General Mills betting big on the bunny

by Eric Schroeder
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When General Mills, Inc. announced its intent to acquire Annie’s, Inc. in a deal valued at approximately $820 million, the Minneapolis-based company known for its Big G ready-to-eat cereals and Progresso soups sent a clear message: We believe in natural and organic foods.

General Mills’ offer of $46 per share represented a 37% premium above Annie’s closing price prior to the announcement, a 65% increase over the company’s 52-week low, and a 142% premium to the $19 per share price that Annie’s set as its initial public offering back in March 2012.

Operating in three categories — meals, snacks and dressings, condiments and others — Annie’s offers 145 different products, including macaroni and cheese, frozen pizza, cookies, crackers, pretzels, graham crackers and granola bars. In its fiscal year ended March 31, 2014, Annie’s had net income of $15,289,000 on sales of $204,104,000. As recently as fiscal 2010, the company’s annual sales were less than $100 million.

The acquisition shouldn’t come as a surprise, as General Mills had given signs that it was looking to inject life into its organic and natural foods businesses. In June, the company promoted Liz Nordlie to president of Small Planet Foods, a unit of General Mills that makes products under the Cascadian Farm, Muir Glen, Larabar and Food Should Taste Good brands.

Ken Powell, chairman and chief executive officer of General Mills, said during a June 25 conference call with analysts that Ms. Nordlie’s promotion was one of several organizational moves made in search of “greater focus, greater prioritization, more fluid allocation of resources.”

The company’s allocation of resources toward natural and organic foods has been more the tortoise and less the hare, but that may be changing. It’s been nearly 15 years since General Mills acquired Small Planet Foods, citing the sharp growth rate in the organic foods industry as a reason behind the move. Steve Sanger, General Mills’ c.e.o. at the time, trumpeted Small Planet’s “great tasting products” and “well-developed sales and distribution relationships with natural and organic food retailers” as a reason behind the transaction.

The company added the all-natural Larabar brand to the Small Planet Foods portfolio in 2008 and, in 2012, purchased Food Should Taste Good, making it a player in 14 categories in the natural and organic segment. In the fiscal year ended May 25, net sales for General Mills’ natural and organics products portfolio totaled approximately $330 million. Bringing Annie’s on board will provide a significant boost to the business, company executives said.

“The acquisition of Annie’s will significantly expand our presence in the U.S. branded, organic and natural food industry, where sales have been growing at a 12% compound rate over the last 10 years,” Mr. Powell said during a Sept. 17 conference call with analysts to discuss first-quarter results. “Annie’s competes in a number of attractive food categories, with particular strength in convenient meals and snacks — two of General Mills’ priority platforms. Consumers know and trust Annie’s purpose driven culture and authentic brand.

“We believe that combining the Annie’s product portfolio and go-to-market capabilities with the General Mills’ supply chain, sales and marketing resources will accelerate the growth of our organic and natural food business.”

Adding scale to Annie’s

Asked to assess the opportunities for Annie’s, Mr. Powell began his response by calling the company “a terrific equity.”

“It’s a unique equity in that organic space — it’s an all family equity,” he said. “It’s moms buying organic products for herself and for her family and the kids, which is a very attractive positioning within the organic space. As you know, they’ve had consistent very strong growth, and we think that the brand is very flexible and very expandable, given that broad positioning and gatekeeper target. So we really like the positioning. And the reason we bought it is because of that flexibility and the growth opportunity.”

Mr. Powell said he also sees business model opportunities that may arise from the combination of the businesses.

“First of all, we just have more sales force capacity that we can bring to Annie’s, and that means that we’re very confident that we can continue to increase the distribution of those brands,” he said. “And that’s a good opportunity for us. There are numerous margin expansion opportunities with Annie’s. Everything from the sourcing, and how ingredients are brought in, to the logistics, and how we reach customers. All of the other internal supply chain H.M.M. (Holistic Margin Management) things. We think there are many opportunities here, and we’ve actually jointly discussed these opportunities with Annie’s management. And they’re quite excited by those opportunities. And then again, there will just be some cost savings that we can capture as the corporate entity Annie’s becomes part of General Mills.”

When it comes to positioning Annie’s in the marketplace, Mr. Powell said General Mills will look to its past experiences in the natural and organic category.

“We learned that lesson about 15 years ago when we first acquired Small Planet Foods,” Mr. Powell said. “We have learned a tremendous amount from these various natural and organic companies that we’ve acquired over the years. We’ve been very good I think about leaving them alone. Let them do their thing. We’ll retain Annie’s headquarters in Berkeley (Calif.). These are very talented people. They’ve built a really good brand. And the key is, just to figure out where we have capabilities that can really help them and bring them those capabilities, which they’re actually eager to have, to accelerate the growth of this thing.”

