third-quarter earnings on Tuesday.
(Reporting by Mihir Dalal in Bangalore, Jessica Hall in Philadelphia and Martinne Geller in New York, Editing by Ian Geoghegan)