What would a mega-merger mean for Bakkavor and Greencore - and the own label manufacturing market?

Greencore CEO Dalton Philips was in confident form as he fronted the sandwich maker’s first capital markets day for more than five years in February, impressing the gathered analysts, investors and supermarket partners. Riding high on an impressive turnaround at the group, the former Morrisons boss set out new medium-term financial targets and floated the idea of expansion into new areas through M&A.

“We [have been] out of the market for so long,” Philips said during his presentation. “My first year I don’t think I got a single IM. And then we had to literally call people and just say, ‘Hey, we’re Greencore. We used to buy businesses, now we’re back in the market again’.”

And on Friday last week, Greencore certainly did return – with a bang – revealing it was going after Bakkavor. The move, which caught the industry by surprise, would create a convenience colossus with combined sales of £4bn.

Matthew Webb of Investec says the combination is compelling given the potential cost synergies and benefits of industry consolidation. Damian McNeela of Deutsche Bank Group adds that as the undisputed leader in the fresh prepared foods category, the enlarged group would have more pricing power when negotiating with suppliers and customers.

However, Bakkavor turned down the “unsolicited” proposals – the latest made on 10 March was worth 189p a share, representing a premium of 25% and valuing the business at £1.1bn – after deciding they “significantly undervalued the company and its future prospects”.

Shares in Bakkavor, which floated on the London Stock Exchange at 180p in 2017, soared 18% to a near seven-year high of 179p, suggesting the market is optimistic Greencore still has more in the tank. Although, the stock has slipped back to 160p this week.

Will Bakkavor founders sell up?

The question is whether the Gudmundsson brothers, who founded Bakkavor as a cod roe manufacturer and exporter in Iceland in 1986 with three employees, are minded to sell. The pair, who retired from running the company day to day in 2022, still control 49% of the shares, with US private equity firm Long Range Capital also holding a 20% stake.

“We suspect they would want a larger premium to the undisturbed share price than is typically demanded by institutional shareholders, to reflect the value of the further potential for UK margin recovery and, in particular, the growth potential of the US business,” Webb says.

A deal would cap a remarkable comeback for the brothers, who almost lost the whole thing in the aftermath of the Icelandic banking crash in 2008.

Read more:

• Greencore delivers positive Q1 but warns of ‘unprecedented’ labour cost challenges

• Bakkavor delivers strong results despite strike disruption

• Bakkavor subject of ethical trading complaint amid Spalding strike

Indeed, both Bakkavor and Greencore are now emerging on the other side of a challenging few years, having rebuilt in the aftermath of the pandemic.

Food to go is almost firing on all cylinders once again, with our latest category report revealing sales across retailers and foodservice operators surged 13.3% year on year to just shy of £38.4bn [Kantar 52 w/e 1 September 2024]. The recovery is partly driven by workers returning to the office, but also by cost-conscious consumers opting for supermarket meal deal sandwiches over other more expensive lunch options.

And ready meals have been reinvigorated by a move to premium and healthier offerings, led by the likes of Charlie Bigham’s on the branded side, and a resurgence of top-tier own label with Tesco Finest and Sainsbury’s Taste the Difference ranges. Tesco, in particular, is pushing its premium offering hard, aiming to add another £1bn in sales to the £2bn already being made annually. Good news for Greencore, which supplies the best-selling Finest lasagna SKU, and Bakkavor, which supplies pizzas and pasta sauces for the range.

Turnaround success

Philips joined Greencore at its nadir in September 2022, with a share price languishing at 62p and the group in need of a new direction. His ‘Horizon’ turnaround strategy laid out a three-pronged plan to stabilise, rebuild profitability and grow.

In December, the group cheered investors with stronger-than-expected full-year results as adjusted operating profits rose 28% to £97.5m and dividends were reinstated following a five-year hiatus.

Greencore shares have more than doubled under Philips’ leadership, prompting Nigel Smith, who is head of strategy and responsible for M&A at the group, to declare at the CMD that “hand on heart we are in the best shape I’ve ever seen us”.

The bold tilt at Bakkavor signals Greencore entering the final stage of ‘Horizon’: exploring growth opportunities.

A tie-up with Bakkavor would take Greencore back overseas following its embarrassing exit from the US in 2018, when it sold off the business less than two years after committing to the market with a blockbuster £600m acquisition of Peacock Foods. Bakkavor generates about 10% of its £2.3bn revenues in the US, with the business there back on track following a few stumbles, and a further 5% in China. The group’s future in the latter market is uncertain, with a review currently underway.

Even if Greencore and Bakkavor are not household names in the UK, consumers would find it hard to avoid their products. The pair manufacture more than 5,000 combined SKUs across sandwiches, salads, ready meals, sushi, soups, sauces, quiche, pizza, bread, Yorkshire puddings and desserts, and are sold by every major supermarket, c-store, forecourt and coffee chain.

