Breakingviews: French fries make a tasty $11 bln takeover target

French fries work better as a side dish than a standalone meal. The same goes for Lamb Weston, one of the biggest suppliers of frozen potatoes to restaurants and supermarkets. Pressure from pushy Jana Partners could spark changes, but the best option is a sale to a more diversified company.

Lamb Weston owes its standalone status to Jana, which pressed Conagra Brands to offload it. The campaign, which led to the 2016 spinoff to shareholders, lends the hedge fund manager some credibility: without spuds separated, investors in the owner of brands such as Chef Boyardee would have been starved for returns.

Recent developments are troubling, however. The stock price halved in the two years to early August. Contributing factors included poor implementation of a new software system that impeded Lamb Weston’s ability to fill customer orders. The $11 billion company also devotes a chunky 9% of net sales to capital expenditures, which funded extra capacity that boss Tom Werner is now scaling back as part of a restructuring plan unveiled last month.

The shakeup probably does not go far enough. Jana blames a “litany of self-inflicted missteps,” which suggests the 5% stakeholder, in conjunction with agribusiness investment firm Continental Grain, could seek board seats, a new CEO or more aggressive changes. Yet none would fix a bigger issue for the McDonald’s supplier.

A fundamental problem is that Lamb Weston operates in an oligopolistic market with a select few large, private companies. Among the related challenges are that investors are left trying to value a publicly traded oddball.

This conundrum points to a simpler solution: sell to an agribusiness or food processing peer. It wouldn’t necessarily be easy. Assume a buyer offers $16 billion for the Lamb Weston enterprise, a 25% premium on the equity. With $950 million of projected operating profit, the implied return on investment would be a mere 4.5%, Breakingviews calculates, against the 7.1% cost of capital estimated by Morningstar. It would take synergies equivalent to 6% of revenue to bridge the gap: challenging, but probably attainable.

Post is one plausible suitor. The Weetabix cereal maker held talks to merge with Conagra’s french-fries business eight years ago. Its market capitalization is nearly half Lamb Weston’s, but CEO Robert Vitale could enlist outside investors or creative financial engineering. Another potential candidate is closely held giant Cargill, which teamed up with Continental Grain two years ago to buy poultry producer Sanderson Farms. However a deal were to be sliced, these taters are a tasty takeover target.