An amendment to Garan’s rights agreement was also pre-pared for the purpose of excepting the transaction from the rightsagreement.  The  terms  of  these  various  agreements  were  negoti-ated over the course of the next 12 days.
On July 1, 2002, Garan convened a special meeting of the non-employee  members  of  its  board  of  directors  to  update  themregarding  the  proposed  transaction  and  the  discussions  withBerkshire Hathaway to date. Representatives of Goldman Sachsand Garan’s lawyers (including Tannenbaum Dubin & Robinson,
12035_Imperiale_c08.f.qxd  11/24/04  9:22 AM  Page 104
104
THE MICRO CAP INVESTOR
LLP, general counsel to Garan; Hunton & Williams, Virginia coun-sel to Garan; and Simpson Thacher & Bartlett, special counsel toGaran)  were  present  and  led  the  discussion.  Goldman  Sachsadvised  the  nonemployee  directors  of  the  progress  of  negotia-tions  and  the  process  by  which  Berkshire  Hathaway  wasapproached  regarding  a  potential  transaction.  Goldman  Sachsalso  discussed  with  the  nonemployee  directors  other  strategicoptions available to Garan. The nonemployee directors discussedwith  Goldman  Sachs  the  likelihood  that  other  likely  potentialacquirers  would  be  interested  in  making  a  superior  offer  toacquire or merge with Garan. The nonemployee directors askednumerous  questions  relating  to  the  process  by  which  BerkshireHathaway  was  approached  and  the  possibility  that  any  otherpotential acquirers could present Garan with an alternative trans-action  following  the  announcement  of  a  transaction  with  Berk-shire Hathaway.
In the early afternoon on July 2, 2002, the nonemployee mem-bers  of  the  board  of  directors  again  met  with  Garan’s  lawyers.After discussion and questions, the nonemployee members of theboard of directors determined that they were inclined to supportapproval  of  the  transaction,  subject  to  the  discussion  at  theupcoming full board meeting.
Later in the afternoon of July 2, 2002, Garan convened a spe-cial meeting of its board of directors to consider approval of theacquisition of Garan by Berkshire Hathaway for $60 in cash pershare. Garan’s lawyers and Goldman Sachs were present. Garan’sboard of directors was advised of events relating to the transac-tion and the status of meetings of the nonemployee directors ofGaran. Garan’s lawyers advised Garan’s board of directors of itslegal  duties  in  connection  with  the  proposed  transaction  andreviewed with the board of directors the terms and conditions ofthe  merger  agreement,  the  stockholders  agreement,  the  amend-ments  to  the  employment  agreements,  and  the  amendment  toGaran’s rights agreement.
Representatives of Goldman Sachs then reviewed with Garan’sboard  of  directors  Goldman  Sachs’s  financial  analyses  withrespect to the proposed transaction. Following this presentation,Goldman Sachs orally delivered its opinion to the board of direc-tors of Garan, which was subsequently confirmed in writing to theeffect that, based on and subject to the factors and assumptions
12035_Imperiale_c08.f.qxd  11/24/04  9:22 AM  Page 105
Micro Cap Case Study: A Company with All the Indicators
105
set forth in its opinion, as of July 2, 2002, the $60 in cash per shareto be received by the holders of Garan common stock pursuant tothe merger agreement was fair, from a financial point of view, tothose  holders.  After  extensive  discussion  and  deliberation  andbased on the factors described, Garan’s board of directors unani-mously  determined  that  the  merger  agreement,  the  stockhold-ers  agreement,  the  merger,  and  the  transactions  contemplatedthereby  were  fair  to  and  in  the  best  interests  of  Garan  and  itsshareholders, approved and declared advisable the merger agree-ment,  and  resolved  to  recommend  that  the  Garan  shareholdersvote to approve the merger agreement.
Following the special meeting of Garan’s board of directors,the  merger  agreement,  the  stockholders  agreement,  the  amend-ments to the employment agreements, and the rights agreementamendment were executed, and Garan and Berkshire Hathawayissued a joint press release publicly announcing the execution ofthe merger agreement and other agreements.
