This note was originally published May 13, 2013 at 11:52 in Consumer Staples
With Dean Foods (DF) reporting last week, we wanted to take the opportunity to update our thoughts with respect to the value and opportunity surrounding the fluid milk business at DF (DF less WhiteWave (WWAV), or the DF stub).
We expect a good bit of volatility in both DF and WWAV as we move toward the May 23 distribution date (WWAV shares to be distributed to DF shareholders on a pro rata basis). Holders of DF as of May 17 will receive a total of 115.6 million shares of WWAV, or approximately 0.62 shares of Class A and Class B WWAV shares for every DF share held. DF will retain an approximately 19.9% ownership interest in WWAV subsequent to the distribution, with plans to monetize that portion at some point over the course of the next 18 months.
Admittedly, it’s tough to isolate the value at DF – buying DF and shorting WWAV is difficult because WWAV is such a tough borrow at this point. Fully half the float is short, but note that it likely isn’t “squeezy” short as a significant portion of those shares won’t need to be covered in the market, but will be covered through the distribution. Still, eliminating the value of WWAV over the near term is likely to be dodgy.
Also, DF is currently an S&P 500 component, but its continued inclusion post-distribution is an open issue given what will be a much lower share price and reduced market cap. Forced selling by index funds and closet indexers is a consideration, adding to the complexity of trading the stub in the near term. In terms of the lower share price, DF announced on its first quarter earnings call last week that it would seek approval for a reverse stock split with the appropriate split ratio to be determined.
So, lots of moving parts, but let’s keep our eye on the prize. In Q1, the DF stub generated $116 million of EBITDA, putting it squarely on track to exceed our forecast of $415 million of EBITDA for 2013. DF currently has a market cap of $3.540 billion, which represents both the value of the fluid milk business and the ownership of 86.7% of WWAV. Excluding the value of WWAV (86.7% times WWAV market capitalization of $3.108 billion) from the market cap of DF gets us to a stub equity value of approximately $845 million. The stub has net debt of $1.034 billion and therefore an associated Enterprise Value (EV) of $1.898 billion covering over $400 million of EBITDA, or right around 4.5 times EV/EBITDA. That’s just too cheap, in our view. Admittedly, we have never liked the fluid milk business and are loathe to put an sort of significant multiple on it, but even a reasonable 7.5 times multiple makes this a compelling investment.
Part of the reason it’s cheap is precisely because it is so difficult to isolate the value. However, we believe that investors should be prepared to move if any of the near-term volatility presents an opportunity (short-covering at WWAV, forced selling at DF because of index considerations). Further, once we move past the distribution date, we think it makes sense for long-only small and mid-cap investors to become involved in what is a very compelling opportunity.