Investment Analysis and Portfolio Management

Jams with

Or

The Best Part of Wakin’ up

Has Got to be Good

FI561 Term Project

Christa Midcap

December 17, 2009

Executive Summary

The 2008 acquisition of the Folgers Coffee Company by the J.M. Smucker Company

was applauded when announced as it seemed a positive move for all involved. The

synergies and efficiencies created in this conglomerate merger provide higher

margins and profits for Smucker’s and also positive value for Folgers. Smucker’s

has added value to their firm by acquiring the top coffee maker at a positive net

present value of $1.5 billion. Smucker’s is well on its way to achieving dominance

in grocery stores’ center aisles.

The Players

The J.M. Smucker Company (SJM) has grown its Ohio-based fruit

spread business over the last hundred years into a top selling nationally known

brand. More recently, the company has grown very quickly as a result of food

industry acquisitions that have served to fulfill the company’s strategy to own and

market number one brands within respective categories. By doing so, Smucker’s

has steadily gained market share among food producers. In the years from 2002-

2005 which included some of their largest acquisitions, Smucker’s grew from a $1

billion company to an $8 billion dollar company with plants and operations across

the United States and Canada.

The Folgers Coffee Company was established over 150 years ago in

San Francisco and has become the number one selling retail coffee brand by sales

and volume. While part of the Procter & Gamble Company, Folgers’ market share

grew to nearly 40% of the packaged coffee market, but had begun to experience

dragging sales due to the growing popularity of the foodservice coffee shops.

The Goal

Smucker’s goal in acquiring Folgers is part of their long term strategy to promote

balanced growth of the company through increases in market share. The company

executes this strategy by buying companies they have strong synergies with and can

create efficiencies. The results have been sales growth, operating efficiencies and

the repurchase of shares which increases value of the firm. In the area of sales

growth, Smucker’s successfully increases sales by marketing, cross-brand

promotions and introducing new products.

Smucker’s expects total savings from synergies with Folgers to total $80 million.

Savings will come from the areas of administration, supply chain, warehouse and

distribution costs. Smucker’s and Folgers have the same marketing demographic,

people who prepare meals at home. Also, the sale and distribution of Folgers is

aligned with Smucker’s current sales model. Smucker’s anticipates more

innovation capabilities in formulation, processes, and packaging.

The financial impact of the acquisition will result in growing operating profit and

EBITDA margins and an increase in free cash flow. Folgers is a $1 billion company.

The addition of their high volume of sales will produce a nearly 50% increase in

revenue. Together with the predicted savings from COGS and SG&A of 4%,

Smucker’s hopes for an increase of 8 percentage points of operating profit margin.

Smucker’s will also be able to focus more attention on Folgers and make the

changes needed to boost growth for the coffee maker.

The Deal

In the summer of 2008 Smucker’s proposed to buy the Folgers Coffee Company from

Procter & Gamble, who had been looking to split off the popular coffee maker due to

sluggish growth prospects. By year end, Smucker’s came to an agreement with P&G

to acquire Folgers for a total of approximately $3.3 billion. The company offered

P&G shareholders about 1.6 shares of SJM for their P&G shares. Smucker’s issued

roughly 63 million shares and P&G shareholders owned 53.5% of the new company.

To increase value to their own shareholder’s Smucker’s agreed to pay a special

onetime cash dividend of $5 per share to existing shareholders indicating the

strength of the combined businesses. In addition to the tax free share exchange and

special dividend, Smucker’s agreed to take on $350 million in Folgers debt.

The New Company

Smucker’s with the addition of Folgers aims to be a low cost provider that is also

looking to differentiate itself in the market. They will achieve this through an

efficient distribution and better access to capital and buyers. What differentiates

them are their strong brands with a loyal customer base.

High volume drives this new company as they seek to add top selling, familiar

brands with a large presence in their respective markets. Cost and price are also

very important as Smucker’s strives for efficiencies and looks to improve the quality

or the perception of improved quality in all its brands in order to change

prices.

With the integration of Folgers, the product mix of Smucker’s was radically

transformed. The newly acquired company now contributes 42% of Smucker’s total

sales. Net sales increased 48% in fiscal year 2009 compared to FY2008. Net income

increased by more than 50%. Selling and administrative expenses decreased as a

percentage of net sales by 7%. Free cash flow from operations has also been boosted

causing a comfortable level of liquidity. Smucker’s appears to be achieving the

growth predicted before the merger in sales, profit and synergies.

Because of the success of the merger, each earnings release beats expectations and

this is reflected in the spike of the stock price and volume every three months.

Compared to the previous year, although earnings rose dramatically, EPS only

increased by 4% due the higher number of shares. More investors are taking notice

of the added value of the merged companies and SJM is gaining more attention as it

grows in market share.

SJM : NYSE

Industry: Food Products

The Added Value

The value added by Folgers consists of its incoming cash flows plus the value of the

assets that provide those cash flows over and above the costs incurred by Smucker’s

to acquire and integrate the company.

To approximate future cash flows, I took the average of the last 3 years’ EBITDA

and multiplied it by a growth rate of 6% which was the long term objective stated by

Smucker’s. These cash flows were discounted by using the cost assumed from the

Folgers debt plus a small premium to cover risk for a total required rate of return of

12%. Using these inputs yields a present value of the future cash flows of $5.9

billion.

The explicit cost to Smucker’s for the stock exchange and special dividend was

approximately $3 billion. The implicit costs were the assumed debt of $350 million

plus any opportunity costs sustained by combining the two companies and added

income tax and interest expense. I estimate the total costs to be about $4.4 billion.

The net present value to Smucker’s of acquiring Folgers is $1.5 billion.

The Happy Ending

In the end, Smucker’s gains one billion dollars of added value to the firm. Procter &

Gamble gains by divesting a company that no longer fit into their long term

strategy. Folgers also gains a partner who is willing and able to grow the firm to its

full potential. Smucker’s shareholders gain by steady, balanced growth. Everybody

wins.

The Calculation of NPV

PV =

PV = 331.25 + 313.50 + 296.71 + 4945.16

PV = $5,886,620

NPV = PV – Explicit Costs – Implicit Costs

NPV = 5.9B – 3B – 1.4B = $1.5 billion

Resources

All company financial data taken from Smucker’s annual

reports and investor presentations obtained at

www.smucker.com

Company information on Folgers and details on the merger

transaction gathered from SEC filings found on

www.sec.gov/edgar/searchedgar/webusers.htm

Analysis and stock chart found on www.cnbc.com