Kraft (KFT) is shedding big brand names like Post cereal in an effort to focus the big food company on other promising, growing brands.
In a complex deal announced Nov. 15, the Post business will be spun off and then merged with Ralcorp (RAH), primarily a maker of store-brand cereal and other food products. The new Ralcorp will sell Post's well-known brand names like Honey Bunches of Oats, Shredded Wheat, Grape Nuts and Pebbles cereals.
Though the deal values Post at about $2.9 billion, it's structured in a way that minimizes taxes, making it the equivalent of a $4 billion cash deal. Plus, in the all-stock deal, Kraft shareholders will get Ralcorp shares and end up owning 54% of the new company.
Kraft had already exited brands like Milk-Bone, Cream of Wheat and Minute Rice in a bid for — in one executive's words — "reliable growth."
Wall Street seemed to see big benefits to Ralcorp for the deal. Its stock was up more than 10% at midday on Nov. 15. Total sales at Ralcorp would increase 50% with the addition of Post to its product line-up, the company says. Profit margins on Post brands are much wider than Ralcorp's products, so earnings could be boosted even more.
"This is a transforming event for Ralcorp," co-chief executive and president Dave Skarie told analysts. The deal will better balance Ralcorp's businesses, and provide cash flow to make more acquisitions of brands, execs said.
Post Cereal, the third largest cereal maker in the country after Kellogg and General Mills, would represent 32% of the new company's sales.
For Kraft, the benefits are less clear. Kraft shares were down 1% on Nov. 15.
Deutsche Bank (DB) analyst Eric Katzman wrote it was "a positive move to further focus Kraft."
But D.A. Davidson analyst Timothy Ramey said he doesn't understand "why Kraft management devoted even five minutes of their time to consider this deal." The price isn't high enough, Ramey wrote, for Kraft to lose one of its most profitable business units. The deal "destroys value for Kraft shareholders," he wrote.
JP Morgan (JPM) analyst Pablo Zuanic has a different take, warning of possible problems for Ralcorp. It will have to spend more on advertising, the deal is not expected to generate big cost savings and Ralcorp must worry about holding onto Post's management team. But for Kraft, "the strategic benefits of increased focus ... should help" the stock's value.
Indeed, Kraft executives seem to be delivering on the restructuring they promised to shareholders earlier this year.
Kraft "assessed each of our businesses by category and by country based on their growth potential, relative market share and profitability," Kraft vice president Chris Baldwin said Nov. 15. "From that process, we decided that Post would have greater opportunity to realize its full potential under different ownership."
Kraft is so huge that there's a limit to how much damage a misguided Post deal can do. As Standard & Poor's analyst Tom Graves notes, Post makes up only about 3% of Kraft's huge sales revenue. The deal may hurt Kraft earnings per share, but shareholders will get the benefit of Ralcorp stock, he wrote in a Nov. 15 note.