Motley Fool Hidden Gems Investing - Nobody Told Us This Was M&A Week

Starting point is 00:00:00 It is merger mania this week. This is Motley Fool Money. Welcome to Motley Fool Money. I'm Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Lou Whiteman, with three of us being part of the Hidden Gems team here at Motley Fool. As we said, there has been a lot of movement in the merger and acquisition field in the past couple of days, and we're going to try to break down as many of those deals as we can. Also, we're going to get to some listener questions. But to start, let's go with a lot of the deals that's going on in the food industry, because we had two doozies. There must have been a lot of lawyers and investment bankers putting in extra hours this past weekend, because first,

Starting point is 00:00:55 we got news on monday that cisco the food distributor not the networking hardware company was acquiring private retailer restaurant depot for 26 billion dollars we'll get into the details in a second here but i think that was going to be the headline deal we were going to talk about and then this morning we had a even bigger deal where mccormick basically said hold my beer because they decided to merge with unilever's food division in a 44 billion dollar deal and what makes that striking is that McCormick itself is a $14 billion company, and Cisco, doing a $26 billion deal, was a $30 billion company. So, these are massive transformative changes in pretty sleepy consumer brand food distribution sort of businesses. Now, personally, as I looked at the initial deals,

Starting point is 00:01:41 I was a little dubious. But if forced to choose, I would probably say the Cisco deal looks a little but better. But I wanted to turn to you guys and see what you guys thought of both of these. I'm going to start with you, Matt. Are either of these deals making Cisco or McCormick more attractive? I'd agree that the Cisco deal is the more interesting of the two to me. If you're not familiar, Cisco is the largest food service distributor in the United States. I had a short career in the restaurant industry many years ago. I worked at a total of four restaurants across two states. Cisco was the primary food supplier for all of them, and that's among the other 700,000 restaurants it serves worldwide.

Starting point is 00:02:21 It is a massive distribution network. It gives it a major efficiency advantage over its competitors. On the other hand, Restaurant Depot, it's a network of in-person wholesale restaurant supply warehouses. Think of it as like a Costco or a Sam's Club, but specifically for restaurants. It's carved out a very nice niche among restaurant owners who value flexibility and pricing over the convenience of the national distributor, Cisco. Yeah. Now, as Matt says, Restaurant Depot is a much different business, arguably a better business, better margins, decent cash flow. And it better be because Cisco is paying a price that's higher than Cisco's multiple. So they are hoping to see

Starting point is 00:03:01 their business improve because of Restaurant Depot. Real question for me is, can they get this done? Last time Cisco tried something like this with U.S. Foods, antitrust got in the way. it's a decade later and as i said they are different businesses but you know we'll see how it plays out uh tyler i do have to say though you said interesting and to me when i back when i was in deal making world there was nothing more interesting than a reverse morris trust mccormick gets it just for interest just for that because they are doing this they're using this kind of cool thing where they are merging with part of unilever and unilever gets to spin it off tax-free. I'm real curious about this because it used to be deals like this made sense. Shelf

Starting point is 00:03:41 space mattered. Jamming more things into a truck that's heading to the store, that gives you scale, that gives you synergies. That was supposed to matter. Recent history, including Kraft Heinz and some other deals we can get to, it's less settled science now whether that works. Maybe this is an opportunity to find out how much of what went wrong in other deals was the management execution compared to just the strategy uh the strategy could make sense mccormick and paper i think is better managed so i i am at least curious to see how this plays out to lose point thinking about like jamming stuff into trucks it it certainly there there is some sort of logic to what's going on here but i feel like m&a activity in specifically in like consumer

Starting point is 00:04:26 brands has been like that joke from the tv show arrested development it became like an internet meme where it's like, well, did it work out for them? And then they go, no, they delude themselves into thinking it won't work, but it destroys value. But it could work for us. And every single time, I've been running through the mental Rolodex of consumer goods deals over the past decade, where you can say it was definitively a win for its investors. We mentioned Kraft Heinz. That was kind of a blunder. The AB InBev buying SAB Miller to unite the beer worlds, that was not so great. Curring Dr. Pepper merger hasn't turned out too well either. I mean, the jury's still out on this recent one with Kimberly Clark and Kenview. But I can't think of a major consumer

Starting point is 00:05:12 brands deal where we're like, yep, really good stuff. Now, consumer brands is historically a defensive sector. So the goal for some investors may be just collect a dividend, call it a day. it's fine. That's what a lot of investors want. But aside from that, this track record of value destruction at these major brands has to be like a red flag going into these sort of deals, don't you think? My theory here is it's not the deals, it's the companies. The value of brands have been diminished over the course of the last 20 years or so. I kind of blame the internet, better flow of information, but who knows? But consumer goods to me today is a barbell. Most consumers will pay up for certain specific items, whether it's on holding shoes in any

