2023-08-08 14:46:21 ET
Summary
- Sovos Brands' shareholders saw a 25.2% increase in share price after the announcement of its acquisition by Campbell Soup Company.
- Campbell Soup Company aims to grow its sauces business and sees Sovos Brands, particularly its Rao's Homemade brand, as a valuable addition to its portfolio.
- The deal is valued at $2.34 billion and is expected to result in cost synergies of $50 million for Campbell Soup Company.
- At best, this makes Sovos Brands fairly valued, but without the synergies, the deal looks quite pricey.
August 7th was a really fantastic day for shareholders of Sovos Brands ( SOVO ). After news broke that the company was being acquired in an all-cash transaction by soup giant Campbell Soup Company ( CPB ), shares of the business spiked, closing up 25.2% at $22.56 apiece. Although it is entirely possible that some investors who own shares of Sovos Brands are unhappy with this development, my own opinion is that they should be rejoicing. At the price agreed upon, the company looks, at best, fairly valued. At worst, it might even be overvalued.
While there is a certain benefit that will accrue to Campbell Soup Company, it is my opinion that the clear winners of this transaction are the shareholders of Sovos Brands. Of course, the question that investors are likely asking now is whether they should hold on for a little extra upside or if it might make sense to look elsewhere for opportunities. My own view is that there are definitely better prospects that can be had from this point on. But for those who are optimistic that the deal will be completed and who want a stable but very limited amount of upside, holding on to those shares or picking up some additional ones might not be the worst idea. But for most investors, it is probably not a bad idea to sell units and look elsewhere for opportunities.
Dissecting the deal
According to a press release issued by Campbell Soup Company on August 7th, the company had agreed to acquire Sovos Brands in an all-cash transaction valuing the company at $23 per share. This implies a $2.34 billion equity value on the business and a roughly $2.7 billion enterprise value. Given the fact that this is a cash-only deal, there is not much to analyze in terms of the mechanics of it. Assuming all goes according to plan, by the end of this year, investors who own stock in Sovos Brands will see their shares disappear and will get, in return, $23 for each unit that they owned.
For Campbell Soup Company, there is a good deal of rationale behind this transaction. In the past, the management team at the conglomerate stated that it was their goal of growing the sauces business under the Campbell Soup Company brand to one that generates $1 billion a year in revenue each year or more. Before we get into more of those details, it might be helpful to understand the current revenue categories for the enterprise. Using data from 2022, soup, which is the product it is most known for, accounted for only $2.62 billion, or 30.5%, of the company's overall revenue. The largest source of sales was actually the snacks category, with revenue of $4.10 billion accounting for 47.9% of overall sales.
The smallest of the product categories for the company involved the beverages that it sells. Only $753 million, or 8.8%, of the company's revenue fell under this umbrella. Lastly, we have the 'other simple meals' category. This includes, but is not limited to, gravies, pasta, beans, canned poultry, plum products (prior to the sale of that part of the business in 2021), and, most important for this conversation, sauces. Total revenue for the combination of these products was $1.09 billion in 2022. That's about 12.7% of the company's overall revenue.
One sad truth about Campbell Soup Company is its sales have remained more or less flat over the past three years. With the exception of the 'other simple meals' category, sales have been essentially flat. But that category is distinguished in the respect that revenue has actually declined. From 2020 through 2022, sales dropped consistently year after year, declining from $1.18 billion to the $1.09 billion that I stated already. That's a 7.9% drop, with some of that due to the aforementioned asset sale in 2021.
Recognizing an opportunity, the management team at Campbell Soup Company expressed their interest in growing the sauces business to a $1 billion a year endeavor. The primary reason for this is that it is a space that has been growing rather nicely. From 2017 through 2022, for instance, retail sales for Italian sauces saw sales growth of only 4% per annum for the mainstream products that are out there. But the premium market has been doing very well. What management calls the 'distinctive' brands have seen sales growth of 7% per annum. But the 'ultra-distinctive' category has grown at a rate of 33% per annum. And at the very top of that list is none other than Rao's Homemade, which is owned by none other than Sovos Brands. In fact, from 2019 through 2022, annualized sales growth for that specific brand totaled 39%. It also boasted the number one market share position, with its overall market share growing by over 10 points from 2019 through the end of last year.
