Following a wave of consolidation among food companies that has also spread to retail grocery stores,

Kellogg

(K) - Get Report

agreed to buy

Keebler Foods

( KBL) for $42 a share, or about $3.6 billion in cash, the companies said Thursday.

Flowers Industries

(FLO) - Get Report

, which owns a 55% stake in Keebler, has agreed to the deal, the companies said.

Battle Creek, Mich.-based Kellogg said it would assume an undisclosed amount of Keebler debt, and the companies expect the deal to close in the first quarter of 2001.

The deal pairs Kellogg, most famous for its breakfast cereals, with Keebler, the nation's second-largest maker of cookies and crackers. The combined food company would have $10 billion in annual sales and a branding infrastructure including the Keebler Elves, Tony the Tiger and Snap! Crackle! and Pop!

Kellogg said it expects to realize an increase in its cash earnings per share within a year.

"We are entering the next phase in the renewal of Kellogg," said Carlos M. Gutierrez, chairman and chief executive of Kellogg. "Combining with Keebler is a significant component of this advancement, but we also need to simplify our current Kellogg business, prioritize its resources, and refuel it with a return to previous levels of marketing investment."

Kellogg has had recurring trouble achieving its earnings expectations, while Elmhurst, Ill.-based Keebler has never missed, analysts said.

Kellogg also reported a 6.5% increase in its third-quarter earnings Thursday that matched the consensus estimate of analysts polled by

First Call/Thomson Financial

. But it warned that it "may be challenged" Wall Street's forecasts for the fourth quarter and said that growth in its earnings per share next year would be limited to "a mid-single-digit rate."

For the third quarter ended Sept. 30, Kellogg posted net income of $181.9 million, or 45 cents a diluted share, compared with net income of $170.8 million, or 42 cents a share, in the year-earlier quarter. The results exclude 1999 restructuring and disposition-related charges.

Third-quarter sales slipped 1.2%, to $1.85 billion, from $1.87 billion in the comparable 1999 period, and third-quarter volume was off 1.4%. Excluding the effects of foreign exchange, acquisitions, and divestitures, sales were up 1.1% and volume up 1.3%, the company said.

Kellogg said it expected sales growth to accelerate next year.

Keebler and Flowers have been exploring the alternatives for the food company, including a possible sale, since July.

"Flowers had a profitable investment in Keebler and a problem investment in Mrs. Smith's" said Leonard Teitelbaum, analyst for

Merrill Lynch

. "Flowers wanted to get rid of the company."

Flowers said it would spin off to its shareholders a new company, Flowers Foods, consisting of its

Flowers Bakeries

and

Mrs. Smith's Bakeries

businesses. After deducting certain liabilities at Flowers, the company's management said it estimates that cash proceeds of approximately $12.50 per share will be paid to Flowers shareholders. In addition to those proceeds, each Flowers shareholder will receive shares representing a proportionate interest in Flowers Foods.

For Thomasville, Ga.-based Flowers, the options now seem to be growing the baking business or positioning itself as a cash-bloated acquisition target, Teitelbaum said. For Kellogg's integration of the profitable Keebler business, several questions remain unanswered, including the fate of Keebler management, he said.

Teitelbaum rates Kellogg shares neutral and Flowers shares accumulate. His firm participated in a recent distribution of shares for Keebler and has done no other recent underwriting for any of the parties.

Other recent food industry mergers include

Unilever's

(UN) - Get Report

purchase of

Bestfoods

in June and

Phillip Morris'

(MO) - Get Report

purchase of

Nabisco Holdings

( NA) shortly thereafter.

Kellogg finished Thursday regular trading up $1.56, or 7%, at $24.31; Keebler finished up $1.06, or 3%, at $40.44; and Flowers Industries ended down $2.31, or 12%, at $16.25.