Kraft sets sights on Cadbury

by Josh Sosland
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NORTHFIELD, ILL. — In a move that would bolster its position in the snacking segment while expanding its presence in emerging markets around the world, Kraft Foods Inc. on Sept. 7 disclosed it was pursuing a $16.7 billion takeover of Cadbury P.L.C. The board of London-based Cadbury summarily rejected the bid, and Kraft said it would continue to pursue the acquisition.

Kraft proposed paying 300 pence ($4.95) in cash and 0.2589 in new Kraft Foods shares per Cadbury share. The offer would value each Cadbury share at 745 pence ($12.29) and values the entire issued share capital of Cadbury at £10.2 billion ($16.7 billion).

Cadbury issued a tersely worded statement rejecting the Kraft offer.

"The board is confident in Cadbury’s standalone strategy and growth prospects as a result of its strong brands, unique category and geographic scope and the continued successful delivery of its Vision into Action plan," Cadbury said in the Sept. 7 statement. "The board believes that the proposal fundamentally undervalues the group and its prospects."

At $16.7 billion, the transaction would be the fourth largest ever for a food processing company, but Cadbury’s rejection generated speculation that the price may go up with Kraft raising its bid further, a competitive bid or bids emerging, or some combination of the two.

After the announcement, Cadbury shares climbed 41% to 803.5 pence at midday onSept. 7 on the London Stock Exchange before closing at 783 pence.

Kraft justified its 745 pence bid by a number of measures, noting it was 42% above the Cadbury share price on July 3, before recent analyst speculation about a takeover; 34% above the 90-day average price of 555 pence; and 31% above the Sept. 4 closing price of 568 pence.

Looking to make the transaction more attractive to Cadbury shareholders who may not wish to own Kraft shares or may not wish to receive cash, Kraft said it would offer "a mix and match facility" under which Cadbury shareholders may choose to vary the proportions of cash and Kraft shares they receive, subject to availability.

From a strategic perspective, Kraft said the addition of Cadbury with brands that include Cadbury, Trident and Halls would position the company for growth, creating a business with $50 billion in revenues that would be a "global powerhouse in snacks, confectionery and quick meals."

Cadbury’s sales in 2008 totaled £5,384 million ($8.9 billion) with operating profits of £638 million ($1.1 billion).

Kraft said that if it acquires Cadbury, it expected to revise its long-term growth targets to 5% plus for revenue and 9% to 11% for earnings per share, from its previously announced 4% plus and 7% to 9%, respectively. Additionally, the company said the transaction would be accretive to earnings per share in the second year and would not imperil Kraft’s investment grade credit rating.

The ability for Kraft to grow by leveraging the Cadbury business was a central theme voiced in discussions of Kraft’s plans by Irene Rosenfeld, the company’s chairman and chief executive officer.

"This proposed combination is about growth," Ms. Rosenfeld said. "We are eager to build upon Cadbury’s iconic brands and strong British heritage through increased investment and innovation. We have great respect and admiration for Cadbury, its employees, its leadership and its proud heritage. As we have done, Cadbury has built wonderful brands by focusing on quality, innovation and marketing, but we believe the next stage in Cadbury’s development will be challenging, given the increased importance of scale in the industry. Cadbury’s brands, which are highly complementary to our portfolio, would benefit from Kraft Foods’ global scope and scale and array of proprietary technologies and processes."

In the aftermath of the rejection by Cadbury’s board, Ms. Rosenfeld said Kraft plans to continue to "engage with the board of Cadbury on a constructive basis with the goal of consummating a recommended transaction."

For Cadbury, a merger would end the company’s brief experience as a standalone company, independent from its soft drink business. Its Americas Beverages business was separated in May 2008 when the drinks business, renamed Dr Pepper Snapple Group, began trading on the New York Stock Exchange.

The spinoff, which had been overwhelmingly supported by shareholders, was premised on the idea that a focused confectionery company would be able to produce better results as a standalone company.

