Rush is on to get takeovers wrapped up
Merger mania is sweeping Wall Street once again, underscored by the bid from top management of RJR Nabisco Inc. to buy the giant food and tobacco company for $75 a share, or $16.9 billion, potentially the largest corporate acquisition ever. For the week ended Oct. 21, the Dow Jones industrial average closed up 50.32 points, at 2,183.50. But the RJR Nabisco deal, which rocked the investment community last week, is only the latest in a series of acquisition efforts involving consumer food companies. The Philip Morris Companies has offered $11.1 billion for Kraft Inc. Grand Metropolitan PLC, a British beverage and food company, wants to buy Pillsbury Company at a cost of $5.23 billion - an effort Pillsbury has rejected. Tyson Foods, meanwhile, has offered $900 million for Holly Farms Corporation.
``There's a feeling on the market that companies had better get their takeovers wrapped up now,'' says Hildegaard Zagorski, a market analyst with Prudential-Bache Securities. Part of the reason is political, Ms. Zagorski says. Neither a Bush nor a Dukakis administration is expected to be as tolerant of mergers as the Reagan administration has been. But part of the current takeover activity - linked as it is to consumer food companies - is cyclical, related to underlying market factors, Zagorski says. Food companies, with their steady cash flows and consumer loyalty to brand names, are particularly attractive in periods of market uncertainty, such as is now the case.
The merger-and-acquisition fervor in the food area is ``sweeping up from retail stores all the way to the top, to big companies like RJR Nabisco,'' says Charles Lemonides, an analyst with Gruntal & Co. In the middle of last week, following the bid by Philip Morris for Kraft, Mr. Lemonides was asking people what might be next. If Kraft could be taken over, he said, ``anyone is fair game.'' So when the RJR Nabisco leveraged-buyout offer came late in the week, Lemonides was only less surprised than most.
The RJR Nabisco LBO would surpass all previous corporate mergers and takeovers, including the largest one now on record, the acquisition of Gulf Corporation by Chevron Corporation in 1984, at a cost of $13.3 billion. The largest leveraged buyout recorded was the buyout of Beatrice Foods by Kohlberg, Kravis, Roberts & Co., in 1985, at a cost of $6.1 billion. Under a leveraged buyout, shareholders are paid off with cash borrowed against the value of the company's assets.
What the management of RJR Nabisco has on its hands is a ``huge earnings cow,'' says Lemonides of Gruntal. In addition to its tobacco products, such as Winston, Salem, and Camel cigarettes, the company produces a wide range of food items, including Oreo cookies, Ritz crackers, LifeSavers, Planters nuts, Cream of Wheat, and Del Monte canned goods.
Assuming the management group is successful in buying out the company - and thus taking it private - it would probably sell off the food sector as quickly as possible, Lemonides says. ``The cash flow from the tobacco sector is much greater than the cash flow from food sales,'' he notes.
Two-thirds of the operating income comes from tobacco, rather than food. That means, he says, that if the actual final LBO cost is about $95 a share, or a total cost of $28 billion - an amount Lemonides finds more realistic than the $75 a share offered last week - the management group could sell off the food sector for about $16 billion. But that means that it would be able to acquire the profitable tobacco sector for about $11 billion, or roughly five times the cash flow from tobacco, which is about $2 billion. That, he reckons, would be ``a very successful acquisition.''
Going private at this time ``would give management much greater control over the future direction of the company,'' says Marshall Blume, a professor of finance at the Wharton School of Business. ``Some people within the corporate structure might well lose their jobs'' during a subsequent reorganization, says Mr. Blume. But on the other hand, he says, top management would be better able to focus on ``long-range policies,'' rather than having to satisfy shareholders eager for quick and profitable results on a month-to-month basis.
One question being asked here last week was whether the takeover bid by RJR Nabisco management might somehow be a ruse, designed to lure other potential buyers into courting the stock of the tobacco/food giant. Most analysts see the stock as undervalued. Following the LBO offer the stock soared 21 to 77 on Thursday. Yet, before that upsurge, RJR stock was selling at about 11 times earnings, far less than the earnings ratios of many non-tobacco food companies.
``The company is just very valuable,'' says Ron Morrow, an analyst with Smith Barney, Harris Upham & Co. Mr. Morrow sees no reason to doubt that the group headed by RJR Nabisco chief executive F.Ross Johnson is anything other than eager to go ahead with the buyout. ``They have the best food company that a tobacco company owns. It's a huge generator of cash.''
``The one thing that all of these mergers now seem to have in common is the search for a recession-resistant cash flow,'' says Charles Cerankosky, an analyst with Prescott, Ball & Turben Inc., in Cleveland. Mr. Cerankosky, a food specialist, notes that such major retail giants as Kroger and A&P have recently been linked to either attempted hostile takeovers (in Kroger's case), or acquisitions (for A&P).
Cerankosky does not believe the current merger activity will necessarily lead to greater concentration within the food industry, or a lessening of product innovation, as has been feared. Independent retail chains continue to flourish, he notes. And even many large producers such as Kellogg continue to be highly innovative, he notes, while smaller, regional producers are introducing new products.