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  1. Analysis
February 2, 2011

Comment: Sara Lee split fails to dampen takeover talk

Sara Lee's management no doubt hoped the announcement of plans to split the US food group in two would give the market some clarity over its future but, writes Dean Best, Wall Street analysts believe the new-look companies will still be potential takeover targets.

By Dean Best

Sara Lee’s management no doubt hoped the announcement of plans to split the US food group in two would give the market some clarity over its future but, writes Dean Best, Wall Street analysts believe the new-look companies will still be potential takeover targets.

So, after months of speculation, Sara Lee has laid out plans for its future.

The US food group has been firmly in the spotlight since the summer, when chairman and CEO Brenda Barnes stepped down for health reasons.

The lack of clarity around Sara Lee’s strategy meant the company faced rumours it was selling its North American bread business – and that the business as a whole was a takeover target for private-equity firms. In November, Sara Lee did sell that bread unit, striking a deal with Mexico’s Grupo Bimbo.

However, all the while, and particularly in the run-up to and after Christmas, reports in the US linked the likes off KKR and Apollo Global Management to a takeover of the business – and claimed Brazilian meat giant JBS had made – and failed with – a bid for the company.

The announcement last week that Sara Lee would be split in two – one company to focus on the group’s North American meats operations and one to focus on its coffee business and its international bakery unit – was not a complete surprise. The rumour mill had also been spinning that possibility. Nevertheless, Marcel Smits, the now formal replacement to Barnes after initially succeeding her on an interim basis, was forced to fend off some stiff questions from analysts about how the split would benefit investors.

Smits admitted that Sara Lee had received “unsolicited indications of interest” from unnamed parties to buy the whole company but said the split was “in the best interests of the business and shareholders”.

Pure-play companies, Smits said, “tend to do well”. Management, he insisted, would be closer to the market. And he emphasised that the Sara Lee board had spent time deliberating before coming to its verdict on the company’s future.

“We wanted to look at it from every angle to make sure we did the right thing,” Smits said. “We have done all that we can to make sure we have come to a careful and well-informed decision.”

Smits was talking to analysts after Sara Lee announced the plans to split – and many of the questions from Wall Street focused on the tax implications of the division.

One analyst said that it appeared that the unnamed business that will house the beverage and bakery operations could be moved and based in Europe to reduce the tax impact of the split. Smits refused to comment but said “redomiciling” that company was an option being considered to reduce that business’ tax rate.

In a note to clients issued on Monday, Andrew Lazar, an analyst at Barclays Capital argued that “several questions” around the split persist but said: “The most important is how a separation creates value if it does not address a fundamental tax dilemma for Sara Lee – that a great deal of cash is generated out of its European unit, not to mention the proceeds from the household and body care sale [to Unilever] and that Sara Lee must pay repatriation taxes to bring all of this back to US.”

He continued: “Our sense is pursuing a split solely for the purposes of minimising taxes might not work, though there are other reasons – strategic focus, for one – that likely also motivate the separation. That said, we see nothing wrong with the notion that the new company – Coffee Co. – could afterwards attempt to look for a more efficient arrangement.”

Lazar said, after estimating the value of shares in the two companies on a “sum-of-the-parts framework”, he believes Sara Lee has a “potential price range” of $17-20.

“The higher end [is] more achievable if ‘Coffee Co.’ can get redomiciled in Europe and thus mitigate the $880m repatriation tax bill that Sara Lee is currently counting on – not to mention benefit from a lower corporate tax rate,” Lazar said.

The question of the tax impact of the split is, of course, just one consideration for Smits and his team to ponder when they start to press ahead with their plans. A division – which is scheduled to be completed in early 2012 – will give management time to focus on two businesses that have little geographic or category overlap. What’s more, the coffee operations, which enjoy higher margins than the meats business, are increasingly exposed to attractive emerging markets. However, this year Sara Lee’s management will be pursuing a split of the business in what remains a very tough economic and operating environment.

Another unknown is whether Sara Lee remains – or will be again once divided – a takeover target. Sanford Bernstein analyst Alexia Howard acknowledges a sale of the whole company “could still happen” but, in a note issued on Monday, said it was “more likely targeted at individual businesses like meats or coffee”.

JBS, she suggested, would still be interested in Sara Lee’s meats division, which sells brands including Ball Park hot dogs. “JBS appears to be keen to gain more exposure to branded meat in the US, and given the appetite for the US meat players to move into downstream, more value-added brands, we could see a few willing trade buyers being willing to step up here, which could increase the price paid for the business,” Howard said.

Over the next year or so, then, Sara Lee could remain a fixture of the headlines on the business pages.

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