12035_Imperiale_c08.f.qxd  11/24/04  9:22 AM  Page 106
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 107
CHAPTER 9
ConsolidatingIndustry Case Study
This chapter will attempt to answer the following questions:
• How  can  you  take  advantage  of  an  industry  consolidation
through micro cap companies?
• What does a typical industry consolidation look like?
As discussed in Chapter 5, the consolidation of fragmented indus-tries can be another powerful tool for finding micro cap opportu-nities.  There  are  several  different  variations  on  the  industryconsolidation  theme  that  can  be  played  out  in  the  micro  caparena. The most common consolidation strategy often focuses ona single acquiring company that has clearly stated its intention toconsolidate a highly fragmented industry or industry segment bypurchasing  and  consolidating  a  large  number  of  smaller  publicand private companies into a single operating entity that can takeadvantage of the size and scale of a public operation as well as thelower  cost  of  capital  of  a  public  company  to  create  value  forshareholders.
These  types  of  fragmented  industry  consolidations  oftenbegin with the initial public offering of a relatively large companythat has been created through a series of highly leveraged trans-actions to acquire a number of private operating entities to con-solidate under a single public entity. Typically, the IPO transaction
107
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 108
108
THE MICRO CAP INVESTOR
of this consolidating company takes the form of an equity offeringto deleverage the private company and raise additional workingcapital  for  additional  acquisitions.  These  industry  consolidationIPOs  can  be  attractive  investments  in  and  of  themselves;  how-ever, they are often a powerful indicator of the early stages of anindustry consolidation that can be played through the ownershipof micro cap stocks within the same industry venue.
CASE STUDY OF SUIZA FOODS
One  of  the  more  interesting  case  studies  in  this  area  is  that  ofSuiza Foods, which since 1996 has been in the process of consol-idating the manufacture and distribution of fresh milk and relateddairy  products  in  the  United  States.  In  April  1996,  Suiza  Foodswent public. Between the time of the company’s formation in 1988and its initial public offering, the company made 38 acquisitionsin the fresh milk and dairy industry. Through these acquisitions,the company attempted to realize economies of scale and operat-ing efficiencies by eliminating duplicate manufacturing, distribu-tion, purchasing, and administrative operations. By the time of itspublic  offering,  the  company  had  acquired  a  number  of  well-known  private  and  public  dairy  companies  including  SuizaBrands of Puerto Rico, the initial acquisition; Velda Farms; SwissDairy Corporation; and Model Dairy. In its first Form 10-K annualreport, the company stated its business strategy as follows: “Thecompany’s strategy is to continue to expand its dairy, ice creamand related food businesses primarily through the acquisition ofdairy, ice cream and related food businesses in new markets andsubsequent  consolidating  or  add-on  acquisitions  in  its  existingmarkets.  After  entering  new  markets  through  acquisitions  ofstrong regional operators, the company will pursue consolidatingor  add-on  acquisitions  where  such  opportunities  exist.  In  addi-tion, the company will seek to expand its existing operations byadding new customers, extending its product lines and securingdistribution  rights  for  additional  brand  and  product  lines.”  (SeeFigure 9.1.)
From its initial public offering, Suiza sounded the battle cry ofan industry consolidation. Company management clearly articu-lated a business strategy that sought to take a highly fragmented,
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 109
Consolidating Industry Case Study
109
FIGURE 9.1 Suiza Foods price chart.
highly geographic-specific business—that of the production anddistribution  of  milk—and  consolidate  it  into  a  large-scale,  cen-trally managed operating business that would take advantage ofthe efficiencies of scale that could be created by such an enter-prise. In its initial public filing, the company put everybody whomight be interested in reading the report on notice that it was inthe market to acquire dairy companies and related businesses.