Starting point is 00:05:53 given moment or one just kind of splurge. But otherwise, consumers are happy to buy generic. That's a nightmare for these mid-tier brands. And that's most of what we're talking about with Kimberly Clark, Kenview, Kraft, and Heinz. If that's the case, this is a bad move for McCormick. And honestly, I believe in enough that I personally try not to invest in brands in the middle. The bottom line is, I don't think people still find value in buying, say, Tylenol versus Kroger brand Tylenol. That's a problem for anyone selling these wide distribution, but a little bit extra

Starting point is 00:06:30 because it's a brand name sort of products. There have been a few decent examples of deals like this that have worked. Performance Food Group, getting back to the Cisco situation, is one that looks really interesting. Ticker symbol is PFGC. Between 2019 and 2023, it acquired three of its major competitors, including Cheney Brothers, which is a big Cisco competitor. A major reason was to add new consumer segments, which is one of the reasons Cisco is acquiring Restaurant Warehouse. The stock is up 160% since the start of 2019. I'd call that a pretty solid example and a pretty close parallel, but I completely see your point. there is a lot that can go wrong with these types of acquisitions, especially when a company like

Starting point is 00:07:16 Cisco is taking on $21 billion of new debt to make it happen. Yeah. And just for keeping score, too, the deal between Unilever and McCormick is also going to be taking on a rather considerable portion of debt as well. And whatever happens with these, the question for the next couple of years is, how quickly can we get these debt levels back down to pay off and make these things worth they're wild. So we will be watching that. And then after the break, we're going to look at another M&A deal, but completely unrelated industry. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad. I get it. I'm Siaya and I live in Ice Cove.

Starting point is 00:07:58 I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Okay, so we're going to shift gears in the industries we're talking about. We're going to stick with M&A. Yesterday, Eli Lilly announced it was acquiring Centessa Pharmaceuticals.

Starting point is 00:08:27 As the case with most biotech deals, it is contingent on Centessa meeting some milestones. But assuming Centessa hits them, the deal is worth approximately $7.8 billion. Now, I'm going to leave it to you, Matt, to kind of get into the details of what it does. But Centessa is a clinical stage development company that's looking to treat narcolepsy. But why is Eli Lilly willing to fork over $7 billion for a company that doesn't really even have a commercial treatment yet? Yeah, that's a really good question. So, as you mentioned, they're a clinical stage pharmaceutical.

Starting point is 00:09:02 They develop treatments for rare diseases. It's not just narcolepsy. They have some other things in the pipeline, but that's their most promising candidate. They have a product that's in later stage trials. It just passed a phase two trial. That was very promising. And the main product, it looks like it's going to become the first to market treatment and the most effective for several forms of narcolepsy. And this is estimated to be a $5 billion market. It has several other treatments, like I mentioned in earlier trials, but that drug is why Lilly's buying it. The idea is that Lilly's capabilities can help it accelerate its time to market. If it's successful in obtaining FDA approval, which is those milestones you mentioned,

Starting point is 00:09:44 in order to get that full $7.8 billion, it would have to get FDA approval for all these forms of narcolepsy. If that happens, the treatment could be worth several times what Lilly's paying for it. It's a big if, but that's the goal. That's why Lilly's paying up for a company it doesn't have a commercial product yet. This is just a big part of how R&D works in the industry. I mean, look, I've seen the estimates. It's almost $2 billion that big pharma spends to get just one drug into production through clearance. If you can do kind of closer to a sure thing for $7 or $8 billion, suddenly it doesn't look too bad. In Lilly's case, too, this is a proactive move to make sure that this does not become a one-hit wonder or one product company. Right now, about

Starting point is 00:10:33 60% of Lilly's revenue comes from GLP-1s. And if anything, given all of the trials they have for different treatments, trying to get other GLP treatments on label, that's likely to only go up from here. The nature of pharma is all good things come to an end. You're constantly racing to stay ahead of a patent expiration cliff, investing in a prominent therapy outside of GLP-1s, that makes a lot of sense, assuming their scientists think that there is a there here, and I'm going to leave it to their scientists, not me, to say whether or not what they're buying really makes sense. Apparently, they think so.

Starting point is 00:11:09 To that point, too, I'm not going to claim to be somebody who can read clinical trial data very well and say whether it's good or bad in the direction they're going, but as somebody who has invested in the space from time to time there are some like hard numbers that investors should think about when looking at clinical stage pharmaceutical companies and it's something around like 20 to 30 percent of drug candidates that start a phase two clinical trial end up actually getting all the way through trials and fda approval so you want to think of it as almost like companies with lots of shots on goal in their pipe development pipeline because you know, there's no far-growing conclusion that any of these in particular ones are going to make it

Starting point is 00:11:50 through. And as we mentioned, there are some kind of like contingencies built into the deal that says, hey, you know, you have to meet these milestones for us to actually pay out the number that we're saying. I want to shift gears a little bit because talking about healthcare in general, I want to get your guys' thoughts, but I don't want to drift too far here. One thing it's hard to shake when looking at the industry right now is FDA approvals. You know, the rules and processes for getting approvals look pretty different in this current administration than in prior ones. And I think we mentioned it on a prior show earlier this year, Moderna CEO Stefan Banz said that it is scaling back clinical trials for its mRNA vaccines because it would be,

