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Wednesday, October 04, 2006

Sara Lee Could be Acquired, But It's Too Expensive

Sara Lee (SLE-NYSE)
Stock Price: $16.40
52wk Range: $14.08-19.64 (ex-Hanes)
Market Cap: $12.48 Billion

Sara Lee (SLE) is up 2% again on continued hopes of a private equity leveraged buyout. There are articles and media reports that the company has interested parties reviewing the possibilities. A deal has been rumored and speculated on for many months, and while it would be good for the company it might not be great for the buyer. It may take up to $15 Billion to get shareholders to go along with this, and when you run the math it starts getting too expensive.

Sara Lee received a one-time payment of $2.4 billion from Hanesbrands as part of its spin-off agreement and received $575 million for its EU meats business, plus the assumption of pension-related liabilities of $39 million.

Here are some forward metrics from recent announcements, and some of these may already be lower:

-expects full year fiscal 2007 EPS to be in the range of $.80 to $.88 per share, but that includes $.06-$.08 per share of earnings from owning the branded apparel business through Sept. 5, 2006 and an item of $.15 per share from the sale of its tobacco business in fiscal 1999, which was received in early fiscal 2007.

-so looks more like $0.58 to $0.66 EPS for 2007 is a range from actual operations.

-expects net sales for fiscal 2007 for core Sara Lee businesses to increase by 2%-3%.

-year-over-year sales will increase in each quarter; profit should be up in each quarter for the remainder of the year.

-targets 2010 sales at $14 Billion and views 12% operating margins; current outlook is for sales growth of 2%-4% per year, with margins increasing annually over the next several years.

-forecast operating margins of 7.1 percent to 7.3 percent for 2007, up from 6.7 percent in 2006, and cash from operations of $400 million to $500 million.

Here is the key issue in my mind that a private equity group will look at: THE CASH.

The balance sheet overall has not been that great, but now with the $575 million and $2.4 Billion cash receipts it actually looks much better. It still isn't good enough though. Id a private equity group was going to buy this company they need to do it vulture-style or going for a quick-flip. With all the cash that has been raised the private equity owners can kick themselves a whopper of a dividend next year, maybe even to the tune of 10% to 13% without sucking the company too dry. Then they can explore a fast IPO for late 2007 to early 2008 if the turnaround goes as it is expected and could explore selling some more units (even though the company said they finished restructuring). This is still a market gamble for a buyer, because if the stock market turns weaker this one won't look as good as many other potential IPO's.

They also would need to act fast because the company is buying back shares, and all that does for a new would-be buyer is prop up the stock and take cash off the balance sheet.

A private equity buyer here would have to be a true believer. The good news is that this would commit $15 Billion or so in private equity funds that are just sitting on the sidelines, but it would also take them away from being able to do smaller and more rewarding deals. The bulk of the restructuring has occurred if you believe the company. If a private equity buyer steps in they should need to keep management and give them a huge pay-off if they can execute a great turnaround in 18 months.

David Faber was on CNBC this morning and was questioning an LBO of SLE as a possibility, and I must admit that I am in his camp on this one. If an LBO comes down for SLE, then you will have proof that investors in private equity are demanding that their managers go for quantity rather than quality.

Jon C. Ogg
October 4, 2006

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