This acquisition makes sense not only because of the sauces that Sovos Brands sells directly, but also because there are adjacent categories that play well with Campbell Soup Company's position as a diversified provider of food products. For instance, it's estimated that the frozen meals category is particularly appealing. Year over year, Rao's growth has been 51%, with the company capitalizing on the $12.6 billion meals market and the $6.2 billion pizza market. Similar growth was seen when it came to the $2.6 billion dry Pasta Market and the $2 billion RTS (Ready to Serve) soup space. Even with that growth, the brand had a market share for the frozen meals, pizza, dry pasta, and RTS soup of less than 2% each. This leaves open the opportunity for attractive growth.
There are, of course, other brands under the Sovos Brands umbrella. And the management team at Campbell Soup Company sees those as interesting avenues to explore. They specifically provided some discussion in their investor presentation regarding Michael Angelo's and Noosa's finest yoghurt brands. As part of this transaction, Campbell Soup Company believes that it can achieve cost synergies of $50 million on an annual run rate basis by the end of year 2 following the completion of the deal. Of course, this will cost them about $90 million in one-time integration and restructuring expenses. But this could be just the beginning. For instance, they did state that Michael Angelo's product line could lead to additional cost savings as the business scales with Campbell Soup Company's own supply chain. Under the Noosa brand name, management seems to be thinking mostly about the ability to expand into new categories by innovating on offerings that already exist.
In the event that the $50 million in cost savings ultimately come to fruition, it's likely that around two-thirds of the improvements will come from targeting certain operational costs like selling, general, and administrative expenses. This would basically involve trimming the fat by eliminating duplicate positions within the company and eliminating other redundancies. The rest of the savings, meanwhile, should be driven by sourcing and procurement, as well as efficiency, gains, and cost savings in the company's supply chain.
Should the transaction be completed, and synergies captured as management anticipates, the price paid for Sovos Brands will have probably been worth it. The implied EV to EBITDA multiple, using trailing 12-month data and factoring in the aforementioned savings should result in a reading of 14.6. This is considerably higher than the 11.4 that Campbell Soup Company is trading for. But that's not such a massive premium to pay for a brand that's achieving attractive growth and that is unlikely to significantly cannibalize the offerings currently made available by the acquirer. Using my own estimates, the price-to-adjusted operating cash flow multiple with the aforementioned synergies factored in should be around 15.3. By comparison, Campbell Soup Company is trading a bit lower than that at 13.4.
So far, it looks to me as though this deal is being done more or less close to fair value for Sovos Brands. But in the event that the synergies do not materialize, Campbell Soup Company is likely overpaying. Without the synergies, the EV to EBITDA multiple becomes 19.8, while the price-to-operating cash flow multiple spikes to 22.7. That's quite a hefty price to pay compared to what shares of Campbell Soup Company are presently going for.
Takeaway
From what I can tell, it looks as though shareholders of both companies could benefit from this deal. Clearly, Sovos Brands gets the hefty payday. But Campbell Soup Company does get a vibrant brand that should continue to grow from this point on. If the synergies do not materialize, the picture becomes far less attractive. As for what investors should do, that's up to each individual one. I don't currently own shares of Campbell Soup Company, but if I did, I would likely sell my position and look elsewhere for opportunities. After all, the implied upside from its current share price to the buyout price is only about 2%. And it could take us nearly five months to get there.
I will say, however, that I am rather pleased with how things turned out regarding Sovos Brands. Those who follow my work closely might know that I have written about the company before. In both instances, I ended up rating it a 'buy' to reflect my view that shares should outperform the broader market. With this surge, the stock is up 55.5% compared to the 19.2% seen by the S&P 500 since I wrote about it last in October 2022. And from the first time that I wrote about it in December 2021, shares are up 35.5 percent while the S&P 500 is down 4.3%. Because of how I feel about the company and now from a valuation perspective, I do believe that a revision to my prior rating is necessary. Because of how much the stock has risen and how much limited upside there is from here, I have decided to downgrade the company to a 'sell' rating since upside is very limited from here and the only thing that could occur would be a significant downside should the deal fall through. This is an unfavorable risk-to-reward scenario, which makes this decision easy.
For further details see:
Campbell Soup Company's Pricey Purchase Of Sovos Brands