Dean Foods paving way for a split

by L. Joshua Sosland
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BOCA RATON, FLA. — While acknowledging shareholder value would be maximized if Dean Foods Co. would separate its two principal segments, the company’s top executive said the time for such a step has not yet arrived.

Gregg L. Engles, chairman and chief executive officer of Dallas-based Dean, said that at present, the company’s debt load is too heavy to allow the spinning off of its WhiteWave-Alpro division from its dairy processing and distribution business. Mr. Engles spoke Feb. 22 at the annual conference of the Consumer Analyst Group of New York at the Boca Raton Resort and Club in Boca Raton.

Mr. Engles’ discussion of strategic alternatives for WhiteWave was preceded by a guarded outlook about prospects for the company’s struggling Fresh Dairy Direct — Morningstar segment.

“Wholesale pricing felt like it was in the process of finding a bottom in Q4 as well,” he said, having noted that industry profitability appeared to be stabilizing. “The fluid milk industry is a relatively low-margin business, and we believe the majority of our competitors have operating margins below ours. As the industry has renegotiated prices with retailers, margins have been compressed. The recent competitive behavior leads us to believe that there may not be much room left for additional price compression. While we don’t expect material improvement over the short term, these signs of stability give us increased confidence that we will find a base that we can build on in the back half of 2011.”

By contrast, he said Dean’s WhiteWave unit is “hitting on all cylinders,” enjoying strong earnings momentum.

The business sells a range of branded dairy, soy and plant-based beverages and foods. Its brands include Silk soy and almond milk, Horizon organic milk and other dairy products, International Delight creamers and Land O’Lakes creamers. Alpro is a branded soy business in Europe.

Mr. Engles said the division’s success has prompted investors and analysts for some time to ask how to maximize shareholder value for WhiteWave.

At the outset of his discussion, Mr. Engles validated the question.

“I think it’s safe to say that the market would assign an independent WhiteWave-Alpro company a significantly higher multiple than the combined businesses currently receive,” he said. “The viable alternatives for getting at the value, however, each has significant costs or obstacles today.”

He said Dean has looked at a range of strategic alternatives but has focused on three, beginning with an outright sale of WhiteWave Alpro. On the plus side, such a transaction would allow Dean to “eliminate much of the financial risk” associated with the company’s current high level of indebtedness and would give Dean the resources it needs to transform its remaining dairy business.

“But this strategy comes with significant costs,” he said. “First, because of our low tax basis in these businesses, we would incur significant taxes upon sale, which would materially diminish the net proceeds we would receive for the business and meaningfully erode the premium multiple we seek to capture. But more importantly, we would have parted with our highest-growth, highest-return business and concentrated our value into our slower-growth, lower-margin segment.”

A second alternative is a tax-free separation that would give Dean shareholders ownership in two distinct companies — F.D.D.-Morningstar and WhiteWave. He described this option as “both a theoretically and practically attractive alternative” that would allow each company to find a “natural investor base” and to be “fairly valued by the market.”

Keeping such a transaction, at present, from becoming a reality is Dean’s high level of debt. At the end of 2010, Dean had $3.9 billion of long-term debt against $1.5 billion of equity.

“We have been unable to construct separate balance sheets for the two businesses that each company could support,” he said. “To do so would require substantial amounts of equity.” He warned that infusions of equity capital would “significantly dilute current shareholders,” an outcome contrary to the objective of the spin-off.

“That leaves our third option — hold the WhiteWave-Alpro business in the Dean portfolio and continue to feed its growth, supporting the continued strong growth in earnings that we expect while reducing the leverage on our balance sheet,” he said. “This approach preserves our future ability to separate the businesses tax-free until such time as we have sufficiently deleveraged our balance sheet to support two separate businesses without diluting our current shareholders by issuing additional common equity.”

While affirming that the third option is the one currently being pursued, Mr. Engles said other alternatives would be considered in the future “if circumstances warrant.”

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