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Bellamy’s (ASX: BAL) is soaring on the back of a $1.5bn takeover offer from China Mengniu Dairy, which is proposing to acquire Bellamy’s in its entirety. The board of Bellamy’s approved the deal and is advising shareholders to accept it, which is why merger arbitrage traders haven’t priced in a significant chance of the deal failing this morning. Since executives see things about a business that average shareholders do not see and are perceived to be more informed as insiders, the market usually pays very close attention to whether they approve or disapprove of a proposed deal.
Bellamy’s announced a sharp decline in full year profits this year (Credit: Natonic)
Bellamy’s announced disappointing full year results this year, with full year earnings declining 49.8% to $21.7m on the back of a challenging business backdrop in China. Revenue declined 21.6% on the previous year and the company needed to contend with substantial margin compression and the loss of $18m in China label sales. One positive in the results however was the company announcing 10-15% net revenue growth at a consistent EBITDA margin, an outlook which signals that management believes that the worst is over for Bellamy’s. Management argued that the substantial deal premium for Bellamy’s was reflective of their efforts to turn the company around, but they are still acquiring the company at a lower price than before the introduction of adverse regulatory changes in China.
Bellamy’s can no longer advertise infant formula in the 0-12-month-old market segment, and China is set to favour domestic producers which it wants to obtain a 60% market share. Companies can be directly exposed to the Chinese growth story through either the daigou channel or direct business relationships. The daigou channel has been hit in recent times, with China now requiring people operating daigou businesses to acquire licences to operate daigou businesses in both China and the other country the operate in, meaning those companies are subject to the same taxation as normal businesses. This has hurt Australian businesses reliant on the daigou channel, since it increases the average effective rate of tax consumers in China pay on their goods, pricing some consumers out of the market.
The deal today increases the chance of similar takeover offers for A2 Milk (ASX: A2M), Bubs Australia (ASX: BUB) and Blackmores (ASX: BKL). Most stocks have still sold off as investors got increased clarity around the financial impact of the regulatory changes this reporting season. One attribute of China’s more state-run economic model is that they have the power to make regulations more favourable to local companies in ways most Western countries would not. In this case, it allowed local infant formula companies to acquire Bellamy’s at a price they would have struggled to attain in a free market economy. This acquisition fits into China’s overall strategy of having domestic infant formula companies acquire foreign ones, which is why it could signal a wave of infant formula M&A.
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