Ralcorp's acquisition of Sara Lee's refrigerated dough business and stock impact

¶ … Ralcorp Holdings, Inc.'s proposed an acquisition of Sara Lee Corp on its stock price. This paper is done with a buy decision for Ralcorp Holdings stock in mind. The sell recommendation in relation to the content of the news article titled "Ralcorp Holdings to Purchase Sara Lee's Private Brand Refrigerated Dough Business." This is done with the necessary theories of mergers and acquisition in mind as well as with relevant calculations and support documentation. The goal is to determine what the content of the news article means for the investment merits of the stock by evaluating how the event covered in the article have a positive, negative or neutral effect on the stock price. This paper also explains how this affects my investment recommendation.

Introduction

Some time back, Ralcorp Holdings, Inc. indicated that it had acquired the Sara Lee Corp., a North American private brand refrigerated dough business at close to $545 million (Earnst & Young, 2011, p.2). This transaction represented an enterprise value of close to eight times the EBITDA, tax benefits as well as pre-synergies. Sara Lee's refrigerated dough business is both a manufacturer and distributor of a wide range of private brand refrigerated dough products throughout the U.S. The acquisition was expected to increase the value of the corporation on a GAAP basis by more than $0.30 per share in the initial year with an inclusion of synergies but while excluding the expenses associated with the acquisition. On a cash basis, the corporation expected an accretion of $0.50 per share in the initial year. The acquisition was expected to improve the rate of cash flow at Ralcorp while also generating various operational synergies of between $6 million to $8 million after the 3rd year post-closing while excluding the one time costs of transition. As indicated in speech made by Mr. Kevin J. Hunt, the Co-CEO and President of Ralcorp, the transaction was noted to have catapulted Ralcorp to be a private-brand leader in the close to $1.8 billion value refrigerated dough category. Sara Lee's higher margins as well as free cash flow were also expected to lead to a creation of significant value to the company's stocks. A trend analysis indicated that the percentage impact of this transaction could be more significant after the expected Post Foods separation that would ultimately lead to the reduction of the private-brand earnings base. The high quality of Sara Lee's business coupled with the attractive financial markets, tax attributes as well as synergy potential of this given transaction would mean that this acquisition represented a continuation in Ralcorp's strategy of improving shareholder value via private-brand acquisitions (Ralcorp,2010).

Improving stock value through private-brand acquisitions

Acquisitions are noted to be important contributors to a company's growth strategy (Pope et al., 2008).There are several strategic reasons for firms pursuing an acquisition growth strategy. The work of Pope et al. (2008) identified several successful acquisition cases that involved gains to shareholder value. There are however cases whereby the outcome is disappointing due to an invalid strategic rationale or by several post-acquisition problems as well as issues. Several firms are therefore very careful while implementing their acquisition plans. A focus on a customer-written plan of acquisition can effectively help companies that are seeking more strategic approaches to their acquisitions.

In order to evaluate the impact of acquisition on stock value, it is important to examine the impact of the acquisition on the accounting performance. Several studies report an improvement in the level of profitability. The short-term reactions to the acquisition process are often positive. The long-run shareholder value is however shown to be negative in some of the cases. There is a claim that the very methodology that is employed to measure the long run share returns is never reliable. Takeovers are also noted to create value in terms of gains to short-term share prices and profits as noted by Andrade, Mitchell and Stafford (2001).

On the contrary, Tichy (2002) noted that the long run negative share returns is a reflection of the overvaluation of the takeovers at the very time of announcements. This is noted to lead to losses as well as a destruction of the shareholder value.

From the financial perspective, the key question to be asked is whether the present value of the financial benefits of the acquisition to Ralcorp would be greater that the present value of the costs of acquisition with an inclusion of the initial investment. The main issue should therefore to determine if the marginal value of acquisition is less or greater that the marginal cost. In this case, a buy decision would be appropriate since the marginal value of the acquisition would be greater in the long run than the marginal cost of the acquisition. While making the buy decision, it is critical to consider the residual income that is left after the acquisition (Feltham and Ohlson, 1995).The events described in the news article titled "Ralcorp Holdings to Purchase Sara Lee's Private Brand Refrigerated Dough Business" has a positive effect on the stock price. This is due to the financial gains and other synergies that are associated with the strategic private-brand acquisition.

Why investors should sell Ralcorp Holding's stocks

S

The sell decision is informed by the outcome of sentiments analysis, fundamental analysis as well as technical analysis.

Sentiment analysis

Sentiment analysis involves the analysis of the opinions/sentiments of industry observers in an effort of predicting the future performance of a given industry or stock. A sentiment analysis of the global food demand indicates a general increase in the price of foodstuff. This is due to the very strong link existing between global food price and commodity speculation (Keim,2012). A World Bank report indicates that the global food price is on the rise again (World Bank,2012).This coupled by the ever rising demand of food as a result of population increase is bound to make Ralcorp stock prices to increase constantly.

Technical analysis

A technical analysis attempts to accurately predict the future market price of a corporation's stock on the basis of the historical stock price performance as well as the overall trend of the stock market. A technical analysis of Ralcorp stock prices indicates a weak financial future. This is evident from the historical data of ROE. In December of 2011,it was -6.74%.It then rose to a high of 26.43% in March,2008.It has from that time seen a gradual decrease to -6.75% in December,2011.At the moment it is at -11.25% when the industry average is 21.68%. The return on investment (ROI) also indicates a losing trend. Currently, it stands at -5.26% when the industry average is 14.26% (Reuters,2012).See chart 2 at the appendix

Conclusion

The best thing to do is for the shareholders at Ralcorp to sell/dump their shares as quick as possible and then buy them later should the trend change in the future. This is as indicated by the fundamental and technical analysis outcomes.