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Campbell Soup (CPB) is making a stir in the M&A market this morning, announcing its intention to acquire premium pasta sauce maker Sovos Brands (SOVO) for $23/share in an all-cash deal. Coming off a disappointing 3Q23 earnings report in which it barely beat EPS estimates as revenue growth slowed to the lowest level in five quarters, CPB is looking for the right recipe to jumpstart its financial performance and its ailing stock. So far in 2023, shares of CPB have skidded lower by about 20%.

• The company believes that SOVO has the ingredients to heat up its cooling growth, but it won't come cheaply. At $23/share, CPB is paying a premium of 27% versus last Friday's closing price, while the total deal value of $2.7 bln represents a 14.6x adjusted EBITDA multiple. For the sake of comparison, CPB's adjusted EBITDA is about 11.4x.
• On the other hand, SOVO, which is a fairly recent IPO, going public in September 2021, is generating strong growth and is comfortably profitable. In FY22, SOVO's revenue jumped by 22% yr/yr to $878.4 mln, while adjusted EPS came in at $0.60.
• In addition to Rao's pasta sauce, SOVO's brands include Micael Angelo's frozen meals and noosa yogurt. However, the Rao's brand is the crown jewel of this acquisition, accounting for nearly 70% of SOVO's total revenue with organic net sales growth of about 35% in FY22.
• From a strategic standpoint, the acquisition is a good fit in our view as the premium Rao's pasta sauce brand should nicely complement CPB's lower-priced Prego brand. Using its scale and vast distribution network, CPB believes it can increase the geographic footprint and household penetration of the Rao's brand.
• With sales declining by 2% last quarter, CPB's Meals and Beverages segment (Prego, soup, Swanson, etc.) could certainly use a spark. The company's flagship soup category in particular has struggled recently as U.S. food retailers return to more normalized ordering patterns. The addition of SOVO will place more emphasis on the sauce category -- a business that CPB is aiming to grow to over $1.0 bln.
• Integration expenses and other related costs will likely create an earnings headwind for CPB this year, but the company is anticipating the transaction to be accretive to adjusted EPS in year two.
• The main issue we see is that CPB is raising more debt to finance this deal. Given that the cost of debt has increased so much due to rising interest rates, the prospect of adding to CPB's current long term debt balance of $4.5 bln may not be sitting well with some investors.

Overall, though, we like this deal as we believe CPB's size and resources can help the Rao's brand more fully capitalize on its strong growth potential.