A  review  of  the  preliminary  proxy  statement  filed  in  March1997 would show a team of officers and directors that was builtfor  the  task  of  acquiring  continuing  operations.  Gregg  Engles,chairman of the board, was involved in and had been chairman ofthe  board  of  Suiza  Puerto  Rico  and  had  functioned  in  variousother capacities since 1988. Mr. Engles had served as the presi-dent of Kaminski Engles Capital Corporation since 1988 as welland has been president of Engles Management Corporation sinceFebruary 1993. Those two companies, with which Mr. Engles wasdirectly involved, are investment banking and investment bank-ing consulting firms, respectively. Mr. Engles was also presidentof  Engles  Capital  Corporation,  an  investment  banking  and  con-sulting firm, from May 1989 to October 1992. This is a very impres-sive resume for the chairman of the company, who in 1997 was 39years old.
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 110
110
THE MICRO CAP INVESTOR
Other  key  members  of  the  management  team  includedCletese Beshears as president and chief operating officer of Suiza.Mr.  Beshears  had  been  the  CEO  of  Velda  Farms,  an  acquisitionmade by Suiza Foods in 1988. Prior to that, Mr. Beshears providedconsulting  services  to  companies  pursuing  acquisitions  of  dairycompanies  from  1980  through  1988.  From  1965  to  1980,  Mr.Beshears  had  been  president  of  the  Southland  Corporation  andchief operating officer of its dairy group.
A review of the balance of the officers and outside directorsof  the  company  would  show  a  virtual  who’s  who  of  the  invest-ment banking and dairy industry, including Steven Green, manag-ing  director  of  GE  Capital  Corporation’s  Corporate  FinanceGroup;  Tracy  Knoll,  former  president  of  the  Morningstar  DairyGroup; David Miller, former vice president of the board and chiefoperating officer of J.C. Penney Corporation; and Robert Kamin-ski, president of Robert Kaminski Interests, a private investmentand investment banking consulting firm. Clearly, this was a formi-dable  management  team  that  had  access  to  public  and  privatecapital  markets  and  an  outstanding  history  in  consolidating  thedairy business.
With this now-public declaration of the company’s intentions,everyone was on notice that there were opportunities within thedairy industry. During 1997, a quick search of the standard indus-trial classification (SIC) codes related to dairy and dairy productswould have included SIC code 2021, creamery and butter produc-tion; SIC 2022, natural and processed cheese; SIC 2023, dry andcondensed  and  evaporated  milk  products;  SIC  2024,  ice  creamand frozen dairy products; and SIC 2026, fluid milk. At the time,there  were  18  publicly  traded  companies  within  those  industrysegment SIC codes, of which 11 were micro cap opportunities.
Among  these  micro  cap  companies,  which  at  the  time  werepublicly traded, was a successful and growing national brandedproduct company called the Morningstar Group. Morningstar, atthe time, had a market capitalization of approximately $115 mil-lion; in addition, the company had been growing sales at a rate ofabout 15 percent per year for the previous five years and traded ata  P/E  multiple  of  less  than  12.  The  company  had  good  primaryinstitutional  research  sponsorship  with  Donaldson,  Lufkin  andJenrette  (DLJ)  as  a  principal  research  and  investment  bankingsponsor.  Analysis  indicated  that  not  only  was  this  a  well-run
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 111
Consolidating Industry Case Study
111
public company in the dairy space, but it would also likely be thetype  of  company  that,  due  to  its  valuation  and  quality  manage-ment team, would be of interest to a larger company attemptingto consolidate the industry.
In  June  1997,  Suiza  announced  a  definitive  agreement  toacquire Morningstar in a stock swap transaction for 12.6 millionshares, or approximately $190 million, a 30 percent premium overwhere Morningstar had been trading prior to the announcement.In its 1997 annual report, the company indicated that the dairyindustry had excess capacity and had been in the process of con-solidation for over a decade. Excess capacity was the result, intheir opinion, of the development of more efficient manufacturingtechniques,  the  establishment  of  captive  dairy  manufacturingoperations by large grocery and retail chains, and relatively littlegrowth in demand for fresh milk products. As the industry con-solidated,  many  smaller  dairy  processors  were  eliminated  andseveral  large  regional  dairy  processors  emerged.  According  topublished  industry  statistics,  in  1995  there  were  approximately651 fresh milk processing plants in the United States, a decline ofapproximately 50 percent from the 1,191 plants that were operat-ing in 1982. The number of plants with 20 or more manufacturingemployees declined from 792 to 447 over the same period. As aresult  of  this  consolidation  trend,  which  Suiza  believed  wouldcontinue,  the  company  believed  it  had  favorable  opportunitiesgoing forward to pursue additional acquisition opportunities.
