Mega deals create £660m debt

Three years ago, just after Kerry Group paid over £250 million for the American food ingredients group DCA, Kerry chief executive Denis Brosnan told The Irish Times: "Within two years, we will be able to do the same again, if not bigger."

It may have taken Kerry a bit more than two years to do another mega-deal, but yesterday's £394 million acquisition of Dalgety's food ingredients business puts Kerry firmly in the front rank, if not the lead position, in the world food ingredients industry.

To get to that position, however, Kerry has had to pay a high price and it will take all the group's financial management skills to make this deal work.

When this deal is completed, Kerry will have total debt of around £660 million on shareholders funds of just £120 million. This represents a debt/equity level of over 500 per cent - an astronomical level of debt for a company of the size of Kerry.

But the Irish group has traditionally carried a load of debt on its balance sheet and has funded the vast bulk of its £800 million of acquisitions of the past 10 years through debt.

Increasingly, analysts are ignoring gearing when assessing companies after heavily leveraged acquisitions like Kerry's purchase of the Dalgety food ingredients businesses.

Interest cover and cash flow generation are used as more accurate gauges of a company's ability to meet its debt obligations. So, on this basis, how does Kerry rate?

In 1996 (the most recent set of figures) Kerry had an operating cash flow of £116 million, while Dalgety had operating cash flow of around £50 million. The total 1996 operating cash flow of the combined business was £166 million, and would obviously be higher for 1997, a Kerry spokesman stated.

But that £116 million figure of Kerry in 1996 is operational cash flow and does not accurately reflect the company's ability to cut down debt. From that £116 million must be deducted £28 million of interest payments, a further £9 million for tax, £6 million for dividends and also capital expenditure.

Goodbody Stockbrokers has estimated that free cash flow as opposed to opera- tional cash flow in 1996 was £41 million and £71.5 million in 1997.

Throw in Dalgety's free cash flow and Goodbody analyst Mr Liam Igoe believes that Kerry will be able to reduce that £660 million net debt figure to £590 million by the end of 1998 and reduce it substantially further in succeeding years.

Interest cover after the deal is completed in late February will be 3.2 times, a low level of cover but by no means the lowest interest cover that Kerry has had on its balance sheet. So against the background of those balance sheet figures, why has Kerry decided to do an all-cash deal?

"We spoke to our banks and were able to put the funding in place, we can review that at any time but at the moment there are no plans for a placing or a rights issue," said a spokesman, citing Kerry's ability to pay off substantial acquisitions in the past with the minimum amount of equity being raised.

At 11 times operating profits of £29.9 million sterling, the Dalgety businesses are not coming to Kerry cheaply.

There is some surprise that the Irish group has given a clear commitment to retain all of the Dalgety assets being bought, even the Homepride flour business. Kerry decided to buy the Dalgety businesses as a unit even though it seems that the British group was willing to consider separate sales of its ingredients and milling businesses.

The Kerry statement does not break down the valuation it put on the two parts of the Dalgety businesses, which had sales of £359 million sterling and operating profits of £29.9 million sterling in the year to mid-1997.

It is understood, however, that the higher margin ingredients business had sales of about £185 million sterling and operating profits of around £18 million while the milling business had sales of around £175 million sterling and operating profits in the region of £11 million sterling.

"It's a combination of high margins in ingredients and comparatively low milling margins," said one analyst of the deal.

The acquisition, however, fills a major strategic gap in Kerry's food ingredients business and makes the Irish group the clear number one in the industry in Europe and possibly number one in the world with sales of £1.2 billion, depending on what is considered a food ingredient.

Within the food ingredients side of the Dalgety business, there are tremendous synergies, both in terms of geography and products, with Kerry's DCA business in North and Central America and the Ciprial businesses in continental Europe.

But even with the Spillers milling business, there are clear synergies with Kerry's ingredients business with Spillers Premier Products operating in the same area as Kerry's DCA bakery products business in the US.

Actual flour milling makes up only a portion of the Spillers business and will be maintained, despite speculation that Kerry would sell on the flour milling at an early stage.