General Mills Paid Silly Money for Pet Food
General Mills violated the cardinal (and counter-intuitive) rule of value investors: Don’t just do something, stand there. While most of us are inclined to the opposite, this wise advice—which turns the old adage on its head—is designed to prevent action for the sake of action. And action for the sake of action can have dangerous consequences. General Mills might have to learn the hard way after it bought Blue Buffalo Pet Products Inc., a fast-growing pet food company for an enterprise value of $8 billion.
Blue Buffalo has its charms. Just nothing worth the sum that General Mills paid for it in a deal that closed earlier this year. Since the deal was announced, the market has rendered its unsurprising verdict, incinerating more than $3 billion in market capitalization.
General Mills is not alone in its apparent desperation. Traditional, old-school food companies from Campbell’s Soup Co. on down have been making hasty, madcap acquisitions in a headlong desire to do something about their paltry growth rates. The results of their fear have not been pretty. Campbell’s recently leveraged itself to the precarious hilt borrowing over $5 billion to buy Snyder’s-Lance, maker of pretzels and chips. The result is a harrowing debt-to-EBITDA ratio of five times, which led to the review of the company’s credit rating by Moody’s and the departure of the CEO.
To examine the Blue Buffalo deal is to take a gander at the dark side of paying up: the intersection of desperation and pollyannaism.
No one can deny General Mills’ frantic need for growth. According to Morningstar, the cereal products company suffered a -2.4% five-year growth rate, as consumers have turned away from carbs. Such a sales result is scary and would prompt many CEOs to do almost anything to reverse the trend. But that’s when you need to take a deep breath and meditate for a minute, not pay a devil-may-care 6.3 times sales for a pet food maker. As a paleo-centric, protein-focused peddler of treats and food for dogs and cats, Blue Buffalo is trendy, well-positioned and understandably attractive—just not at over six times revenues. To give you an idea of how astounding that multiple is for a pet food company, J.M. Smucker paid 2.5 times sales for Big Heart Pet Brands, maker of Milk Bone and Meow Mix, in 2015. Big Heart is a traditional purveyor, so is not a perfect comparison. But General Mills is not paying a 10% or 20% premium to the Big Heart Multiple; rather, it’s paying more than double.
To add value, a company’s returns on capital must exceed its costs on that same capital. General Mills will have to make Blue Buffalo into even more of a wunderkind than it is to generate sufficient returns to justify the cost of money on $8 billion.
Multiples in tech acquisitions frequently reach the six times sales level but this is food, not software. By definition the food biz lacks scale, switching costs and all the attributes that make dominant tech players so appealing. The food business is always the food business no matter your growth rate. Sure, with Blue Buffalo wider distribution is promised. And possibly even synergies. But as Warren Buffett warns, “If the historical performance of target falls short of validating its acquisition, large ‘synergies’ will be forecast. Spreadsheets never disappoint.”
CEO Jeff Harmening is a talented executive, having reportedly spearheaded the acquisition of Annie’s in 2014 when he was not yet head of the company. But Annie’s was bought for $820 million on $204 million in sales. The multiple here is much higher, the stakes much larger. He has his work cut out for him.