The  company  continued  acquiring  public  and  private  dairyoperations.  During  1997,  Suiza  acquired  Country  Fresh  Dairy,  aleading regional processor of milk, juice, and ice cream productsbased  in  Grand  Rapids,  Michigan,  and  Land-O-Sun  Dairies,  aTennessee-based operator of fluid, dairy, and ice cream process-ing facilities in the southeastern United States. Those two acqui-sitions had combined sales of nearly $1 billion. During 1997, thecompany also embarked on a strategy to begin acquiring variouscompanies involved in plastic packaging and packaged ice busi-nesses. An observer of Suiza Foods at the time would likely haverecognized the chance to study micro cap companies in the pack-aging  and  ice  business  to  look  for  opportunities  for  additionalmicro cap acquisition targets.
As Suiza Foods continued to gobble up existing private andpublic  companies  in  the  dairy,  ice,  and  packaging  businesses,
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 112
112
THE MICRO CAP INVESTOR
other smaller companies within the industry began to consolidateas  well.  In  general,  valuations  began  to  rise  across  the  dairyindustry,  as  consolidation  and  acquisitions  began  to  play  out  inthe sector. At the same time, in July 1998, Horizon Organic Hold-ing Corporation (HCOW), a producer of organic milk and brandedrefrigerated organic dairy products and juices, went public at aninitial  offering  price  of  approximately  $15  per  share.  The  com-pany  marketed  its  products  under  the  Horizon  Organic  and  theOrganic Cow of Vermont brand names in the United States, andRachel’s Organic brand name in the United Kingdom. It sold itsproducts  primarily  through  natural  and  organic  retailers  andregional conventional supermarket chains and mass merchants.
Shortly after the company went public, a review of a relatedForm  13-D  showed  Suiza  Foods  Corporation  as  the  beneficialowner  of  1.1  million  voting  shares  of  Horizon  Organic  commonstock, or approximately 11.5 percent of the company’s outstand-ing  shares.  The  company  had  an  initial  market  capitalization  ofapproximately $175 million, putting it squarely in the micro caparena.  During  1999  and  2000,  the  company  stumbled,  missingearnings estimates in 1999 by a wide margin as well as showing acontinued  decline  in  earnings  from  $.14  per  share  to  $.07  pershare  in  the  1999-to-2000  fiscal  year  comparison.  In  addition,management  took  a  $.21  per  share  restructuring  charge  during1999 and an additional $.02 per share in 2000. (See Figure 9.2.)
Through  all  this  disappointing  operating  performance,  thecompany’s share price sank from $15 to $5 per share by the end ofthe  year  2000.  During  the  year  2000,  the  company  would  haveshown up frequently on simple valuation screens. In the first halfof 2001, the company shares traded at or below book value for anextended period of time. In addition, during the same period oftime, the company sold for a multiple of between 4.3 and 7.5 timescash flow. This was particularly cheap in consideration of the factthat the company had less than 10 percent long-term debt to totalcapital.  With  Suiza  Foods  being  their  single  largest  outstandingshareholder and a virtual who’s who of value investors beginningto file Forms 13-D, this was another company that was displayingall the classic indications of a micro cap that was ripe for invest-ment opportunity. (See Figure 9.3.)
