(Reuters) - If Wednesday’s 9 percent drop in General Mills Inc shares weren’t hard enough for the cereal maker’s shareholders to stomach, they may soon have another bitter pill to swallow as the company closes its purchase of pet food maker Blue Buffalo.
That’s because the $8 billion all-cash deal hinges in part on General Mills (GIS.N) raising $1 billion through a stock sale - an offering that will likely now be larger and more dilutive to shareholders and future earnings than before this week’s sell off.
The General Mills’ profit warning on Wednesday that gave the stock to its worst one-day performance in nine years was the latest leg down in a slide that began after the Cheerios cereal and Yoplait yogurt maker’s announced it would buy Blue Buffalo Pet Products Inc BUFF.O, a premium packaged pet food company. The stock has fallen about 15 percent since the deal was announced on Feb. 23.
“The timing of the miss is unfortunate for the company, which is going to issue secondary stock soon to help finance its acquisition of Blue Buffalo,” J.P. Morgan analyst Ken Goldman wrote in a note.
“It goes without saying that the lower the GIS stock price, the more shares need to be issued, and thus the greater the earnings per share dilution from the transaction.”
At the latest share price - around $45.30 on Thursday - General Mills would need to issue nearly 22 million shares to raise its targeted $1 billion of equity financing, up from around 19 million shares at the stock’s level shortly after the deal was announced, according to Reuters calculations. As of Feb. 25, General Mills had about 583 million shares outstanding on average.
“We believe this ‘reset’ in valuation for General Mills should have the company rethinking selling equity at this price. An equity offering near the current stock price is now about 2 cents more dilutive to EPS (earnings per share),” Stifel analyst Christopher Growe wrote in a note.
“We have not made any changes to the plans we laid out during the announcement of the acquisition on Feb. 23,” Bridget Christenson, a spokeswoman for General Mills said in an email.
To be sure, the deal does not hinge on issuing shares alone. It plans to pay for Blue Buffalo with a mix of new stock, cash on hand and debt, and it has lined up a bridge loan of up to $8.5 billion backed by Goldman Sachs that should allow it to close the deal by the end of its fiscal year end in May.
While the bridge financing might allow General Mills to bide its time waiting for its stock to recover before issuing new shares, analysts say that may not be so easy.
Higher transportation and rising commodity costs - the culprits behind the profit warning - mean the packaged food industry’s operating cash flows will continue to be pressured this year. Moreover, with retailers now significantly heaping more pressure on brands to innovate, they don’t expect food companies’ margins to improve.
At least six Wall Street brokerages cut their price targets on General Mills’ stock, citing the company’s forecast for slower than expected growth in adjusted earnings per share this fiscal year than previously anticipated.
UBS was the most bearish on the stock, cutting its price target by $10 to $48. Brokerages including Stifel and Citigroup cut their targets by between $6 and $9 a share.
General Mills shares were trading little changed Thursday, at around $45.50, a 7 percent discount to its median price target of $49.
Editing by Dan Burns