We recently witnessed an unexpected bidding war over Hillshire Brands (NYSE:HSH). After a back and forth between Tyson Foods (NYSE:TSN) and Pilgrim’s Pride (NASDAQ:PPC), the latter company gave up, with the former willing out at $7.7 billion. At first, investors applauded the bidding war. As it was going on they were paying a premium for Hillshire Brands in anticipation of higher bids. They were also bidding up the prices of both Tyson Foods and Pilgrim’s Pride. When Tyson made its first counteroffer, the stock soared 7 percent that day, while Pilgrim’s Pride shares fell. Meanwhile, when Pilgrim’s Pride came back with a higher offer, investors sold off shares of Tyson Foods.
However, this pattern stopped when Tyson made its final bid for the company. The stock was down that day, and it fell the following day, as well. Since Tyson made the bid to end the bidding war, its shares are down from $40 each to about $36 each.
The thinking here is that Tyson simply went too far and overpaid for Hillshire Brands. On the surface, this makes sense. After all, Hillshire Brands is trading at about 35 times earnings, and the company has shown minimal signs of growth. But we have to keep in mind why a bidding war broke out in the first place. The large packaged food companies realized that they could save a lot of money by merging, and this adds intrinsic value to the acquired company from the perspective of the acquirer.
After Pilgrim’s Pride dropped out of the bidding war, leaving Tyson the victor, Tyson came out with a presentation in which it justifies the acquisition. In the presentation, we learn that the combined company will net savings in excess of $300 million per year once the integration is completed (this will take about three years). If we add $300 million to Hillshire Brands’ more than $200 million in net earnings for the trailing 12 months, $7.7 billion doesn’t seem like a high price to pay. This works out to about 15-16 times earnings, which is lower than the current multiple in the S&P 500.