It was no surprise that after the second restructuring charges,significant  management  changes  were  made.  During  that  time
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 113
Consolidating Industry Case Study
113
FIGURE 9.2 Horizon Organic price chart.
period, Lord Abbott & Company, the well-known New York valuefirm, had acquired 8.27 percent of the outstanding shares, and alarge number of shares had been acquired and reported as ownedby  insiders  at  Suiza  Foods  as  well  as  insiders  at  HorizonOrganic—again, an indication that valuation had become cheapbut business opportunities might be improving in the near future.With  regard  to  management  changes,  during  the  year  2000,Thomas Briggs joined the company as a new chief financial offi-cer  and  treasurer.  For  the  previous  10  years,  Mr.  Briggs  hadserved  as  the  chief  financial  officer  for  Denver-based  LeprinoFoods Company, the world’s largest manufacturer of mozzarellacheese and one of the biggest private companies in the U.S. dairyindustry.  (In  the  interest  of  full  disclosure,  it  should  be  madeknown  that  Uniplan  managed  investments  for  Leprino’s  profit-sharing plan during that time.) In addition, Clark Driftmier joinedthe company during the year 2000 as senior vice president of salesand marketing. During the previous 10 years, Mr. Driftmier servedat Small Planet Foods, the parent company of Cascadian Farmsand Muir Glen Foods, two leading organic food brands. Finally,Steven Jacobson joined the company in 2000 as vice president ofoperations.  Mr.  Jacobson  had  been  a  consultant  with  Denver
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 114
114
THE MICRO CAP INVESTOR
FIGURE 9.3 Historical valuation analysis.
Management  Group,  a  consulting  organization  to  the  dairy  andbeverage industry, as well as having served as a distribution direc-tor for Medal Gold Dairies, a national milk processing and market-ing company. With these key new employees in place, it appearedthat the operating problems at the company were being addressed.During 2001 the company earned $.017 per share with no spe-cial charges, and then during 2002 the company doubled earningsto $.34 per share, again with no special charges. The stock priceexploded during that period from $5 a share to $15 a share by theend of 2002. In July 2003, Suiza Foods announced its intention toacquire Horizon Organic in a going-private transaction valued at$24 per share.
In  an  interesting  and  seemingly  ironic  climax  to  this  case
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 115
Consolidating Industry Case Study
115
study,  during  2001  Suiza  Foods  announced  its  intention  toacquire Dean Foods, the largest publicly traded dairy companybehind Suiza and perhaps the most well-known name in the dairyspace. On December 24, 2001, Suiza Foods completed its acquisi-tion  of  Dean  Foods  and  officially  changed  its  name  from  SuizaFoods  to  Dean  Foods,  effectively  disappearing  into  the  dairyworld as the leader in the dairy case, after consolidating most ofthe fragmented industry. Dean Foods, formerly Suiza, now has amarket  capitalization  of  approximately  $6  billion  and  an  enter-prise value of $8.5 billion. During the fiscal year 2003, Suiza hadrevenues of over $9 billion and earned $2.27 per share. (See Fig-ure 9.4.)
The company continues its growth-through-acquisition strat-egy. During 2003, it acquired another micro cap company, WhiteWave, Inc., for $189 million. White Wave, based in Boulder, Col-orado,  is  a  maker  of  soy  milk  and  other  soy-based  products.Again, for a micro cap investor, Dean Foods’ entry into the soy-based products area could offer some interesting clues for con-tinued  consolidation  and  acquisitions  and  opportunities  as  amicro cap investor.
FIGURE 9.4 Dean Foods price chart.
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 116
116
THE MICRO CAP INVESTOR
OTHER OPPORTUNITIES
Another opportunity that arose out of the industry consolidationdone by Suiza is the case study of Michael Foods of Minnesota.Michael Foods is a producer and distributor of food products. Thecompany’s primary business was the production and processingof  eggs,  which  included  extended-life  liquid  eggs,  precookedfrozen  eggs,  and  other  specialty  products.  The  company’s  eggplants were fully integrated, housing nearly 13 million producinghens.  In  addition,  Michael  Foods  processed  and  distributed  abroad  range  of  refrigerated  products  directly  to  supermarketsand  these  included  cheese,  butter,  margarine,  various  muffins,juices, and bagels. Michael Foods also had a dairy products divi-sion that would process and sell soft-serve ice cream mix, regularice  cream,  frozen  yogurt  mix,  and  other  pasteurized  milk  prod-ucts.  Finally,  the  company  had  a  potato  products  division  thatprocessed  and  distributed  refrigerated  potato  products  to  thefood service and retail grocery market. Because of the consolida-tion being undertaken by Suiza, Michael Foods would be of inter-est because a prudent investor might surmise that Michael mightconsider selling its dairy-related operations to Suiza in light of thecontinued industry consolidation.
