Billionaire Sandell's New Activist Idea

 | Sep 27, 2013 | 2:00 PM EDT
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Billionaire Tom Sandell has a tremendous track record as an activist investor but most investors don't know him. This week Sandell filed a new 13D filing with the SEC disclosing his new target: Bob Evans Farms (BOBE). Before deciding whether Bob Evans is a good investment, let's take a look at Sandell's investment thesis. Here is what Sandell said in a letter addressed to the company's board:

We believe that Bob Evans suffers from a conglomerate discount as a result of the company's two disparate business segments: a restaurant business, Bob Evans Restaurants, and a packaged foods business, BEF Foods. Due in part to this conglomerate structure, which has negatively impacted analyst coverage and ignores the different constituencies of restaurant and packaged foods investors, the company has traded at a perennial discount to its restaurant peers, and at an even greater discount to companies in the packaged foods space.

... We believe that the Company should take the following actions:

(1) Separate BEF Foods: Take steps to separate the company's BEF Foods segment, including filing a preliminary registration statement for an IPO, as a pre-cursor to a full spin-off. Based on our internal estimates, Bob Evans is trading at an enterprise value of approximately 8.7x FY2014E EBITDA, which is a substantial discount to the value ascribed to other publicly-traded packaged foods companies such as Campbell Soup, ConAgra, and Hormel. It is our belief that BEF Foods could command a multiple in excess of 10.0x EBITDA if it were to be spun-off to shareholders and traded on a stand-alone basis. Alternatively, in our view, BEF Foods could command an even higher multiple of EBITDA if it were sold to a third-party, particularly given the robust M&A activity witnessed in the packaged foods industry, with recent transactions for companies such as Ralcorp and Heinz taking place at multiples of 12.5 times and 14.3 times EBITDA, respectively, according to Bloomberg.

(2) Sale-Leaseback: Enter into a sale-leaseback transaction to unlock the significant real estate value embedded in the company's owned restaurant properties. As noted, Bob Evans owns 482 restaurants, representing 86% of the company's entire restaurant base, all of which will have been "Farm Fresh" remodeled by the end of Fiscal 2014. Given the company's fully-remodeled store base, we would view management's justification for owning real estate due to the "flexibility" inherent in such ownership as specious and no longer relevant to Bob Evans. Our analysis indicates that over $720 million could be generated via a sale-leaseback of the company's owned restaurants, a value that may be conservative given recent analyst estimates (e.g. "The company's real estate could be worth another $800MM - $1B" - CL King, April 26, 2013; "We are upgrading BOBE...due to what we view as a cleaner story for investors with improving margins, good underlying sales momentum in its core businesses and nearly $900 mil. in real estate value (64% of the enterprise value)" - Stephens Inc, January 30, 2013.)

(3) Repurchase Stock via Self-Tender: Apply most of the proceeds from (1) and (2) above to effect a large, one-time self-tender for the company's shares. To be clear, we feel it is important that Bob Evans provide the investment community with certainty that it will repurchase shares via a self-tender, as opposed to an indeterminate share repurchase "authorization." By our calculations, the company could generate proceeds of approximately $1.08 billion should the company sell its BEF Foods business and complete a sale-leaseback of its restaurant properties. As a hypothetical example, the company could use 75% of such proceeds to repurchase a significant number of shares via a self-tender at $58 per share while still leaving the company with substantial cash on its balance sheet. The resulting company would be a pure-play restaurant operator with a simplified corporate structure and a greatly reduced outstanding share count.

This was a rather long investment thesis but it is crucial that you understand what Sandell is proposing. First of all, we agree with Sandell that BEF Foods should be spun out or sold in a private transaction. I don't think BEF Foods can fetch an EBITDA multiple of more than 10, as interest rates have crept up over the past few months. Nevertheless, Bob Evans will probably receive around $500 million from a private transaction. The sale of BEF Foods will also open the doors for cost reductions at its corporate offices, but Sandell's analysis doesn't assume any cost reductions at this point.

We also agree with Sandell that there is no point in owning 86% of the restaurant properties. A sale-leaseback transaction will bring in another $700 million and after taxes, the company will have around $1 billion from these two initiatives.

Tom Sandell assumes that once Bob Evans completes these two transactions it can buy back nearly half of all outstanding shares of BOBE at a price of $58 per share. Bob Evans currently trades at $57, in short because it is a conglomerate and it has a ton of hidden assets. Once the markets believe that Sandell will be successful in his quest, the stock price of BOBE will increase to around $66 by our calculations. So, Bob Evans won't be able to create additional value by buying half of its outstanding shares at a discounted price. That's why we think Sandell's estimated value of $74 per share for BOBE is exaggerated. We think the stock has a realistic upside potential of 15% assuming that the overall market stays level over the next year or so while Bob Evans takes steps to implement Sandell's proposals.

I don't think this is going to be an easy campaign for Sandell and it may take more than a year to get things done. However, his proposals sound convincing and he will get the support of other shareholders in case there is a proxy contest. If you are a fan of the restaurant business, I believe Bob Evans will be a decent investment in comparison to other restaurant stocks over the next year or so.



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