Starting point is 00:12:29 you know, as his quote said, difficult to see return on investment. Now, that was specifically tied to mRNA vaccines. And we know that the current administration's position on vaccines is very different than what we've had in the past. And I know that both of you have some ties to the healthcare industry through your families and stuff like that. But as you look at this space as investors, have the recent changes in FDA approvals maybe changed the way you think about investing in clinical stage companies, at least in the time being? I generally avoid the pharmaceutical industry for the reasons that you mentioned, because only 20% to 30% of the drugs that pass phase two trials actually come to market. So for me, it hasn't really changed the way I invest

Starting point is 00:13:12 personally, but it's definitely something that healthcare investors should take into account. Yeah. So I am, due to family, for most of my career, I've been restricted by conflict of interest. I can't. So that's an easy answer for me. But I will say this, these are long-term projects. It takes upwards of a decade to get some drugs through clearance. I don't think these companies have to worry about any one regime because usually things have changed over the course of it. So I don't think, I mean, I think it's something for investors to be aware of, but I wouldn't lean into political wins, changes kind of coming from the agency with, you know, cycle to cycle. I think that, you know, if the science is good, there's a ways to get it done.

Starting point is 00:14:00 And so you focus on trying to figure out the science. After the break, we're going to dip into the mailbag. New from Nespresso. Blend wellness into your coffee routine with the Coffee Plus range, infused with functional benefits. Choose the coffee you love with added B vitamins, like Coffee Plus B12 to help support immune function and Coffee Plus B6 to keep your day moving. Or go with the flow and choose Ginseng Delight, our new double espresso with ginseng extract. Whatever lies ahead, don't change your morning. Let your morning change you. discover coffee plus on espresso.com quick reminder we want to make you part of the conversation so if you have a stock or investing question for matt lou myself or anyone else on the motley fool

Starting point is 00:14:42 money show you can now email us at podcasts at full.com we'd love to have your mailbag segments whenever possible so send in your questions and just remember to keep them foolish that email again is podcasts at fool.com podcasts at fool.com and i'm going to read this listener question that we got a little while ago. It comes from Vijay Kant. I apologize if I mispronounce any names. I guarantee it's going to happen whenever we do these mailbag sections. His question was, I want to get your perspective on the long-term investment thesis of Whirlpool. The ticker is WHR. I'm drawn to the generous dividend, but also question the sustainability of the dividend, given its high debt load on the balance sheet. I also want your opinion on the long-term narrative

Starting point is 00:15:22 of the company, given the international competitive environment in the large appliance sector. Thanks for the comments. Cheers. Matt, I want to start with you. Whirlpool, what is your take? My short answer is, the market doesn't seem too convinced on the long-term thesis for Whirlpool either. The stock is down more than 50% from its high. It's still a profitable business. It has a 6.9% dividend yield, as we're recording this, that's well covered by its earnings. It trades for about 9.3 times trailing 12-month earnings and less than 9 times forward earnings. It has about $6.5 billion of debt. I don't view that as an unreasonable debt load, especially because it's steadily declined for the past three years. Now, management has made some questionable

Starting point is 00:16:06 decisions recently. I will say that. They did a dilutive capital raise about a month ago. It caused the stock to drop 15%. That was a good portion of that decline I mentioned. It's a solid business, a nice dividend stock to own, but it's not one to buy and forget. I think I'm with the market on this one. The bull case is a recovering housing market plus continued tariffs boost sales. I think we're quite early in the recovery of housing, and I'm not sure what to think on tariffs. Dividend does look okay for now, but remember, they already cut it in half last year, so they are willing to make the hard decisions. And they did just raise capital in February. That makes things look better, but that speaks to a business that is not firing all

Starting point is 00:16:49 cylinders. There's probably a trade to be done here, guys, because Matt's right, the business isn't going away and there is probably, you know, a bottom to bounce off of, especially with activism involved. But for me, I don't see this as an attractive long-term investment. Too many, the deck is stacked against them. As a company that we can say is sensitive to the economic headwinds or tailwinds of the housing industry, whether that be new construction or refurbishment or anything like that, it's going to take a while for something like Whirlpool to really turn around. All you have to do is look at mortgage originations or refinancing originations to see that the housing market is in a very, very slow space. And as long as that is kind of crawling

Starting point is 00:17:33 along, it's hard to see Whirlpool making a really strong recovery. So I think we're all kind of in consensus here. There's probably a long-term narrative somewhere, but with the headwinds that the company is facing, maybe just sit on the sidelines for a while. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks for

Starting point is 00:18:10 producer Dan Boyd and the rest of The Motley Fool team. For Matt, Lou, and myself, thanks for listening, and we'll chat again soon. you

Motley Fool Hidden Gems Investing - Nobody Told Us This Was M&A Week

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