Michael  Foods  typifies  many  of  the  conundrums  faced  bymicro cap companies. Having gone public in 1986, it had an initialmarket capitalization of approximately $120 million. During theperiod from 1986 through 1996, the company traded in a narrowprice range with a low of approximately $6 per share and a high ofapproximately $15 per share, with only a brief period during 1991when the company’s valuation exceeded that range. During thatsame time, the company had successfully grown sales at a com-pound average annual rate of 7 percent and had grown companyearnings at a rate of nearly 12 percent per year. (See Figure 9.5.)It’s important to recall that a large percentage of the companywas closely held by the Michael family. Their ultimate goal was tocreate  a  liquidity  event  and  higher  company  valuations  throughthe public markets. Since becoming a public company in 1986, theboard of directors and management of Michael Foods, along withthe Michael family, had set various goals in terms of sales growthand earnings growth in the hopes of enhancing shareholder value.
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 117
Consolidating Industry Case Study
117
FIGURE 9.5 Michael Foods price chart.
Over that period, the board of directors and management gener-ally felt that the publicly traded price of Michael Foods commonstock  had  not  reflected  the  underlying  value  of  Michael  Foods,the company. The company believed that a number of items hadadversely affected the value of the stock. These items included alack  of  investor  appreciation  for  the  value-added  nature  of  itsbusiness, the small market capitalization and small daily tradingvolume of the stock, the inability to attract a sufficient number ofmarket makers and investment banking firms willing to prepareresearch and analysis on the company, and the fact that directlycomparable  companies  against  which  institutional  investorscould evaluate and analyze the performance of the company didnot exist.
In  July  1999,  the  board  of  directors  retained  U.S.  Bancorp,Piper  Jaffray,  and  Merrill  Lynch  as  financial  advisors  to  assistthem in evaluating strategic alternatives to enhance shareholdervalue.  Keep  in  mind  that  the  Michael  family,  which  was  a  largepercentage shareholder and interested in enhancing the valuationof its holdings, primarily drove this process.
The board and management began to assess various alterna-tives related to the strategic plan of Michael Foods as a public com-pany. The company looked at options such as generating growth
12035_Imperiale_c09.f.qxd  11/24/04  9:22 AM  Page 118
118
THE MICRO CAP INVESTOR
through  strategic  acquisitions,  exploring  the  potential  for  amerger  with  a  similar  company,  either  public  or  private,  ofapproximately equal size, and it also explored the possibility ofseeking a sale of the company in its entirety to a strategic or finan-cial buyer. The board of directors was particularly concerned thatany strategic plan would result in a situation that could create suf-ficient growth to maintain and grow market position for MichaelFoods in a consolidating industry, in particular fluid milk and thedairy section of the supermarket. If the company was to remainpublic, they felt they needed to achieve higher valuation throughsome combination of those alternatives. In this pronouncementfrom the board, which was made in numerous public filings, werethe  echoes  of  the  overt  pressures  of  Suiza  consolidating  theindustry.
The  company  considered  what  would  be  the  most  commonoption for a small public company, and that would be to sell theentire  company  to  a  strategic  or  financial  buyer.  The  board’sdesire  to  maximize  shareholder  value  (possibly  for  the  Michaelfamily)  was  the  primary  consideration  for  a  possible  merger  orsale. Board members considered the potential risk of attemptingto  continue  executing  the  current  business  plan  without  anychanges.  They  also  considered  the  additional  risk  and  potentialbenefits  to  shareholders  associated  with  strategic  acquisitionsand enhanced internal growth. The board also felt that there wasa lack of a compelling merger of equal candidates available in thepublic or private market. Finally, the board considered the possi-bility of strategic and financial buyers, particularly as this relatedto  what  was  at  the  time  a  strong  market  for  acquisitions  thattranslated  into  good  financing  liquidity  for  financial  buyers