Diamond Foods has bought the Pringles brand from P&G

Diamond Foods has bought the Pringles brand from P&G

Every now and then, a deal is done that significantly alters the direction of a business. Diamond Foods' agreement to buy the Pringles brand looks set to do just that, tripling the size of the US firm's snacks business and boosting the company's exposure to overseas markets. Dean Best reports.

Pringles, for a long time the odd one out in a Procter & Gamble portfolio that includes batteries, nappies and fabric conditioner, was always going to be sold. The questions surrounded when and to whom.

On Tuesday (5 April), US snack firm Diamond Foods, founded almost 100 years ago as a co-operative of walnut growers but now a listed business with annual sales of around US$680m, announced it had made a move for Pringles and struck a deal worth $2.35bn.

The agreement was not a complete bolt from the blue. Last September, reports in the US said talks between Diamond and P&G on Pringles had foundered over the way the snack maker was structuring a deal. Six months on, the two sides have shaken hands on a complex transaction that will see Diamond put up $1.5bn of its stock and assume $850m of Pringles' debt.

Under the terms of the deal - designed to minimise the tax impact on P&G shareholders - P&G will set up a separate entity for the Pringles business. The new Pringles entity will be "distributed" to P&G investors taking part in the transaction and - at the same time - the business will merge with Diamond.

The deal gives P&G investors the opportunity to exchange their shares for the stock put forward by Diamond. P&G shareholders are expected to take a 57% stake in the combined business, with existing Diamond investors accounting for the remaining 43%.

The transaction - which remains subject to regulatory approval in certain markets - is expected to close by the end of the year.

While the mechanics of the deal may be complicated, the outcome for Diamond - in terms of its expansion - are a lot clearer. Diamond said the move would triple the size of its snacks business, double its snack sales in the US and the UK and mean that the company would make 49% of its revenues outside its domestic market.

The deal means the combined business would enjoy annual sales of $2.4bn, EBITDA of up to $410m and - crucially for Diamond's investors - would, the company said, be "immediately accretive" to earnings. The market welcomed the deal and Diamond's share price shot up on the day the deal was announced.

Diamond has, in recent years, shown a willingness to grow not just organically but through serious acquisitions - the 2008 purchase of General Mills' popcorn business Pop Secret and last year's move for upmarket crisp maker Kettle Foods are prime examples.

However, analysts have noted that the potential impact of the Pringles deal could be greater. Barclays Capital analyst Andrew Lazar said the Pringles deal was "transformative" for Diamond and added that, while the move was "an ambitious undertaking" for the company, it made sense "through both financial and strategic lenses".

Investors, Lazar reasoned, may question the impact that Pringles could have on Diamond's growth. Over half of Pringles sales are in the US and the UK and growth has been hard to come by. Nevertheless, Lazar said the "pipeline of potential revenue and cost synergies" could keep Diamond's earnings per share growing "well above" the average of its peers in the next three years.

Diamond chairman, president and CEO Michael Mendes believes in Pringles' ability to drive sales, telling analysts on Tuesday that the brand was a "real thoroughbred" and had "real potential to grow the top line".

The strategic benefits of the move, Lazar said, include greater distribution in the US and overseas. Pringles' distribution in the US, for one, could benefit Diamond's existing portfolio, particularly in channels including convenience stores - and this was emphasised by Mendes when he discussed the deal with analysts.

Internationally, Pringles could help Diamond's current portfolio, even brands like Kettle that have built a significant presence in the UK. Markets in western Europe and further afield are now set to become more open, Lazar argued.

There is, of course, a risk when expanding a business to this extent. For all the opportunity that lays in the US and in new markets, integrating the Pringles business into Diamond will be a challenge.

Heather Jones and Brett Hundley, analysts at BB&T Capital Markets in the US, are broadly positive about Diamond's move for Pringles. The deal "greatly" improves Diamond's "scale in the snack aisle" in the US and the UK, they wrote in a note to clients yesterday, and they argued that Pringles' "international platform" could act as a "springboard" for brands such as Kettle, Pop Secret and Emerald nuts.

Nevertheless, the analysts did have a note of caution for Diamond about the company's international plans.

"There will be an integration risk - specifically in international markets, excluding the UK - where the company has no existing production and roughly one-fifth of distribution is unstructured," Jones and Hundley said. The BB&T Capital Markets analysts also pointed to "a possible step-up in competitor behaviour and greater absolute financial leverage".

However, Jones and Hundley acknowledged that Diamond's Pringles move is "not as risky" as its acquisition of Kettle, a business that, they said, the company had integrated "smoothly".

That said, the analysts were correct to point to the competition that Diamond faces. According to data from Euromonitor, Pringles was the world's fourth best-selling sweet and savoury snacks brand in 2009. The top three positions, however, were taken by PepsiCo's Lay's, Doritos and Cheetos. In the US, Pringles ranked eight, with four PepsiCo brands leading the poll (Tostitos was third, joining Lay's, Doritos and Cheetos).

PepsiCo will be watching the Diamond/Pringles combination with interest, both globally and its own backyard. Lazar said Pringles will mean Diamond and PepsiCo will be closer competitors.

"Pringles puts Diamond in much more direct competition with deep-pocketed competitor [and PepsiCo snacks arm] Frito Lay," Lazar said. "Whereas Diamond has grazed against Frito's business through Kettle, Pringles is surely considered a mainstream potato chip like many of Frito’s products."

The combination between Diamond and Pringles is just the latest stage in the consolidation of the snacks sector following last year's merger between two US firms Lance and Synder's of Hanover to create Snyder's-Lance.

Lazar, pointing to Kraft Foods' takeover of Cadbury, said there was "a definite trend emerging when it comes to a consolidating snacks universe". Regulatory issues could hinder further consolidation but Lazar wondered whether the likes of Campbell Soup Co., General Mills, Kellogg and ConAgra Foods - the owners of Pepperidge Farm, Nature Valley, Keebler and (in ConAgra's case) an own-label snacks business - could look to increase their position in the sector.

"Presumably, Pringles was one of few pure-play snacks assets in the market and, to the extent that others' appetite for greater snacks scale grows, we wouldn't rule out Diamond showing up on potential target lists over time," Lazar, rather intriguingly, noted.

Consolidation in the snacks sector has popped. When - and how - will it stop?