Private-label cereal maker Ralcorp buying Kraft's Post cereals unit for almost $1.7B in stock

CHICAGO - Kraft Foods Inc. agreed to sell its two dozen Post cereals to Ralcorp Holdings Inc. on Thursday in a nearly $1.7 billion stock deal that will make the private-label food maker a major player in the cereal market.

The acquisition, which is expected to be completed in mid-2008, catapults the maker of store-brand cereal into the No. 3 position behind industry leaders Kellogg Co. and General Mills Inc.

"This acquisition is indeed a watershed event for Ralcorp," said Kevin Hunt, the St. Louis-based company's co-chief executive officer.

But industry observers said Ralcorp faces an uphill battle to foster, market and develop brand-name cereals like Spoon Size Shredded Wheat, Raisin Bran, Honeycomb and Pebbles.

"I don't recall a branded company being able to run private label or a private label being effectively able to run brands," said Deutsche Bank analyst Eric Katzman.

If Ralcorp succeeds, the payoff will be substantial.

The tax-free transaction will boost Ralcorp's 2007 sales by 50 percent to $3.3 billion a year from $2.2 billion, with Post cereals accounting for about 32 percent of total annual sales.

"For them, the biggest challenge long term will be running branded versus private label and running them concurrently," said Morningstar analyst Greggory Warren. "The focus will now be delivering on the branded goods against very strong competitors. It's not going to be an easy road for them."

At Kraft, the Post portfolio generated sales of $1.1 billion last year.

The deal

Under terms of the agreement, Kraft will first split off or spin off Post and its related assets to shareholders. The Post cereals business would then be combined with Ralcorp. Kraft shareholders would own about 54 percent of the new Ralcorp when the deal is complete, with Ralcorp shareholders owning about 46 percent.

Ralcorp will also assume $950 million in debt, boosting the total deal value to $2.6 billion.

Ralcorp officials said they opted not to fold Post into their generic cereal brands, and are instead crafting a new division within the company to run Post.

Meanwhile, the Post addition gives Ralcorp momentum to pursue more acquisitions in the future.

"The Post platform gives us the scale to now look at the potential of branded acquisitions," said David Skarie, co-chief executive officer who will be responsible for Post after the transaction is completed.

The sale, which must receive shareholder and regulatory approval, is the biggest since Kraft Chief Executive Irene Rosenfeld announced an effort to shed slow-growing units to help the world's second-largest food and drink maker better focus its massive stable of products.

"The business is in good shape today but it can do even better with a company like Ralcorp," said Chris Baldwin, vice president of Kraft's snacks and cereals group.

Kraft will provide transition services for up to 18 months after closing.

Operations to stay put

Post's marketing and sales support team will continue to be based in New Jersey, and its R&D team will continue to be located in Battle Creek, Mich.

Kraft said if the deal is conducted through a spinoff, it expects shares to be diluted by 13 cents on an annual basis. A splitoff would dilute earnings by 7 cents.

Ralcorp said the acquisition will increase its earnings by $0.44 to $0.68 per share during the 2008 fiscal year.

"(The) transaction makes sense for both companies and should satisfy some critics of Kraft that it has moved too slowly to focus portfolio," Wachovia analyst Jonathan Feeney wrote in a research note Thursday.

The expanded Ralcorp will include the Post cereal manufacturing plants in Battle Creek, Mich.; Jonesboro, Ark.; Modesto, Calif.; and Niagara Falls in Canada. Ralcorp will retain employees at those facilities.

Kraft shares fell 61 cents, or 1.9 percent, to $32.37 Thursday. Ralcorp shares hit a three-month high, climbing $5.77, or 10.4 percent, to $61.24.