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.
But it gets better: Tyson is borrowing the money it needs to acquire Hillshire Brands. With interest rates so low, this will cost very little, and provided that the combined company’s earnings remain consistent or rise, it should have little trouble paying the interest, while excess income can be used to pay down debt.
Thus, in many ways, Tyson has taken on a large carry trade, which is a trade put on by an institution that wants to buy a higher-yielding asset (Hillshire Brands) against a short position in a lower-yielding asset (Tyson is essentially “short” its own debt) in the hopes of pocketing the difference and making a profit.
While it is a little risky, this could wind up paying off tremendously for Tyson shareholders.
Consequently, I think the ongoing selloff is short-sighted, and for investors who don’t mind owning an asset with some leverage (the combined company will have nearly $11 billion in debt versus nearly $15 billion in assets and about $1.3 billion in earnings), the stock is worth buying at $36 per share.
Disclosure: Ben Kramer-Miller has no position in Tyson Foods or in any of the stocks mentioned in this article.