Smithfield Buyout? Not So Fast, Says Starboard

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A few weeks ago, Chinese company Shuanghui International announced a $34 per share bid for Smithfield Foods (NYSE: SFD), a large producer of pork and other meat products. The stock had been trading at about $26 prior to the announcement, so this takeover price represented a substantial premium for shareholders.

However, activist Jeffrey Smith’s Starboard Value is not impressed. The fund recently filed a 13D with the SEC, reporting a position of nearly 8 million shares, or 5.7% of Smithfield. In a letter accompanying the 13D, Smith and his team argued that Smithfield management should pursue a breakup of the company rather than a sale. A breakup of the company, including sales of some of the pieces, could end up valuing the company at around $50 per share according to Starboard’s analysis.

We track quarterly 13F filings from hundreds of hedge funds such as Starboard as part of our work researching investment strategies (for example, we’ve found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year). Our database shows that Starboard initiated a position of 375,000 shares in Smithfield in the first quarter of this year (see more of Smith's stock picks).

This suggests that the activist fund likely was planning to build a stake and push management to break up the company. In addition to Starboard, other filers we track who owned Smithfield at the end of March included billionaire Steven Cohen’s SAC Capital Advisors (find Cohen's favorite stocks).

Starboard came to its conclusion by independently valuing each of Smithfield’s three segments. As a vertically integrated pork producer, the company owns its own hog farms; the fund claims that the pork segment could independently contract for hogs as it currently does for some of its supply. Therefore, selling this division would not negatively impact the rest of Smithfield’s businesses, and the middle of the range of valuations Starboard assigns to this segment is $2.1 billion.

The company’s various international brands (which are mostly sold in Europe) give another $1.4 billion in their analysis. That leaves the pork division. By subtracting out the figures we’ve previously mentioned from the current enterprise value, Starboard claims the pork division is valued at only 4 to 5 times trailing EBITDA.

For purposes of comparison, Hillshire Brands and Hormel Foods trade between 8 and 10 times trailing EBITDA. This leads Smith and his team to conclude that Smithfield is currently undervalued based on this sum of the parts valuation. The stock also looks cheap if we compare analyst expectations for the forward fiscal year between these three companies: Hillshire and Hormel are each valued at 18 times forward earnings estimates, while the forward P/E for Smithfield is only 11.

While these companies do have different fiscal year ends, it suggests that even at its current acquisition-anticipating levels, Smithfield could also be considered undervalued in terms of earnings per share. Its revenue rose 4% in its most recent quarter compared to the same period in the previous fiscal year -- in line with these two peers -- although net income did decline considerably in percentage terms.

Other producers of meat products include Tyson Foods (NYSE: TSN) and Pilgrim’s Pride (NASDAQ: PPC). We’d note that these two companies focus on chicken, though Tyson is at least a somewhat general meat provider. Pilgrim’s Pride has actually been growing its business: revenue grew 8% in the first quarter of 2013 versus a year earlier, with earnings rising 39%. Tyson, meanwhile, has experienced much more moderate revenue numbers coupled with a drop in net income. The forward P/Es here are in the 9-10 range, and so, while there is a difference in product mix, we’d wonder if they’d make even better values than Smithfield.

Pilgrim’s Pride, in particular, may offer an attractive combination of low earnings multiples and decent growth going by recent reports, and it looks like an interesting target for further research. Starboard does seem like it may be onto something with Smithfield however: while the sum of the parts valuation is the key part of the thesis and would need to be tested further, in terms of forward earnings estimates, it also appears that a breakup could create more value for shareholders than the current deal.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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