Here's Why Shares of International Flavors & Fragrances Collapsed Today

What happened

Shares of International Flavors & Fragrances (NYSE: IFF) fell nearly 11% -- and were still setting new daily lows as of this writing -- after the company made two important announcements today.

First, the specialty ingredients supplier announced first-quarter 2018 earnings that demonstrated year-over-year growth across both flavors and fragrances and in all important financial metrics including revenue, operating income, and earnings per share. The strong start to the year prompted management to publicly declare that it's targeting the upper end of its full-year 2018 revenue and operating profit guidance.

Second, the $10 billion company announced its intention to acquire competitor Frutarom for $7.1 billion. Investors aren't sure the expensive premium is worth it, which is why shares are sinking today. As of 3:16 p.m. EDT, the stock had settled to a 10.9% loss.

So what

International Flavors & Fragrances turned in a solid first quarter after struggling a bit in recent periods, and that shouldn't be dismissed by investors. A significant slice of the company's margin improvement in recent years has come from headcount reduction, rather than expanding business. The most recent quarter shows there might be growth left in the tank after all.

The business as a whole reported 12% revenue growth, 34% operating income growth, and 12% EPS growth compared to the prior-year period. But investors weren't going to get too excited over the results from a single three-month period, especially after learning of the proposed merger with Frutarom.

The move reminded investors of the pressures facing the flavor and fragrance industry. After all, the top three companies own 40% of the entire global industry, but they're still struggling to adapt to hitting an innovation ceiling of sorts after exhausting the possibilities granted by synthetic chemistry in recent decades (engineered biology may offer some relief -- if it can deliver).

To complete the proposed $7.1 billion deal, International Flavors & Fragrances said it would pay $106.25 per share of Frutarom in a combination of cash and stock. While the acquisition could add $2.25 billion in annual sales by 2020, it comes at a hefty 20.3 times EBITDA of the smaller specialty ingredients supplier.

Now what

The expensive price being paid for Frutarom isn't exactly surprising in a top-heavy industry where the top three companies own 40% of the market. But that doesn't mean investors should blindly accept the premium. Whether or not International Flavors & Fragrances can deliver on the expected cost synergies -- which rarely work out for most megamergers -- remains to be seen, but it will be necessary to pay down the debt required to close the transaction and maintain its credit ratings.

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Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.