Kellogg's Buy-Out Prospects Appear Greatly Overstated

Amid lots of consolidation in the consumer products space, a buyout of the cereal maker have persisted.
By Bob O'Brien ,

The expiration date on rumors of a takeover of Kellogg (K) - Get Report ? Apparently never.

The Battle Creek, Mich.-based cereal maker has been a persistent subject of takeover speculation for more than two years.

Certainly, investors like the buzz. Shares of Kellogg have climbed to an all time high of $86 in Friday's trading. The stock has added more than 10% just since the start of June, as rumors have continued to swirl.

So what to make of the chatter? Wrong? Or just early?

Obviously, there's been some consolidation in the branded consumer products space. Mondelez International (MDLZ) - Get Report recently offered to buy Hershey (HSY) - Get Report , a company with a $25 billion market cap that closely tracks that of Kellogg.

Two years ago the Brazilian buyout shop 3G teamed with Warren Buffet to acquire Heinz in a $28 billion transaction that included more than $8 billion of equity and a huge slug of preferred shares. The new rollup then went out and acquired what was Kraft Foods.

Since then, 3G has amassed a larger buyout fund that would presumably take aim at takeovers of other consumer companies. Kellogg, with its stable of popular breakfast staples such as Frosted Flakes, would qualify.

Or would it? Kellogg has already tacked on 25% in market value since the takeover rumors really gained traction in January of last year. Nobody buying Kellogg at this point is getting a bargain.

More than that, it would take a real long term perspective to leverage some gains out of Kellogg. Heinz was, by comparison, relatively cheap at the time of the 3G-Buffett buy. Kellogg trades at a much higher multiple.

Meanwhile, Kellogg is debt heavy, with some $7.4 billion in net debt, which would limit any acquirer's ability to leverage the transaction. That presumably rules out any financial sponsor. Credit rating agencies have been somewhat critical of the company, with Fitch being the latest, back in February, to downgrade its credit rating on the company.

Kellogg also announced a plan earlier this year to undertake a huge share buyback initiative. It's a shareholder friendly program, just not the kind of thing that a management trying to pretty itself up for a buyout would engineer.

Kellogg's underlying fundamentals wouldn't argue for a good takeout offer. The somewhat fatigued cereal business grows at about 3% a year. Hardly the dynamic that would attract an aggressive buyer. (Of course, the same could have been said of the ketchup business before Heinz attracted a buyout, though 3G also has a big chunk of the Burger King enterprise, which suggests there could be some synergy there.) 3G is known as an aggressive cost cutter when it executes deals. It would want to see margins of something on the order of 17%, which might be a high hurdle to cross.

There have been some battles for branded consumer products over the years. Think of Hillshire Brands. Citigroup back in May said that Kellogg was a good takeover prospect, though it also mentioned several other packaged goods makers as buyout candidates.

One tangible formidable obstacle to a takeover might be the family-like stake in Kellogg. More than 20% of the stock is held by the W.K. Kellogg Trust, which would almost have to be swayed to make a takeover palatable.

Like a bowl of Corn Flakes in the morning.

Loading ...