General Mills said it intends to fund the acquisition through available credit, and was expected to launch a tender offer by Sept. 23 to purchase all outstanding shares of Annie’s.

The board of directors of Annie’s unanimously has recommended that stockholders accept the General Mills offer, noting the acquisition will enable Annie’s to enter a new phase of growth and success while maximizing value for stockholders.

“We are excited about this strategic combination, which will enable Annie’s to expand the reach and breadth of our high quality, great tasting organic and natural products, provide new opportunities for our employees, realize greater efficiencies in our operations, and maximize value for our stockholders,” said John Foraker, chief executive officer of Annie’s. “Powerful consumer shifts toward products with simple, organic and natural ingredients from companies that share consumers’ core values show no signs of letting up. Partnering with a company of General Mills’ scale and resources will strengthen our position at the forefront of this trend, enabling us to more rapidly and efficiently expand into new channels and product lines in a rapidly evolving industry environment.”

Mr. Foraker said Annie’s will remain dedicated to its mission: “to cultivate a healthier and happier world by spreading goodness through nourishing foods, honest words and conduct that is considerate and forever kind to the planet. Authentic roots, great tasting products, high quality organic and natural ingredients, and sustainable business practices will continue to be the cornerstones of the Annie’s brand.”

Market reaction

The pending acquisition underscores the growing profitability and popularity of natural and organic products. For Annie’s, the move will allow the company to leverage General Mills’ resources to strengthen its position in the natural and organic foods market.

“Looking ahead, the acquisition will ideally translate into Annie’s quickly expanding into new channels and product lines, an endeavor that would only further drive growth in an already booming food industry segment,” said David Sprinkle, research director for market research firm Packaged Facts.

According to Packaged Facts, retail sales of natural and organic foods and beverages in the United States are approximately $54 billion, up 53% from five years ago. That total is expected to grow by 62% between 2014 and 2019, with total annual sales increasing to $87 billion in 2019, the research firm said.

“Packaged and prepared foods such as those produced by Annie’s are expected to account for about 10% of the market’s sales,” Packaged Facts said. “It will be interesting to see how the company utilizes its newfound association with General Mills to potentially introduce new products that could drive sales of packaged and prepared natural and organic foods over the next several years.”

General Mills’ decision to acquire Annie’s drew wide ranging response from the investment community.

David Palmer, an analyst with New York-based RBC Capital Markets, L.L.C., said in a Sept. 8 research note he believes the deal “makes a lot of sense for Mills given significant upside to revenue and margins.”

“Annie’s has the potential to be a $1 billion brand, in our view,” Mr. Palmer wrote. “This is many multiples larger than today’s $200 million in sales. Our survey work shows that it has tremendous brand appeal to millennial moms. It has proven to be a flexible brand with appeal in a variety of snack and meal categories.

“General Mills has the top-rated sales and in-store marketing capabilities in U.S. food and can bolster Annie’s distribution. In addition, Mills is a huge player in snacks and meals — yet it does not have awkward overlaps with Annie’s as Kraft or Campbell’s Pepperidge Farm would have. In our view, General Mills’ challenge over time will be to use its strengths to complete Annie’s journey to becoming a power brand while not compromising its values and strong brand appeal.”

Matthew Grainger, an analyst with Morgan Stanley Research North America, New York, described the transaction as “strategically sound and modestly accretive” to both the top-line and earnings per share, but added he sees stock upside as “limited by the lofty multiple.” At a 22x EBITDA multiple, Mr. Grainger said the acquisition of Annie’s is at the high end of publicly-disclosed food transactions in recent years. By comparison, Kraft’s acquisition of Cadbury was 13x EBITDA, Campbell’s acquisition of Bolthouse was 9.5x and Ralcorp’s acquisition of Post was 9x.

He added that he sees the acquisition having a positive read-through to other growth names in the U.S. food industry.

“The acquisition is noteworthy not only for the peak valuation (albeit on a uniquely high-growth, small-scale asset), but also for the willingness of Mills (a growth-challenged but historically conservative company) to invest more aggressively in portfolio transformation,” he wrote. “We would expect the strongest positive market read-through in other natural/organic U.S. food names such as (WhiteWave), (Hain) and (Boulder), while (Mead Johnson / Hershey) may also receive a more modest boost.”

Robert Moskow, an analyst with Credit Suisse, New York, offered a more cautious outlook on the transaction, writing in a Sept. 8 research note that supply chain integration and portfolio rationalization will be important.

“General Mills will need to improve Annie’s gross margin structure to justify the big price they are paying,” Mr. Moskow wrote. “Annie’s utilizes a complicated network of co-packers for the majority of its business, and it has been having trouble procuring organic durum wheat ever since new entrants in macaroni and cheese entered the market. In addition, with the Annie’s brand now spread so thinly and in so many different directions, we wouldn’t be surprised if General Mills ends up needing to rationalize the portfolio in the first year.”
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