It is with some frequency I read about deals that I consider to be nothing short of absolutely bananas. This considered, you will understand why, upon reading into the details of Chiquita’s $1.07bn merger with Fyffes to create the world’s largest banana supplier, I couldn’t help but crack a wry smile at the irony of a deal which I believe demonstrates the value potential provided by M&A when it functions at its finest. Consequently, in my blog this week I will unpick the details and synergies of the deal in order to explain exactly why I feel that the merger will prove to be not only shrewd by adding scale, combining complimentary product offerings and thus increasing profits, but perhaps essential considering the pressures afflicting today’s banana supply chain.
Let us look first at the potential benefits accruing to ChiquitaFyffes as a result of the amalgamation of what are two very different but complimentary market positions. Firstly, the two companies dominate in separate geographic markets. In North America Chiquita has a market share of 29% whereas Fyffes has a market share of just 5%. Comparatively, in Europe Fyffes is responsible for almost 16% of total distribution. Chiquita accounts for just less than 12%. Under this situation, the capacity for synergies is clear. Indeed, ChiquitaFyffes forecasts that it will realise operating cost savings of $40m per annum by the end of 2016 from the integration of logistics and procurement operations.
Moreover, as a result of the companies differing geographies, I see clear scope for the consolidation to increase the top line of business by driving revenues as well as the bottom line by cutting costs. In its most obvious form this comes from the capacity to utilise each other’s distribution chains. This potential is particularly ripe in regards to the sales of Fyffe in the US where at a market share of 5% it clearly lacks the size to be able to fully exploit the benefits of economies of scale. By using Chiquita’s established North American distribution network as a springboard into the US I anticipate that Fyffes will be able to provide a more competitive price point to US buyers with the result of increasing market share and ultimately higher profits.
Moreover, the two companies operate not only in different geographic markets, but very different product markets also. Chiquita has built its business model on margin and quality whereas Fyffes has generally targeted the mass market; driving volumes by selling at a far lower margin. If the companies maintain these separate positions – and I believe they will – the new combined entity will not only have increased negotiating leverage with large clients such as supermarkets, but also be able to offer them a menu of options. I expect that these factors will be accretive to both revenues and profits.
So far I have presented the cost savings and revenue opportunities arising from the merger as though they are simply beneficial to the firm, a matter of improving its competitive position. However, I would argue that the truth goes far further than this, beyond the luxury of earnings per share and the dividends accruing to shareholders down to the tooth and nail matter of survival in an industry where operating margins continue to be squeezed from both sides. In 2004 Chiquita and Fyffes had operating margins of 3.5% and 4.4% respectively. By 2012 Fyffes’ had declined to 3.5% and Chiquita had fallen even harder to minus 0.1%.
In the first instance, this is the result of disease and bad weather affecting harvests. Consequently, the price at which banana distributors are able to procure bananas has been going up. At the same time, the price at which they are able to realise for the bananas that they sell has been falling. The latter is the consequence of continued supermarket price wars in which staple groceries such as bananas are headline items and over recent years have even been sold at a loss by supermarkets in a bid to gain market share. Indeed, with the recent aggressive discounting announced by Morrison’s in response to falling profits, I believe we are on the verge of a supermarket price war that could depress prices and erode the margins of banana suppliers even further. Under these low margins and adverse circumstances, I believe that the benefits of scale and even relatively low cost synergies of $40m could provide an increase in profits that mark the difference between success and failure.
On a closing remark, a couple of weeks ago I wrote an article entitled “M&A: Don’t bet your House Against the Cycle just Yet”. In this article I argued that the M&A cycle was on an upward curve. Taking a moment to look at the form of the ChiquitaFyffes deal what we effectively have is a merger of equals with the ownership only slightly in favour of Chiquita in a stock for stock transaction. I believe that as well as being significant for the reasons discussed in this article, the deal is also significant as a data point in an M&A upswing that is a far cry from the reserved cash deals that dominated 2013. The market isn’t quite going bananas, yet, but it’s certainly heating up.
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