As serendipity might have it, General Mills (GIS) announced last week the acquisition of Blue Buffalo (BUFF) for $40/share and $8 Billion in enterprise value. GIS paid a 23% premium and 22.5x Ebitda. “It is one of the richest transactions in the food space”, according to Akshay Jagdale, at Jefferies. Management here has two options: 1) continue to operate a business with poor long-term organic growth characteristics; or 2) acquire shiny, fast moving objects for large sums and hope for the best. Between a rock and a hard place is indeed a tough place to be. If you missed my previous thoughts on the secular turn for the worse in CPG, here is the link.
Which brings me to Blue Buffalo. In addition to being Homer’s (my golden doodle) pet food of choice, I made an investment in Blue Buffalo last August for three reasons: 1) an attractive, underpenetrated brand, 2) in the fastest growing natural food sub-category in pet food, and 3) most importantly a cheap asset with the understand that plenty of buyers would line up to buy the Company if operations faltered. Heads I win and tail I don’t lose much is a much better way to invest in businesses and build portfolios. You can find the thesis on Blue Buffalo here.
But back to the story. The transaction rationale is simple – the deal is a pathway to enter and build a pet food platform - anchored by the best brand in the category. With this foundation, GIS can grow BUFF sub-brands, acquire other niche brands, and buy the requisite time to incubate brands. In the big picture, GIS can show accelerating organic growth to its shareholders.
But the problem is two-fold, 1) counting on the very long-term future of BUFF to be as good or better than the past is a mistake, and 2) the deal leaves no margin for error
Let me dive into the first point by telling you the story of BUFF. Bill Bishop (father of current CEO Billy Bishop’s) was an advertising executive at large, sophisticated ad agencies in the 1990’s, co-founded SoBe (South Beach Beverage Co.), grew sales to ~$200 million, and then sold the business to Pepsi in 2001 for $370 Million. Billy Bishop was a part of this success. Product advertising is a Bishop core capability. They doubled down by founding Blue Buffalo soon after, to leverage the early trend in natural and organic, but picked pet food. Over the past 17 years, Blue Buffalo has invested upwards of $700 million - to build a master brand strategy - and executed it to perfection. At the end of the day, BUFF is built on marketing. (Most of the product even today is produced by third party co-packers). If BUFF was starting today, the Bishop’s could likely build a similar business for much lower advertising spend. Network ad platforms (Facebook, Google) provide greater scale for lower costs. Therefore, the competition in the future is likely to be much greater. GIS now takes on this risk. Over the past 18 months, the market has seen other specialty pet food brands scale rapidly. Additionally, the attractive metrics of this deal should attract even more private capital into the specialty end market. Why not? Buyers on the other side are large companies with deep pockets such as Nestle, Smucker’s, Mars, and Colgate. Over the long term, a marketing moat alone cannot fight off the enemy that is trying to break in. Especially in pet food – the business is rapidly moving to e-commerce – as distribution moats are weak and getting weaker.
This brings us to the lack of margin for error in this transaction. When a business is desperate for growth, management justifies high valuations as good for the long-term health of the business. The margin of safety is an after-thought. In this case, not only is GIS paying a premium for the brand and the optionality of future growth, it is also paying BUFF founders to stay and reveal the secret sauce to pet food growth. Will the Bishop’s stay or move on to the next venture? Outside of marketing scale, GIS doesn’t bring much else to the table. BUFF has developed a great brand in the U.S. but cannot be leveraged outside. GIS must put in the work from the ground up or make another acquisition to expand into Europe. The purchase price discounts doubling of the current size. So where is the upside?
Most deals are touted as Win-Win. This is a win for Blue Buffalo shareholders, less so for General Mills and its investors. Between a rock and a hard place is a tough place to be.....
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