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3 M&A Takeaways

Fri, 30 May 2014

Merger activity sizzles in the food business, Apple experiments with Beats, and Pfizer stays disciplined.


Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five: Morningstar's take on five stories from the market this week.

Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You are welcome, Jason.

Stipp: Up first this week, there were two firms vying for Hillshire, and there is another firm on the sideline. So what's the story? There's a lot of interest in this particular name.

Glaser: There really is. M&A activity in the food business is starting to pick up, and we are starting to see some consolidation, and people fighting for it.

This started off with Hillshire Brands saying that they were going to buy Pinnacle. The market kind of shrugged this news off. It didn't see a lot of potential synergies between Hillshire's mostly meat business and some of the vegetable businesses that Pinnacle Foods has.

But this week, first Pilgrim's Pride came out with a $45 a share unsolicited offer for all of Hillshire, contingent on Hillsire not doing the Pinnacle deal. And then Tyson on Thursday said that they were willing to pay $50 a share for Hillshire. In the market, Hillshire went above $50 a share, implying expectations that there are going to be some sweetened offers, as these deals are far from being over.

I think it is interesting to see that these companies are willing to pay a pretty substantial premium in order to get some consolidation. Part of that premium is going to be taken back in synergies--it won't look quite as rich when you combine supply chains and when you potentially have better negotiating power with retailers.

But still, this is a trend we are seeing in a couple of different industries. People are trying to get deals done, and I think it's something that people should be watching out for to make sure that these deals really do make sense.

Stipp: Apple this week sealed a deal to buy Beats. This is the biggest deal that Apple has done but not necessarily a big deal for the firm. But there are some interesting details here.

Glaser: Speaking of deals that may or may not make sense, Apple's purchase of Beats for $3 billion, a little bit less than had initially been rumored, was officially announced this week. Apple was saying that this gives the firm some great assets in terms of the founders of Beats being there to give us some better relationships. They get this hardware business that's growing pretty quickly. And in fact, Brian Colello, our Apple analyst, thinks that business alone might be able to justify the $3 billion price tag. You also get the streaming music business that could potentially fit into iTunes.

Yes, they could have probably done a lot of this in-house, but being able to just buy it all at once is maybe a way to kick-start that and to try something different for Apple. And if it doesn't work out, it's not the end of the world. We are talking about $3 per share of cash; they have $152 per share in cash right now. So there is plenty of room for Apple to do experiments like this without it necessarily betting the farm on Beats working out.

Stipp: Speaking of M&A, again: We had another deal this week, a deal that's not going to happen. Pfizer walked away from the AstraZeneca potential merger. What does this mean for shareholders of both firms.

Glaser: This one was a bit surprising. It really looked like this AstraZeneca deal would get done given the huge premium that Pfizer was willing to pay. They were willing to pay this not because they were irrational--again, they could get some good synergies out of it, the two companies were pretty good fits, and also the tax benefits from moving some of those taxable entities away would provide some savings and allow Pfizer to pay a little bit more.

But AstraZeneca was very firm with their "no," and I think it's a good sign for Pfizer shareholders that Pfizer wasn't willing to keep chasing them. They said OK--this is our sweetened offer, and if you are not going to take it, we are going to walk away from this. We are not going to keep paying more and more in order to get this done. I think that discipline is a good sign.

Like I mentioned in the first point, sometimes these M&A deals can be more about empire-building than about really creating better businesses. I think that discipline is a good sign. AstraZeneca probably passed up a way to realize a lot of value right away in this deal, and we'll see if that's the right choice for them.

Stipp: The government reported a negative GDP for the first quarter on Thursday. Bob Johnson, our director of economic analysis, says don't panic. But this certainly does throw cold water on the most optimistic among us.

Glaser: Coming into this year, there were some projections that we could see 4% GDP growth in 2014, that things were really lining up for the economy to do much, much better. That really seems to be off the table now.

We've seen that obviously not just with this data but also with the weather-related problems that we had throughout the first quarter, which have really slowed a lot of different parts of the economy.

But Bob Johnson points out that it's not just weather-related. There really are some [factors], if not underlying weaknesses, [suggesting that] the economy isn't quite ready to hit that escape velocity and get that rocking ship to take off yet. He is sticking with his 2%-2.5% full-year GDP number, which is maybe less than people were hoping, but it is a sign that we're still very much in this slow-growth world.

Stipp: Lastly, Hank Paulson and Tim Geithner appeared together at an event here in Chicago this week. You attended, and you said there were some interesting points about opportunity cost that might apply to investors.

Glaser: There were couple of interesting parts of the conversation, but one area that came up a few times was when Geithner talked about, and when he was justifying, the choices that he made during the financial crisis. He said it wasn't about coming up with some ideal solution or the best solution. It was about coming up with the least-bad solution. They had to look at the opportunities that actually were out there that were feasible to do, and those are the ones that they chose among.

I think that's a good lesson for investors today. There are not a lot of great options right now. Stocks obviously are fully valued, possibly overvalued in many cases. There are not a lot of big bargains there. Bonds obviously could have trouble in a rising rate environment. Cash isn't all that attractive. And it may be tempting just to say, I wish that there were some great investments out there that I can look for, and keep looking for, instead of really looking at what the actual feasible options are.

I think investors would be well served by diving into … well, if stocks are overvalued mostly, can I find an undervalued pocket? Can I find some high-quality names that are going to hold up? Maybe something with a good dividend yield. Think about it that way, and make those decisions, instead of staying on the sidelines indefinitely.

I thought that was a lesson you could draw from the crisis: It's important to make the choices amongst the actual opportunity set that you have, and not the ones that you wish you had.

Stipp: There is always a huge opportunity cost to missing The Friday Five. Jeremy, thanks for joining me again.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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