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Thursday, 23 October 2014

Less Froot, fewer Loops

Kellogg rescues P&G from over-cleverness

“Half the cleverness, none of the risk” makes an apt cereal-box slogan for Procter & Gamble’s sale of Pringles to Corn Flakes-to-Froot Loops giant Kellogg. By offloading the chips business for $2.7 billion in cash, P&G swaps a complex structure that, while it would have saved on payments to the tax man, put the consumer giant’s corporate finance competencies to a severe test.

And what may be P&G’s loss looks like Kellogg’s gain. While the cereals group is plunking down 15 percent more in cash than Diamond Foods had originally agreed to pay in new stock, the accompanying cost savings more than justify the premium. In a nutshell, this is a reasonable outcome, not least because P&G emerges with a valuable lesson the rest of Corporate America would be wise to observe.

The Kellogg deal makes it easy to see why P&G was tempted by a more complex transaction with Diamond last year. After paying taxes of as much as 48 percent of the value of the deal, P&G will bring in as little as $1.4 billion from the Pringles sale. Accepting a lower offer of $2.35 billion from Diamond would have avoided handing over a big slice of shareholders’ booty in the form of capital gains. Rather than the earnings per share gain of as much as 65 cents it predicted from the Diamond deal, P&G predicts it will reap a 50 cents-a-share gain from the Kellogg arrangement.

As in life, however, there’s no free lunch in the snack foods business either. The so-called “reverse Morris trust” structure required P&G shareholders to elect to receive Diamond stock. And as catalogued and brought to light by Breakingviews, Diamond’s finances turned out to be pretty nutty. The salty snacks purveyor last week came clean on about $80 million of bad accounting and replaced its chief executive and chief financial officer.

Despite having used this structure before, P&G clearly failed to adequately crunch the details on its Pringles partner. The scale of Diamond’s revelations suggests P&G, its accountants and advisers at Morgan Stanley and Blackstone missed, or simply chose to ignore, some warning signs. That should be a lesson to all companies contemplating serving up another firm’s equity to their own shareholders.

Context News

Kellogg said on Feb. 15 it had agreed to acquire the Pringles potato chips business for $2.7 billion in cash from Procter & Gamble, trumping a previously-agreed sale to Diamond Foods, whose accounting issues threatened to collapse the transaction.

“We are excited to announce this strategic acquisition,” said John Bryant, Kellogg president and chief executive officer. “Pringles has an extensive global footprint that catapults Kellogg to the number two position in the worldwide savory snacks category, helping us achieve our

Kellogg says the deal will be accretive to earnings in 2012 by between $0.08 and $0.10 per share before the impact of transaction and one-time costs and changes to its share repurchase program; including these items, the transaction will be dilutive to earnings per share in 2012 by between $0.11 and $0.16 per share.

After generating one-time costs of between $160 million and $180 million, Kellogg expects the deal to generate synergies of at least $10 million in 2012, more in 2013 and ongoing synergies of between $50 million and $75 million a year thereafter.

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