Kraft's big split

by L. Joshua Sosland
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NEW YORK — A decision by Kraft Foods Inc. to split into two publicly-traded companies is part of a wider trend of packaged foods companies adjusting to rapidly and dramatically changing marketplace conditions, said Robert Moskow, senior equity analyst, food, for Credit Suisse in New York.

Announcing the move Aug. 4, Kraft said one of the two new companies would be focused on the Kraft global snacks business and the other on its North American grocery business.

Mr. Moskow said Kraft’s decision is part of a broader trend of consumer packaged goods companies finding ways to make sure they do not become too thinly spread.

“Having a focused portfolio is turning out to be a better strategy than diversified ones,” he said. “When you’re operating in a volatile environment with rapidly changing costs and consumer tastes, being focused gives the ability to adapt faster.”

Under the Kraft plan, the global snacks company would have estimated annual sales of about $32 billion, of which 75% would be from snacks around the world, and about 42% would come from developing markets. The business would include the Kraft Foods Europe, Developing Markets and North American Snacks divisions.

The North American grocery company, with $16 billion in annual sales, would include the Kraft U.S. Beverages, Cheese, Convenient Meals and Grocery segments and non-snack categories in Canada and Food Service.

Kraft said the North American business, even with the spin-off of the larger snack business, would be among the largest food companies in North America.

In fact, the Kraft North American business alone, equating to only a third of the current company, would be larger than the global businesses of every other major U.S.-based packaged foods company. At $16 billion in annual sales, the company would compare with Campbell Soup Co., at $7.6 billion; ConAgra Foods, Inc., at $12.3 billion; General Mills, Inc., at $15 billion; Kellogg Co., at $13 billion; and J.M. Smucker Co., at $4.8 billion.

Swiss-based Nestle S.A., with annual sales of 110 billion Swiss francs worldwide, ($151 billion) has 28.7 billion Swiss francs in Zone Americas sales.

The creation of a Kraft Foods business with about $50 billion in annual sales came about because of a number of large transactions completed over a period of many years, generally dating to the 1980s. In 1981, General Foods Corp. acquired Oscar Mayer & Co., and between 1985 and 1989, Philip Morris Companies, Inc. acquired both General Foods and Kraft, Inc., renaming the company Kraft Foods Inc.

Beginning in the 1990s, Kraft’s acquisition strategy largely was focused on snacking and international growth. The company bought confectionery companies Jacobs Suchard AG and Freia Marabou for a combined $5.5 billion in the early 1990s and bought Nabisco Holdings in 2000 for $19.2 billion. In 2006, Kraft acquired the European rights to the Nabisco brand by buying United Biscuits Iberia. More recently Kraft acquired Cadbury P.L.C. for $19 billion.

While wary of growth prospects for the U.S. packaged foods industry, Mr. Moskow was anything but critical of the Kraft plan.

“It makes strategic sense for a couple of reasons,” he said. “First is that in Kraft today you have two very different operating companies. I’ve always felt snacks and grocery just have different distribution systems. Snacks is D.S.D. (direct-store delivery). Grocery should be warehouse. I think combining the two has always been problematic.

“Second, from an operational per-spective, I thought management lacked focus as they tried to run such a big portfolio of businesses. What the separation does, is it squarely addresses investor concerns that this company was too big (or spread out), too slow and too bureaucratic.”

Mr. Moskow warned against drawing excessively close analogies between the Kraft move and recent actions by other packaged foods companies, such as Sara Lee Corp., which was heavily involved in apparel and household items.

“It isn’t the same as Sara Lee,” he said. “Sara Lee had a 1980s style portfolio that was more like a holding company. And you had a lot of nonstrategic assets to sell. There are no synergies between a bakery D.S.D. and a European coffee business.”

A related phenomenon to heightened focus identified by Mr. Moskow is a move by many companies to get rid of misfit products.

“With all the shedding going on and the deconsolidating, the activity is also a reflection that for many years, we had assets that were simply in the wrong portfolios,” he said. “For example, MilkBone never should have been within Kraft, it always should have been within Del Monte. I’m sure there is more of that to come.”