Cadbury was established in 1824 as a retail shop in Birmingham, England. The company expanded throughout the British empire in the first half of the twentieth century, and in 1969 Cadbury Group Ltd. merged with Schweppes Ltd.

A few years before the 2008 spinoff of the beverages business, Cadbury acquired Adams confectionery for $4.2 billion.

Since 2007, Cadbury has pursued a restructuring plan, dubbed "Vision into Action," aimed at improving operating margins from around 10% to mid-teens by 2011. The company said the plan revolves around generating growth, efficiency and "capability."

In its most recent financial results, the company said revenues in the first half of 2009 were up 4% from the same period the year before and the company’s margins widened 145 basis points on a constant currency basis. Chocolate accounted for 45% of the company’s sales with gum representing 35% and confectionery 20%.

Whatever the merits of the Cadbury restructuring plan, the company would be in better hands if acquired by Kraft, Ms. Rosenfeld said.

"We have taken note of Cadbury’s recent performance and the ongoing implementation of its V.I.A. program," she said. "We believe that Cadbury’s share price already reflects its prospects as a standalone entity and the benefits of V.I.A. Our proposal therefore not only takes into account these factors, but also provides a compelling premium and, we believe, significantly more value for Cadbury shareholders than Cadbury could create independently."

In a Sept. 8 conference call, Ms. Rosenfeld said the transaction would make Kraft Foods a global leader across all major segments of the confectionery business.

"More important, our combined sales would be heavily weighted toward the higher growth chocolate and gum segments," she said.

For Kraft, the pursuit of Cadbury further solidifies a drive for leadership in snacking that began in the 1990s with the acquisition of Jacob Suchard AG for $4.2 billion. Even as Nestle S.A. and Groupe Danone S.A. have focused their portfolios on the better-for-you segment, Kraft has resisted such a shift. In 2000, the company acquired Nabisco Holdings for $18.9 billion and in 2008 acquired Danone’s biscuit business for $8 billion. Nearly concurrent with the Danone transaction, Kraft sold its Post ready-to-eat cereal business for $1.7 billion.

Even though the company has failed, so far, to parlay the snacking acquisitions into impressive earnings growth for shareholders in the current decade, Ms. Rosenfeld staunchly advocated for the proposed Cadbury transaction. In particular, she defended the merits of food companies’ building scale, even as the value of scale, as opposed to focus, has been challenged by the investment community.

"I would say as we look at the increasingly challenging global economy and competitive environment, we see customers consolidating, we see suppliers consolidating, we see our competitors consolidating," she said. "Therefore, the ability to have the funding and the muscle to invest in the equity, distribution and new product development that is essential to be successful would increasingly rely on having a stronger operating base. For that reason, we believe quite strongly that scale has been and will continue to be an important factor."

Pressed on the timing of the proposed transaction, Ms. Rosenfeld said progress Kraft has made against its 2007 restructuring plan justifies this next step.

"As we approach the end of our three-year plan, we did what we said we would do, and we are now hitting our stride," she said. "We’ve rewired the organization for growth and created a high performing organization. We’ve reframed our categories and made them more relevant and more contemporary. We have invested to exploit our sales capabilities and now are better leveraging them in the marketplace."

Commenting on the proposed transaction, Robert Moskow of Credit Suisse in New York said Kraft’s move to acquire Cadbury made "a great deal of strategic sense," but he said Kraft may need to keep raising its bid and straining its balance sheet to successfully acquire Cadbury.

On the bright side, he said a combination may help address weakness identified at both companies.

"Both Kraft and Cadbury have been criticized for having weaker operating margins than their peers," he said. "A combination would allow both companies to slim down and create a management team with the best of the best."

The Kraft bid equates to 12.5 times estimated Cadbury EBITDA for 2009, and it may be that Kraft will need to pay 14 times, Mr. Moskow said.

By contrast, he noted that the 2008 acquisition of the Wm. Wrigley Jr. Co. by Mars Inc. was at a multiple of 17.6.

"This is just round one of a process that will have plenty of twists and turns," he said.

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