By Brad Dorfman - Analysis
CHICAGO (Reuters) - Risk arbitrageurs looking to make a quick buck shorted shares of baby-formula maker Mead Johnson Nutrition Inc MJN.N in December, opening the door for some hedge fund investors with larger and longer-term gains in mind.
Shares of the Enfamil formula maker were one of the most popular new additions to the portfolios of 30 of the largest equity-oriented hedge funds in the fourth quarter. Among them are John Paulson’s Paulson & Co Inc, Lee Ainslie’s Maverick Capital Ltd and Stephen Mandel’s Lone Pine Capital LLC.
For the long-term player, Mead represents one of the strongest bets on population growth in emerging markets, shows commitment to its dividend and makes a possible takeover target for a global food maker.
Mead went public last February in a 30-million share initial public offering spun out of pharmaceuticals company Bristol-Myers Squibb Co (BMY.N).
But Bristol-Myers held on to an 83 percent stake, leaving Mead with a sizable market capitalization of almost $5 billion, but a relatively paltry public float. The small float hampers trading volume and increases an investor’s risk in building a large position.
In December, Bristol-Myers completed the spin-off, dumping the rest of its shares through a complex exchange offer completed on December 23. Arbs made their profits by buying Bristol-Myers shares and shorting Mead for the month until the deal was done. Then they closed out the trade with new shares of Mead issued at a discount.
The short-term win for the arbs could also be a long-term win for other funds. The transactions temporarily depressed Mead’s share price even as the exchange deal dramatically increased the company’s float.
That opened the door for Paulson and his “smart money” cohorts, who are also betting on the global focus of Mead’s London-born CEO Stephen Golsby. The funds did not return calls for comment.
“I get more calls on this stock than any other because it has that perfect story of emerging markets growth and it’s a good takeout candidate,” Credit Suisse food analyst Robert Moskow said. “It’s a growth story and I don’t have a lot of growth stories in my coverage space.”
He rates the stock “outperform.”
The management team “exudes respect” for the company’s role in providing infant nutrition, said D.A. Davidson analyst Tim Ramey. “I want to trust them with my baby,” Davidson said.
Ramey rates Mead “neutral” because of the stock’s lofty price, which may be inflated by takeover speculation.
Takeover talk surrounding Mead Johnson, the only “pure play” stock in the infant formula market, centers on global food makers looking for an edge in emerging markets, such as Danone (DANO.PA), Nestle NESN.VX or H.J. Heinz Co HNZ.N.
That speculation has helped drive up Mead Johnson’s price, giving it a multiple of about 20 times estimated 2010 earnings, well above the 14-times multiple of the Dow Jones U.S. Food Producers Index .DJUSFO, of which it is a component.
The $2.83 billion company gets about two-thirds of its sales outside the United States and its Enfamil brand was the global leader with 11.7 percent of the $22.3 billion baby formula market in 2008, the last year a ranking is available, according to Euromonitor International.
The company is gaining market share in China and is also in a host of other emerging markets, including Thailand, Malaysia, Indonesia and Vietnam. It is starting to move into India.
Formula is used much less widely in emerging markets than in the United States. In China, children ages 0 to 3 years consume about 8.8 kilograms of formula a year, according to Euromonitor International. In India, that figure is only 0.4 kilograms, while in Brazil it is 1.6 kilograms. That compares with 12.9 kilograms in the United States.
But with that emerging market exposure comes attendant risks. The company was hit, for example, by the Venezuelan currency devaluation last year.
Still, Mead Johnson’s biggest risk may be at home. The Glenview, Illinois-based company been losing share in a U.S. market where the declining birth rate has hurt sales. The company also lost some state contracts to provide formula to lower-income families, analysts note.
“You can’t justify a premium multiple if you’re unable to stabilize your home market,” Credit Suisse’s Moskow said.
Golsby said during a recent conference call with analysts that he expects the U.S. birth rate to eventually stabilize.
“I remain confident that families have only postponed their plans to have children and that the birthrate will pick up as the economy improves,” Golsby said.
Mead Johnson had $561.1 million in cash on its balance sheet on December 31 and management said its board would consider raising the company’s dividend in March.
“Returning the cash to shareholders through dividend increases I think is probably the highest priority right now but you will probably see us announce a share repurchase program,” Pete Leemputte, chief financial officer, said during the conference call.
Both moves should keep the company popular with its new hedge fund investors.
Reporting by Brad Dorfman. Editing by Robert MacMillan