Schafer: Hormel is right to get into organics

If there was one thing that Hormel Foods really wanted folks to know after it announced its acquisition last week of the organic meat producer Applegate Farms, it's that this new property will be left to run just as it is.

On a conference call, CEO Jeff Ettinger said leaving the company alone would be "honoring the brand and preserving the special connection it has with consumers."

That kind of hands-off ownership is a little unusual in corporate dealmaking, but given the reputation that Hormel's executives have for being really good at their jobs, it shouldn't be surprising.

Hormel gets it. In this kind of a deal — a Big Food company buying an organic and natural products company — the biggest risk is accidentally spoiling the organic brand that just took a lot of money to buy.

This one really is expensive, too; Hormel will pay $775 million for Applegate, a company that is expected to have about $340 million in sales this year. The analysts tried to tease out the so-called earnings multiple paid for the deal, a basic measure of price for a business, and estimates started about 10 times cash earnings and rose quickly from there.

That's really a lot for a deal where the buyer doesn't immediately try to make the operation a lot more profitable, by, for example, shutting down the headquarters.

Hormel's executives turned down an opportunity to discuss the Applegate deal in more detail, but in a conference call last week with ­analysts they didn't really get into the kinds of things that could go wrong.

In fact, there are so many things that could go wrong it's almost hard to know where to start, at least the way marketing Prof. Tim Calkins, of the Kellogg School of Management at Northwestern University, sees this kind of deal.

Every change dictated by the corporate office, he said, just raises the risk, even ones that sound harmless.

"There's always a temptation to take an acquired brand and integrate it into the company," he said. "That's because there are many, many cost savings from doing that."

One quirky little brand that did well after being bought by a big company, he said, was Ben & Jerry's ice cream. Unfortunately for the reputation of corporate America, the list of ones that did not work out nearly as well is a lot longer. One outstanding example is Kellogg's acquisition of natural cereals company Kashi, back in 2000.

The Kellogg Co. is about as Big Food as they come, an early innovator in breakfast cereals that went on to make such iconic American processed foods as Froot Loops and Pop-Tarts. Kashi, meanwhile, was an upstart that started in the '80s.

The Kashi brand for a while was a strong performer for Kellogg. But among the problems that later beset Kellogg was a social media ruckus kicked off when ­photos of a Rhode Island grocer's explanatory note on the edge of the shelf — after he pulled Kashi products over concerns about artificial ingredients — quickly went viral.

Kellogg also got sued in California for using artificial ingredients in its Kashi products, even though they were being advertised as all natural — ingredients like pyridoxine hydrochloride and soy ingredients processed using hexane, which the plaintiffs pointed out was a byproduct of gasoline refining.

While the suit was later settled, some of the blistering criticism directed at Kellogg was clearly unfair. Among other things, pyridoxine hydrochloride is just a form of a common vitamin. Yet this was still another PR disaster. Any consumer reading news about that suit would have had to wonder what pyridoxine could be. And how much gasoline goes into it?

What Kellogg appears to have done was to seek consistency and cost savings when buying ingredients, a classic move for big food companies. It's the kind of management thinking that turned them into big companies in the first place.

It would still be a great business model if only consumers hadn't increasingly decided they don't like eating processed foods, things that have preservatives and artificial colors, or meat that comes from animals raised with heavy use of antibiotics.

One good strategy for responding to this shift in tastes is making acquisitions of organic and natural product companies like Applegate, but even the analysts closely following Austin-based ­Hormel were a little puzzled by CEO Ettinger's pledge to keep hands-off.

KeyBanc analyst Akshay Jagdale wanted to know, if there isn't going to be any of the usual kind of "synergies" in such things as manufacturing, just what is the point? Why is this a deal for Hormel and not just a financial buyer?

Ettinger acknowledged it was a good question, and he had a good answer.

He pointed out that it's not that Hormel managers won't be helping at all to help the company grow. Hormel has more customers than Applegate and a presence in more markets.

But his answer really boiled down to a critical strategic choice for Hormel. It has to be in the business of selling organic products; the shifts in consumer preferences are just that obvious. The question is how best to do it.

He said that to think about Applegate only as a marketer isn't giving the people who created the business, led by founder Stephen McDonnell, nearly enough credit. To ­create its brand, Applegate had to supply consistently good products, and that took developing relationships with 1,800 farms in the United States and Canada. It was a network years in the making, assembled by patiently meeting and sizing up one producer at a time.

For Hormel to build a network of farmers and other suppliers just like it, even if Hormel quickly developed the know-how, would also take years.

Doesn't it make sense for Hormel to instead get into business with a partner with a 28-year head start?

lee.schafer@startribune.com • 612-673-4302