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How to Play the Dean Foods - White Wave Spinoff

March 04, 2013 | About:
Russell Miller

Russell Miller

1 followers
Summary:

By longing Dean Foods and shorting its spinoff White Wave, it’s possible to purchase the remaining Dean Foods milk business, Fresh Dairy, very cheaply. Once Dean Foods spins off the rest of White Wave in March and April, DF should revalue upwards at 50% upside.

Key Points:

Dean Foods (DF) is spinning off the remainder of White Wave (WWAV), its soy milk division, in the next few month.
  • DF currently owns 86.7% of WWAV. If you subtract out the value of the WWAV business, the DF stub has an implied P/E of 7.43
  • Once the spinoff is complete, the Dean Foods milk business will trade on its own, and should revalue upwards in a month or two due to trading for a much lower valuation than comparable companies.
  • The median P/E for food companies 16; the low end is 12.
  • Currently, Dean Foods has a P/E of 25. The lowest P/E Dean has ever traded for is 9.
Risks:

  • DF’s milk business, Fresh Dairy, is a commodity business with operating earnings that have fallen by half since 200.
  • Dean Foods has very high leverage: 26x debt to equity.
However, Dean’s debt is only 3.7x operating cash flow, so there shouldn’t be any problems in making payments, especially given the short time frame of the trade.

Dean Foods is a Dallas-based milk producer that has grown through aquisitions, financed by debt, since the early 1990s. It’s now seeking liquidity by spinning off its divisions. It just completed a private sale of its Morningstar division, which made coffee creamers, netting $887 million. Also, it began an equity carve out of White Wave this quarter, selling off 13% of the company and receiving $1.16 billion in combined stock proceeds and dividends from White Wave (White Wave paid a large one-time dividend to Dean Foods). According to Dean Foods investor relations, the plan is to distribute the rest of the company to shareholders sometime in March or April. Once White Wave is distributed, all that will be left is the Fresh Dairy milk business.

White Wave had a successful offering, and is currently trading at a very high P/E of 28x 2012 earnings guidance. Because of this P/E level, we do not recommend holding WWAV. Instead we recommend buying DF, and shorting out the equivalent amount of WWAV shares to create one share of DF Fresh Dairy. In other words:

1 Share of Dean Foods = [ 1 share Fresh Dairy + .81 share of White Wave ]

(Dean Foods has 185.23 million shares outstanding, and retains 150m shares of White Wave. So each one share of Dean Foods contains .81 shares of White Wave.)

So,

[ 1 share Fresh Dairy + .81 share of White Wave ] - (Short) .81 Shares of White Wave

= 1 share Fresh Dairy

As of Feb. 26, those prices are:

$15.44 DF - .81 * $14.98 WWAV = $3.30 per share for Fresh Dairy, or a stub market cap of:

$3.30 * 185.23 m shares = $612 million implied market cap for Fresh Dairy

What Is Fresh Dairy Worth?

Dean Foods did $156 million in free cash flow for 2012 according to their fourth quarter 2012 press release, of which 54% was from Fresh Dairy, or $84 million. Earnings guidance at the low end for 2013 is $0.45 per share for Fresh Dairy, or $83 million.

Dean Foods Enterprise Value, ex-White Wave and Morningstar:

$1.4 billion Debt + $612 million Market Cap = $2.3 billion Enterprise Value for Fresh Dairy

EV / FCF = $2.3 billion / $0.84 billion = 27. It’s expensive from an EV / EBITDA metric, but...

Is $612 million a cheap price for Fresh Dairy?

Yes. The implied PE for Fresh Dairy is $612 million / $83 million = 7.4

However, Dean Foods’ lowest historical PE is 9, and average is 16. Granted, this historic PE included the higher growth businesses, but a PE of 7 still seems rather cheap. Once the separation is complete, I expect the Dean Foods Fresh Dairy stub will revalue in one to two months to a PE of at least 9 or so, if not more, for a price target of $4-ish.

The Milk Business

Milk is a commodity business that has seen declining volumes and higher commodity prices in the past few years. Operating income for the Fresh Dairy division has fallen from $642 million in 2009 to $349 million in 2011, and will probably be around $450 million for 2012. DF took a $2 billion goodwill writedown in 2011 because of this general decline.

