Lino Saputo Jr. and his father have built one of the world’s largest dairy companies with a string of more than 30 successful acquisitions. The 52-year-old CEO’s next takeover may be his toughest challenge to date.
Just about every analyst who covers Saputo Inc. says a team from the Montreal-based company is currently going through the books of Dean Foods Co., the largest U.S. milk producer and owner of 50 brands of sour cream, butter and ice cream. Dallas-based Dean Foods effectively put up a “for sale” sign in late February by announcing its board is exploring strategic options after posting a larger-than-expected US$374-million annual loss and suspending its common share dividend.
At the same time Dean Foods went on the auction block, Saputo realigned its senior management to deepen its bench of its U.S. operations, which accounted for half of the company’s $11-billion in sales last year. In recent presentations to analysts, Mr. Saputo and his executive team pointed out that the company has the financial and operational strength to do an acquisition valued at up to $3-billion. (The company declined to comment on any interest in Dean Foods or other potential acquisitions.)
Dean Foods is a poster child for all that ails the U.S. dairy industry. Americans drink less milk with each passing year, farmers have excess capacity and retail chains such as Amazon and Walmart are pushing their own brands rather than buying milk from traditional suppliers. The 94-year-old company’s sales fell to US$7.8-billion last year from US$9.5-billion four years ago, against a backdrop of cost-cutting and restructuring.
The attraction to a buyer such as Saputo is clear: For all its problems, Dean Foods is a market leader, selling one in three jugs of milk consumed by Americans each day. And the equity is relatively inexpensive, with a market capitalization of about US$200-million. In comparison, Saputo dropped $1.7-billion in February to acquire a British company called Dairy Crest Group plc that had sales of $786-million last year, and turned a $257-million profit.
The risks that come with acquiring Dean Foods are equally clear. There is nothing to suggest the U.S. dairy industry will stabilize in the near future, so a new owner may be grabbing a falling knife. And the Dallas-based company is carrying US$887-million of debt, which an acquirer would shoulder. In fact, if credit markets have it right, no buyer will step forward for Dean Foods. The company’s bonds are currently trading for 50 cents on the dollar, a discount that signals there’s no quick solution to the company’s financial problems. Standard and Poor’s rates the company a dismal CCC+.
Analysts who follow Saputo are warning that a takeover of Dean Foods, or any U.S. dairy business, may be poorly received by investors, who have awarded the Canadian company a premium valuation in the past based on its operational skills and takeover savvy.
“While we expect Saputo to be part of the process every time major assets come to market, given the strong pipeline of potential transactions globally, we expect Saputo to stick to its playbook to extend its footprint in growing and attractive milk sheds” or regions, said a recent report from analyst Irene Nattel at RBC Capital Markets. Right now, the U.S. milk market is neither growing nor attractive.
Saputo is also seen as a potential bidder for U.S. sour cream and cottage cheese maker Breakstone. Owner Kraft Heinz Co. is reported to have put it up for sale as part of a larger restructuring of the company, with an estimated price tag of US$400-million.
“Mergers and acquisitions remain a key part of the Saputo strategy,” said a team of four CIBC World Markets analysts in a recent report. “We expect ongoing activity and management highlighted that several of the deals it is looking at today are material.”
The CIBC team went on to say: “While challenging macro dairy conditions could lead to opportunistic deals, it also limits the near-term upside from a transaction.… The [U.S.] market remains challenged by oversupply, while other cost and regulatory issues only add to the pressures.”
For acquisition-focused companies such as Saputo, the timing of a takeover is rarely ideal. More often than not, a market leader such as Dean Foods only comes up for sale during a downturn, or when it faces financial distress. For the chief executive, it’s time to decide if owning a dominant milk producer is worth the risk that comes with increased exposure to a U.S. dairy industry that’s in disarray.