And the Winner is…TSN’s Bankers?

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In news that appears to put an end to the saga of Hillshire Farms (HSH), TSN has emerged as the “winning” bidder with a $63 per share offer.

o   This implies a 15.7x multiple of EV to TTM EBITDA, rarefied air, to be sure, though the multiple does, of course, back off when we consider potential synergies;

o   In our prior report, we suggested that TSN would be foolish to continue to pursue HSH, but also acknowledged a 20% chance that the company would remain engaged in the process (it follows that, via the transitive property, we were placing a 20% probability on TSN management being foolish).

Our thinking was that the asset would end up with PPC – it appears that we underestimated a number of factors in our analysis, including:

o   The attractiveness of HSH;

o   TSN’s definition of “critical” and perhaps the associated level of desperation;

o   And overestimated JBS’ desire for empire building at any cost

TSN’s pro forma debt/EBITDA will sit at an uncomfortable 3.76x – keep in mind that the company has suggested 3.0x as an upper bound;

o   In order to move that ratio to the more comfortable level suggested by management, TSN will almost certainly have to offer shares to the market – a little over $2 billion worth to get the debt/EBITDA ratio back down to 3.0x – that is another 50 million shares (assuming a price of $40 per share);

o   Recognizing that TSN’s business is largely cyclical, management may (and we think should) prefer a more substantial margin for error and take the opportunity to decrease its leverage even further.  To move to 2.75x debt/EBITDA, TSN will have to offer 66 million shares to the market (assuming a share price of $40 per share), or nearly 19% of current shares outstanding.  An offering of this size will effectively wipe out any pre-synergy EPS accretion associated with the transaction.

TSN management has done a commendable job over the past several years, improving operations along with the company’s balance sheet, as well as more recently benefitting from the windfall associated with lower feed prices.  These efforts/circumstances put TSN in a position to use its balance sheet in very aggressive fashion.

o   While we acknowledge the strategic rationale behind this acquisition, we expect that TSN will struggle to justify the price paid, and in the process may have squandered the efforts of several years of the company’s past, along with some of its future.  We were negative on TSN prior to this transaction due to our concerns about where we were in the protein cycle (those concerns remains) and we are now concerned a once in a decade opportunity (TSN’s profitability and balance sheet) were spent on something other than a once in a decade asset.

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