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Kellogg's split may create some opportunities

07/01/2022 | 06:15am

Management and shareholders of Kellogg's have long argued that their group's market capitalization remained chronically undervalued in relation to the sum of its parts. To address these concerns, CEO Steve Cahillane just announced that the group will break itself up into three separate listed entities.

The purpose of these transactions is to unlock the actual value of Kellogg's portfolio by having its different assets either sold or independently valued via "pure play", public standalone companies. The tax-free spinoffs are expected to be completed by the end of next year.

Kellogg said that spinning off the companies will "better position each business to unlock its full potential," following the company's many acquisitions in the past few years. It added that focusing the new companies will contribute to their growth with "financial targets that best fit their own markets and opportunities."

A decade of frustration

The split-up may create a compelling opportunity for both hungry private equity firms and public markets investors, in particular if indiscriminate selling pressure from former shareholders of the consolidated group drives down the prices of the new separate entities.

Kellogg's and packaged food companies in general used to evangelize investors into believing that sprawling portfolios created marketing and distribution synergies. However, performance for a wide panoply of brands were often disparate and underperforming assets were weighting heavily on valuation multiples. After a decade a frustration, that called for a dramatic reorganization — in effect a break-up.

The largest and higher-growth unit, dubbed Global Snacking Co, does $11.4bn in sales, which represents 81% of Kellogg's current revenue, and $2bn in Ebitda (87% of its consolidated Ebitda). Half of sales comes from the U.S. with a portfolio that includes staple brands such as Pringles and Pop-Tarts. The idea is to re-rate this "RemainCo" to trade in line with a direct comparable such as Mondelez. At x15 Ebitda – which is slightly below Mondelez's multiple - RemainCo would be worth $30bn.

Nothing to get excited, yet

The first spin-off is North America Cereal Co. Its sales reaches $2.4bn, while Ebitda comes in at $250 million. The entity includes blockbuster brands such as Corn Flakes, Special K, Pops and Rice Krispies — all solidly entrenched despite stagnating sales. Direct comparables like Post Holdings and General Mills trade at x14 Ebitda. That would fetch a valuation of about $3.5bn for Kellogg's North America Cereal Co.

The second spin-off is Plant Co, a plant-based foods company anchored by MorningStar Farms. This is the smallest unit of the bunch - it does only $340mil in sales - but generates $50mil in Ebitda whereas competitors have yet to reach operating profitability. Peers trade between x2 and x4 revenue depending on whether they're based in the U.S. or in Europe. Splitting this down the middle, a x3 revenue multiple would value Plant Co at $1.2n.

Putting it all together, the sum of these parts gives a "fair" enterprise value of $34.7bn. That is, less the $7.7bn in net debt, including pension obligations, a net value of $27bn. Divided by 338 million shares outstanding, we get a fair value of $80 per share vs. the current share price of $70.

The discount is yet too light to get us excited, especially given the fair amount of time (up to 18 months) before the separation gets consummated. But it's good to keep the above numbers in mind, just in case — a broader market dislocation over the next months, for instance, could create a highly compelling special situation and investment opportunity.


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