DF has responded by aggressively cutting costs. While gross profit for quarter three was flat, DF was able to create $100 million of adjusted operating income, a 32% increase over the same quarter last year. This increase has come from cost cutting. SG&A is down 13% year over year, and DF’s fixed costs and interest expense are also $70 million lower in 2012 than in 2010.

Debt

DF has also focused on debt reduction. Through the spinoffs of White Wave and Morningstar, DF has driven its leverage ratio of net funded debt to EBITDA down to 3.71 times at end of quarter three. This is down from 4.3 a year ago, and far below the max of 5.5 in their debt covenants. DF’s current debt load, ex-White Wave and Morningstar, is only $1.3 billion versus $3.6 billion a year ago.

Big Picture

Going forward, the guidance from DF management is that with the reduced debt load, DF will be better able to manage the ups and downs of the business, and that the milk business still generates high free cash flow.

While the milk business is not a great one, given Dean’s focus on cost and debt reduction, we feel that the business risk given the expected holding time of five months (January through May) is low, and is outweighed by the significant discount the Fresh Dairy business will be offered at.

At an implied market cap of $824 million for Fresh Dairy, and a debt load of $1.3 billion, total enterprise value is 2.15B, and with operating income for Fresh Dairy of $424 million for the past 12 months, this works out to a EBITDA / TEV yield of around 19%, or a multiple of just 5.

Implementation

Shorting out White Wave produces a position that’s only 25% net long, and therefore buffered to a large extent from market movements. However, at this time I have only been able to find large amounts of White Wave available to borrow at Fidelity rather than Ameritrade, so I recommend doing the trade at Fidelity. Fidelity has a borrow rate of 2% and at least $5 million of shares available.

What about just buying Dean Foods?

This is doable, but you would also be exposed to downward movements from White Wave losing part of its value. White Wave represents 75% of the value of a DF share, so a loss in value from White Wave would be significant. Also, since Fresh Dairy currently represents only 25% of the value of a DF share, owning an entire share without shorting out the WWAV portion means that any movement in Fresh Dairy would add much less profit — if the price of Fresh Dairy doubled from its current value, it would only mean a 25% increase in the price of DF overall.



Calculations

Nine months ending September 2012 Operating Income by segment, in millions:

Fresh Dairy 320,114
WWAV 182,210
Morningstar 91,515
Total 593,839
Fresh Dairy Share 54%


Dean Foods Pro-Forma Debt

DF Total Debt, Q3 $3,381,000,000
Minus Morningstar Proceeds, Net -$ 887,000,000
Minus WWAV Total Reduction DF Debt -$1,167,000,000
Minus ½ of Cash -$ 69,775,000
Pro Forma DF Debt $1,292,112,500


Dean Foods Fresh Dairy 2012 Earnings Estimate

Operating Income Breakdown, nine months to Sept. 30, 2012:

Nine-month Operating Income, 2012

from DF Q3 10Q, page 38
DF Stub (Fresh Dairy) $320,114,000
White Wave $182,210,000
Morningstar $91,515,000
Fresh Dairy calculated % of Operating Income 54%
2012 EPS Guidance $1.27 -1.32
Pro Forma Fresh Dairy EPS $.68 - .71

EPS * DF Stub % of operating incom
Pro Forma Fresh Dairy 2012 Earnings 125m - 132m

Pro Forma EPS * 185 m shares


Russell Miller is seeking an analyst opening at an event-driven or value-oriented investment fund. He has a math degree from MIT and an MBA from Texas A&M, and may be reached at rmiller@edmondsoncapital.com.

Rating: 3.4/5 (10 votes)

Comments

rdj1234
Rdj1234 - 1 year ago
I understand that Dean Foods is keeping 20 % of WWAV. Will that affect shorting WWAV?

Roger
Russell Miller
Russell Miller - 1 year ago
Hi Roger - Good question. No, it won't. Your bet is just on DF FDD. By shorting WWAV, you'll be neutral to its changes, even if DF retains some of the shares - you will only profit on changes to the FDD component.
ptobin
Ptobin - 1 year ago
One thing about DF's shares in WWAV. They are a different class of shares than the public float.

The Class A shares (issued during the IPO) are 1 vote per share

The Class B shares (currently retained by DF) are 10 votes per share.

So right now (pre spinoff) DF has a 97% voting interest in WWAV. And "Each share of Class B common stock is convertible into one share of Class A common stock at any time at our election and automatically in certain circumstances."

So after they spinoff the the shares, they still could have majority voting rights over WWAV even with only 34M of the float.

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