General Mills' deal for Annie's hints at organic binge by growth-starved giants

Back in 2012, an investor posted a bearish write-up on the shares of organic-food maker Annie’s Inc. (BNNY) in the members-only Wall Street online idea-sharing forum Value Investors Club.

After setting out the case that Annie’s was overvalued, the poster then detailed a scenario that represented a key potential risk of betting against the trendy stock: “Some massive food producer with flagging revenue growth desperately overpays for BNNY in a few years after BNNY has managed to more or less execute on their growth plans.”

That’s exactly how it went down – or, rather, went up – as General Mills Inc. (GIS) agreed to buy Annie’s late Monday for $820 million in cash, or $46 per share.

Slamming the shorts

That’s a fat 37% premium over Annie’s Monday closing stock price, a final insult to the short sellers who had stalked the company since its March 2012 initial public offering, charging that its products were faddish, not all that healthy and vulnerable to nasty competition in the cutthroat supermarket aisles. On Tuesday, Annie's shares, pushed up by the deal, closed just above the buyout price, at $46.10.

The shorts, who recently accounted for more than 15% of Annie’s freely trading shares, seemed finally to have it nailed, as the stock tumbled from above $51 early this year to the low $30s, and more broadly has underperformed the market since its trading debut.

Yet the General Mills deal shows the no-growth giants of the Big Food industry can serve as a ready exit plan for niche, natural-food brands, which are among the small handful of food companies expanding quickly as “organic” goes fully mainstream. For General Mills, it’s a fairly small (if expensive) bet that the cereal-reliant giant can gain shelf space in the fast-growing category of packaged foods perceived and marketed as healthier.

Wall Street reflexively bid up the shares of other natural-food names, which also have been heavily shorted as part of a general skepticism toward high-multiple, limited-scale consumer stocks.

Hain Celestial Group Inc. (HAIN) shares, with more than 8% of the float shorted, rose more than 4% to a new all-time high near $102, before settling to $101 at the close. Boulder Brands Inc. (BDBD), with 15% short interest and a market value similar to what General Mills is paying for Annie’s, jumped more than 8% to close at $14.32.

WhiteWave Foods Co. (WWAV) also got a bump of nearly 3%, to $36.61, on heavy trading volume. While firmly part of the “natural/organic” food theme, a takeover of WhiteWave might be deemed less likely given that it was just spun off from a larger food conglomerate – Dean Foods Co. (DF) – last year.

Morgan Stanley analyst Matthew Grainger named Hain and Boulder as two likely recipients of follow-on buyout speculation, saying the Annie’s deal was noteworthy both for the “peak multiple” of earnings Annie’s fetched and for what it says about the usually conservative General Mills “to invest more aggressively in portfolio transformation.”

General Mills and its direct peers might feel they have little choice but to pay up for the brands with some growth momentum and a positive image among consumers.

General Mills has had some success promoting Cheerios as a healthier breakfast, is riding the strong yogurt wave through its Yoplait brand and has built its Small Planet Foods organic vegetables-and-sauces unit to $350 million in sales.

Yet the company has struggled with a sluggish packaged-food market;  total projected sales growth is tracking below food inflation rates this year and next. Kellogg Co. (K), Mondelez Inc. (MDLZ) and Danone Groupe (DANOY) are in a similar fix, which will likely keep the natural-food specialists on the merger-and-acquisition radar.

General Mills, a bit more than the rest, seems committed to recasting its business mix with a greater emphasis on purported natural and healthy offerings, though.

Deutsche Bank analyst Eric Katzman says that, while many investors remain skeptical, he sees the Annie’s purchase as evidence the company is “methodically adjusting its portfolio” in this manner. He argues that General Mills ought to “focus less on organic [profit] margins, and more on scale, categories and brands.”

Of course, the very fact that the big processed-food leaders are eager to ingest some “organic” credibility raises the risk that the “organic” label itself is becoming diluted and perhaps co-opted, at least in some consumers’ minds.

Annie’s Facebook page was plastered with some indignant comments from disillusioned purist organic fans of the brand, which has long defined itself in opposition to mass-market food producers.

Walmart Inc. (WMT) teamed with Wild Oats in recent months to create a line of private-label organic products – both an affirmation that organic has gone mainstream and a definitive sign of the “corporatization” of the category.

And as many suggest, the nutritional benefits of “certified organic” packaged foods such as Annie’s crackers or macaroni and cheese over popular competing brands, such as Kraft Foods Group Inc. (KRFT), are not clear.

So while the organic niche food companies might prove irresistible to growth-starved consumer conglomerates, there’s no guarantee that the brands’ perceived virtue or sales momentum will survive the process intact.