Neogen: Cut In Half, Still Some Questions (NASDAQ:NEOG)

Late last year, I concluded that Neogen (NASDAQ:NEOG) was creating a giant in food safety as this small and nimble food safety player was set to become much larger following a tie-up with 3M (MMM) related Food Safety operations.

Neogen has always been a premium business, commanding premium valuations. Back in 2014, the company generated just $270 million in sales, accompanied by 20% operating margins, as Neogen at the time commanded a 6 times sales multiple and 60 times earnings multiple.

Back To 2020

Neogen saw shares trade at $43 late last year as the company has seen solid (organic) growth over time. The company posted fiscal 2021 revenues at $470 million, yet operating profits rose less pronounced, reported at $74 million.

The company had 107 million shares trading at $43 per share, for a $4.6 billion equity valuation, or $4.2 billion if we factor in $370 million in net cash holdings. This valuation comes in at 9 times sales and about 70 times earnings.

The company reached a huge deal as it was combining operations with the Food Safety business of 3M, valued at $5.3 billion. Essentially these activities are spun-off from 3M, to be merged with Neogen.

Investors in Neogen will obtain a 49.9% stake in the combined entity, with 3M owning the rest, while fetching a billion dividend as well. The 3M Food Safety Business is valued at $5.3 billion which marks a higher sales multiple at 13 times sales of $400 million. That said, EBITDA of $175 million is superior compared to Neogen’s $125 million EBITDA number on a run rate of $500 million in sales.

The promise is that $30 million in synergies will be delivered upon, worth around a billion with these multiples, with accretion valued at $5 per share. This makes that shares rose from $40 to $43 per share upon the deal announcement. While the deal made sense, the stand-alone valuations were far too demanding to get upbeat, as I saw no reason to get involved.

A Huge Reset

Forwarding roughly half a year in time, we see shares now trade at just $22, as shares have lost half their value in the time frame of just about half a year. Late in 2021, Neogen posted a 13% increase in second quarter results, with earnings held back by the costs related to the acquisition, as third quarter sales growth slowed down to 10%

Fourth quarter results, as released in July, revealed 10% growth for the final quarter with full year sales up 13% to $527 million. Adjusted earnings, mostly excluding deal related costs, rose six cents to $0.63 per share as these represent nosebleed valuation, even very high valuations here at $22. Moreover, the firm reiterated that the deal is set to close in the third quarter, so basically the current quarter to close that deal.

An Update

With Neogen having 108 million shares outstanding, the share count will essentially double to 216 million shares following closing of the 3M deal, as the company is awarded a $4.7 billion equity valuation here at $22. Neogen holds $380 million in net cash, a number set to resulting in a $620 million net debt load following the 3M spinoff, for a $5.4 billion enterprise valuation here.

The business is set to generate a billion in revenues here as the combined operations could generate $300 million in EBITDA. This results in modest leverage ratios at just over 2 times, yet still an 18 times EBITDA multiple. Of course this has been reset a lot from a ridiculous 30-40 times multiple late in 2021, as these are still very high multiple, but this is of course the result of great secular trends and positioning to these trends.

In the meantime, the sale of the activities by 3M makes that attention there has s been lagging, as 3M reported that sales of the unit were flat in the second quarter, a soft result of course.

Another concern is that 3Ms spin-co has priced $350 million in notes in connection to the deal with an 8.625% coupon, very steep something which is a bit of a sign. At last, the deal structure, in which 3M will actually get part of its value in cash, makes that the decline in the shares hurt investors in Neogen a bit more than 3M itself.

What Now?

The truth is that the valuation reset has been done, as the question is if the current levels offer an opportunity. It is clear that both companies were overvalued to start with, as the deal will invoke some leverage on Neogen, while both businesses are clearly distracted by the upcoming merger, hurting organic growth in the meantime.

All of this and a reversal in valuations make it perfectly understandable why shares are down so much. While I would really see appeal in Neogen on a stand-alone basis, I am mindful of the leverage incurred as many 3M spin-offs/divestments have not been pleasing their future owners too much in recent times. All of this makes that I am waiting for the pro forma implications on deal closing in the coming months, before considering to potentially get more upbeat here.