Tempting synergies

The synergies from combining resources are likely to be significant and a chief rationale for Greencore’s approach.

Investec estimates savings in the realm of £100m coming from procurement, central costs and, potentially, the rationalisation of manufacturing networks, given the pair operate 36 factories between them in the UK and employ almost 30,000 staff.

It would be a meaningful 20%-plus boost for the combined current operating profits of £211m, as well as taking the enlarged group’s margins from 5.1% to 6.4%.

A senior source at a rival ready meal manufacturer says the huge synergies would also be appealing to retailers, which would want a share of a bigger pie.

Alongside the efficiencies, McNeela of Deutsche highlights the benefits of diversification across customers and categories, especially helpful for Bakkavor’s exposure to Tesco, where the business makes 37% of its sales.

The new group’s top three customers would be Tesco at 24%, M&S at 21% and Sainsbury’s at 18%, while it would spread sales more evenly across sandwiches and ready meals, with both estimated by Deutsche to account for 24% each of the new total turnover. Salads would account for 14% of revenues and pizza & breads and desserts would take a further 9% each.

Would the CMA clear the deal?

But it is not just uncertainty around the views of the Gudmundssons which is casting doubt on the chances of a deal happening. Webb highlights a potential significant hurdle in the shape of the competition authorities.

He flags the biggest overlap between the two companies as ready meals. Bakkavor is the category captain (with its meals business of ready meals, soups, dips and pasta sauces making up about 37% of sales at £721m), while Greencore occupies the lower rungs of the sector ladder (with about 12% of its turnover at £217m), but together the two would likely hold a share of around 35%, which the CMA may find to be problematic.

“The prospects of the deal being cleared (or not) would depend in large part on how the various categories are defined, which is highly debateable and uncertain,” Webb adds.

“The two companies are both major suppliers of fresh food and the deal would consequently increase their importance to, and bargaining power with, their major customers.”

But he also argues some affected categories are fragmented and would benefit from consolidation. A larger group would be more efficient and potentially able to improve the offer to customers, Webb says. 

A dealmaker source says the ready meals category is crying out for consolidation as there are already too many players, with 2 Sisters, Oscar Mayer, Samworth Brothers and Pilgrim’s all vying with Greencore and Bakkavor, while Bigham’s leads the charge for the smaller contenders.

Should a merger go ahead, it will be the first big test case for the new regime at the CMA after ex-Amazon UK boss Doug Gurr was installed as interim chairman, with a pro-growth remit from a Labour government concerned the watchdog has been overly zealous in blocking deals in the past.

One boss of a large, chilled foods rival reckons too much has been made of Gurr’s appointment. “He isn’t there to oil the gears of industry. He is there to ensure proper competition mechanisms and if a deal needs calling in, I’m sure he’ll do that.”

Another senior source in the ready meals space is sanguine about a deal, and says it is not seen as a threat. “It might create opportunities for other players as supermarkets may not feel comfortable with all their eggs in one basket,” he says.

“If anything, it may present opportunities for rivals as integrating a deal of this size will soak up considerable management resources, so there is a chance they take their eye off the ball during that time.”

One management source at a major supermarket customer says he’d be supportive of the deal.

“Given the challenges with cost inflation, bringing together two great businesses would drive investment in the sector,” he says.

“The benefits of a stronger own label player would offset any worries about greater pricing power – and there are still a number of big rivals in the industry to keep everyone honest. Dalton knows the supermarket game as well as anyone and [Bakkavor CEO] Mike Edward is an all-round class operator.”

Greencore: ‘We won’t overpay’

All these considerations will be moot if Greencore does not come back to the table before the Takeover Panel’s deadline of 5pm on 11 April.

But McNeela is betting, given the merits of a combination (“strong positions in respective businesses, limited category overlap in the UK and prospective synergies”), that Greencore will return with an improved ‘final’ offer. He thinks the Greencore board could go up to 214p a share (valuing Bakkavor at more than £1.2bn) but adds “this would be too high”.

“We believe that 200p/share for Bakkavor should be the most that Greencore offers… this would be a good offer for Bakkavor shareholders,” he says.

Webb points out the structure of a cash & shares offer makes the potential value of the deal reliant on the performance of the Greencore stock, which declined when news of the approach broke, with investors having one eye on the £500m-plus of debt needed to finance the takeover and the almost £200m of Bakkavor net debt to be swallowed on top.

“This could limit the ability of Greencore to increase its offer, with more generous terms potentially putting downward pressure on its own share price,” Webb says.

The ball is now in Philips’ court. Can he come up with an offer that pleases everyone? At the CMD presentation when speaking about deal multiples, he was very clear. “We’re just not prepared to overpay.”