Updated from 2:37 with comments from Jack Mohr.
The company's stock is up, near its 52-week high of $65.49, after Citigroup analyst David Driscoll said in a Tuesday report that Kraft Heinz (KHC - Get Report) , backed by 3G Capital and Warren Buffett's Berkshire Hathaway (BRK.A - Get Report) , could buy General Mills for $86 per share.
It's not the first time General Mills has been mentioned as a potential target for Brazilian private equity firm 3G, which has played an active role in consolidating the food space.
And the cereal and yogurt maker has been mentioned along with every other major player in the food space as a consolidation candidate, including the likes of Campbell Soup (CPB - Get Report) , ConAgra Foods (CAG - Get Report) , Mondelez (MDLZ - Get Report) and Kellogg (K - Get Report) .
Now that 3G's Heinz has had some time to digest its buy of Kraft to create Kraft Heinz, it may be time again for the food giant to get out its calculator.
Jack Mohr, research director of TheStreet's Action Alerts PLUS likes General Mills and agrees that it may theoretically makes sense from a strategic level, but does not like it from a financial level.
Right now Kraft's 4.0 times levered (net debt/EBITDA) and management has made it explicitly clear that paying down debt while paying out strong dividends is its balance sheet priority (per its first-quarter call, the company said "we are making good progress in balancing a conservative financial policy while remaining committed to a strong dividend payout"). They have committed to paying down $2 billion of debt by July of next year, and will not consider even repurchasing shares until then.
"If Kraft acquires General Mills at $86 a share, that's a $51 billion market cap and nearly $60 billion EV (~$9 billion net debt), so that would take KHC's combined net debt from $21 billion to nearly $80 billion -- assuming it finances through debt raise -- which would take its leverage ratio up to 7.2 times pro-forma 2016 adjusted EBITDA (GIS $3.31B est, KHC $7.8B est, or $11.1B combined).
"I would have to check, but I imagine that would break dividend covenants and obviously lead to a major rating downgrade and flush them with interest expenses and extreme debt load," Mohr says.
"I haven't seen the Citi note, but 3G is still in earlier innings of Kraft integration, and it's going quite well. This is a solid dividend stock, and 4 times leverage is already a sensitive subject, let alone a $60 billion acquisition, Mohr concludes.
General Mills has a market cap of nearly $38 billion, while it has debt of close to $8.8 billion and cash and cash equivalents of almost $800 million as of Feb. 28.
That equates to an enterprise value of $46 billion. That's a multiple of approximately 13.5 times General Mills projected adjusted EBITDA of nearly $3.4 billion for its fiscal-year ending on May 31, according to data provided by Bloomberg.
As Mohr indicates, if Kraft Heinz were to shell out $86 per share, that would equate to an enterprise value of $59.1 billion and a multiple of close to 17.4 times adjusted EBITDA.
Even at a 37% premium to General Mills' Monday closing price, $62.73, an $86 per-share offer would still be in line with what 3G historically has paid to buy large food companies.
Indeed, H.J. Heinz's deal to absorb Kraft at a valuation of about $55 billion worked out to a blockbuster multiple of nearly 23 times EBITDA, The Deal previously reported. That multiple compares to the circa 14 times EBITDA private equity firm 3G and Berkshire Hathaway paid for Heinz itself in 2013.
The multiple for General Mills, calculated utilizing Driscoll's suggested offering price, is also in line with the 18-times EBITDA multiple Tyson Foods (TSN - Get Report) shelled out for refrigerated-meats brand Hillshire.
With investors rewarding Kraft Heinz a multiple of 26.6 times adjusted EBITDA for its aggressive deal-making and cost-cutting efforts, it may be time for the company to order up a second main course.