Still more broadly, Mr. Moskow said the splitting of Kraft is emblematic of an unwinding of models that became popular 30 years ago.

“The trend in the 1980s and 1990s was the view that if you spread in more categories you would have more bargaining power with your customers,” Mr. Moskow said. “Then the customers consolidated, the consumers became more fragmented, and I think the manufacturers needed to respond with a more specialized approach that was channel specific and at times consumer specific.

“A good example is the rise of Costco. It required completely different packaging sizes, price points. Dollar stores, too.

“From a consumer standpoint, you have a growing Hispanic population. You have teens consuming media in different ways. You have the aging of baby boomers. You can’t have a one-size-fits-all approach to the market. You have to adapt quickly.”

Another casualty from the 1990s has been the supremacy of brands, Mr. Moskow said.

“Brands aren’t as strong today,” he said. “The demise of the three major television networks, the fragmentation of that medium played a big role in that. You can’t have one ad that 40% of the population sees on a given day.”

The splitting of businesses into more focused companies does not mean the companies will reach a point of stasis in the years ahead when it comes to major transactions, Mr. Moskow said.

“When you shed non-strategic assets or you split up into pure play companies, you can then reload for more acquisitions that give you increased scale within those areas of focus,” he said. “I would expect that down the road.”

Mr. Moskow identified The Hershey Co. as a model of the focused packaged foods company of 2011.

“They are the leader in the category (U.S. chocolate),” he said. “They have a very clear strategy for innovation and advertising reinvestment. Their sales force investment has provided fantastic returns. They focus on one thing: Chocolate.”

This positive assessment of Hershey stands in marked contrast to concerns voiced about Hershey when Kraft was pursuing the Cadbury acquisition. Analysts at the time wondered whether Hershey would be able to survive competing with giants such as Kraft and Nestle. Additionally, Hershey struggled earlier in the decade when it tried to broaden its product base.

“They were asked to extend into cookies, energy bars and brownies,” Mr. Moskow said. “It didn’t work.”

Even with changes at Kraft and other food companies, Mr. Moskow is cautious in assessing prospects for success in the balance of 2011 and into 2012.

“I think growth is very scarce,” he said. “That’s largely due to very careful consumer spending. Also, I think changing tastes that don’t necessarily favor processed food are a factor. So, in general, we favor companies that have either very strong emerging markets exposure or they participate in some kind of niche categories in food with a lot of brand power.”

Additional amicable separations

Kraft Foods Inc., Northfield, Ill., is not the only food and beverage company spinning off business units in an effort to maximize shareholder value and improve management’s focus. The Sara Lee Corp., Downers Grove, Ill., on June 15 announced plans to spin off its international coffee and tea business and keep its North American meats business. “This transaction is more than a spin-off of one business segment — we are really separating a global company into two, independent pure-play companies, which adds complexity as well as opportunity,” said Jan Bennink, executive chairman of Sara Lee, during the Deutsche Bank Global Consumer Conference, held in Paris in June. “As we began to get into the details of separating the two businesses, we determined there are greater efficiencies to be gained from spinning off the international coffee business.” In July, Ralcorp Holdings, Inc., St. Louis, announced its plans to separate Ralcorp and Post Foods. As part of the separation, Post Foods will issue between $1.1 billion to $1.2 billion of debt with the net cash proceeds of about $1 billion going to Ralcorp. Ralcorp’s board of directors intends to use the proceeds to reduce debt, pursue private brand acquisitions and pursue additional share repurchases under the company’s remaining share repurchase authorization of about 5 million shares. Following completion of the transaction, Ralcorp will continue to trade on the New York Stock Exchange, and Post Foods also is expected to be listed on the N.Y.S.E. Upon completion of the separation, William P. Stiritz, currently chairman of Ralcorp, will serve as chairman of Post Foods. J. Patrick Mulcahy, currently vice-chairman of the Ralcorp board, will serve as chairman of Ralcorp.

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