Spin-Off Alert: Dean Foods Stub Is A Cheap Pure-Play

Dean Foods (DF) is spinning off the remainder of White Wave (WWAV), its soy milk division, in the next few months
DF currently owns 86.7% of WWAV. If you subtract out the value of the WWAV business, the DF stub has an implied P/E of 7.43.

Once the spin-off is complete, the Dean Foods milk business will trade on its own, and should revalue upwards in a month or two due to it trading for a much lower valuation than comparables.

The median P/E for food companies 16, low end is 12. Currently, Dean Foods has a P/E of 25. The lowest P/E Dean has ever traded for is 9.

Risks:
*DF’s milk business, Fresh Dairy, is a commodity business with operating earnings that have gone fallen by half since 2009
*Dean Foods has very high leverage, 26x debt-to-equity.
However, Dean’s debt is only 3.7x operating cash flow, so there shouldn’t be any problems in making payments, especially given the short time frame of the trade.

Background
Dean Foods is a Dallas-based milk producer that’s grown through acquisitions, financed by debt, since the early nineties. It’s now seeking liquidity by spinning off its divisions. It just completed a private sale of its Morningstar division, which made coffee creamers, netting $887m.

Also, it began an equity carve out of White Wave this quarter, selling off 13% of the company and receiving 1.16B in combined stock proceeds and dividends from White Wave (White Wave paid a large one-time dividend to Dean Foods). According to Dean Foods investor relations, the plan is to distribute the rest of the company to shareholders sometime in March / April. Once White Wave is distributed, all that will be left is the Fresh Dairy milk business.

White Wave had a successful offering, and is currently trading at a very high P/E of 28x 2012 earnings guidance. Because of this P/E level, we do not recommend holding WWAV. Instead we recommend buying DF, and shorting out the equivalent amount of WWAV shares to create 1 share of DF Fresh Dairy.

Big Picture
Going forward, the guidance from DF management is that with the reduced debt load, DF will be better able to manage the ups and downs of the business, and that the milk business still generates high free cash flow.

While the milk business is not a great one, given Dean’s focus on cost and debt reduction, we feel that the business risk given the expected holding time of five months (January - May) is low, and is outweighed by the significant discount the Fresh Dairy business will be offered at.

At an implied market cap of ~$700m for Fresh Dairy, and a debt load of $1.3B, total enterprise value is 2.15B, and with operating income for Fresh Dairy of $424m for the past twelve months, this works out to a EBITDA / TEV yield of around 19%, or a multiple of just 5.