No doubt the board of Cadbury are feeling pretty pleased with themselves right now.
After all, they have just managed to extract a higher offer from Kraft, providing an exit at a 50 per cent premium to the level it was trading at the day before the first offer in September.
(You can hear what Roger Carr thinks of the deal in this interview with the FT’s consumer industries correspondent Jenny Wiggins).
But it is worth asking who the real winner is here.
Andrew D Wood, the sector’s top rated analyst, is in no doubt. He reckons it’s Kraft and CEO Irene Rosenfeld who have won this bruising encounter on points.
The Bernstein man says Kraft is getting an outstanding asset at a very cheap price.
(Emphasis ours).
Kraft is getting an outstanding asset
As far back as 2007 (in a report entitled “Global Confectionery: Once in a lifetime? Our assessment of who could bid for Cadbury’s confectionery business”), we discussed the attractiveness of Cadbury’s confectionery business…it is operating in fast-growth categories, with dominant positions, strong emerging market exposure (almost 40% of sales) and the potential for massive margin improvements up to the high-teens level.
We also argued that the spin of Cadbury’s beverages business, leaving Cadbury as a pure-play confectionery company, opened the door for a possible take-out of the company, with Kraft being a likely suitor…which has clearly played out. Our views of Cadbury’s business have not changed…and Kraft will benefit from all of Cadbury’s strength’s, plus extra synergies, now valued at $675m vs. $625m previously indicated.
The deal is a “bargain” for Kraft.
We have been somewhat perplexed by Kraft’s approach to the entire bid process, including taking its original bid hostile, only to eventually come back and talk to Cadbury in the end. Nevertheless, Kraft has acquired a great asset (see above) at a great price…and should be given credit for this.
Although Kraft was forced to take up its bid, or risk the loss of this prize, in the end it is paying just 13x 2009 EBITDA (or 18x 2010 EPS). We consider that this is a bargain…the lowest multiple of any major M&A deal in the Global Food space in well over a decade, for global leadership of the confectionery category!
Looking at it another way, taking our DCF (1,047p) and adding the NPV of Kraft’s synergies (we estimate 230p) gives a value to Kraft of close to 1,280p…50% above what Kraft is paying for Cadbury. Although we have long been bullish on the Cadbury business, we believe that many investors will see that Kraft has been able to acquire a jewel of a business at a very cheap price.
As for Cadbury, Wood says the company made one big mistake and that ultimately sealed its fate.
Frank Riboud, CEO of Danone, has struggled for years under the weight of possible hostile bids for his company, and has argued that the best defence is an expensive stock price! In our view, Cadbury management’s major mistake has been to allow Kraft to start its bid from such a low stock price.
If Cadbury had delivered stronger operating performance between 2003-2006 instead of disappointing the market both strategically and operationally; if it had been even more aggressive with its performance in 2007-2009 (in line with the demands from Nelson Peltz in his open letter from December 2007); and if it had been more specific and less prudent with its short-term and medium term guidance (especially following the H1 2009 results), then its stock would have been much higher on 4th September.
This would probably not have deterred a bid from Kraft…but it almost certainly would have driven a higher (and more attractive) final bid for Cadbury’s shareholders.
In summary then:
We believe the takeover battle is almost over. We do not expect a counter bid from Hershey or Ferrero, and we do expect that Cadbury’s shareholders will approve Kraft’s bid. We would add that while Cadbury shareholders have done very well out of the bid from Kraft, we still consider that Kraft has done even better.
The market, however, is still not sure.
In early trading on Wall Street, shares in Kraft were down almost 3%.
Although it is interesting to note that going back to the day the deal was announced, Kraft shares have actually outperformed the S&P 500 – just.
Update:
More good news for Kraft – it looks as if the company is going to keep its investment grade credit rating.
From Moody’s on Tuesday afternoon:
Moody’s Investors Service (“Moody’s”) said that based on the terms outlined in Kraft Foods Inc.’s (“Kraft”) announcement today of a tentative acquisition agreement reached with Cadbury plc (“Cadbury”), Kraft will likely retain an investment-grade rating. Kraft’s Baa2/Prime-2 long-term and short-term ratings remain under review for possible downgrade pending acceptance by Cadbury shareholders and subject to review of the final terms of the proposed deal. If a rating downgrade should occur, it likely would be limited to one notch to Baa3/Prime-3, Moody’s lowest investment-grade ratings.
“Kraft’s closing leverage under the terms of its latest offer would exceed the normal bounds of the investment-grade rating category; however, we anticipate that Kraft will be committed to debt reduction following the transaction and should have sufficient earnings and cash flow capacity to restore its investment-grade profile within 12-18 months,” said Moody’s senior analyst Brian Weddington. “Whether a downgrade to Baa3 occurs will partly depend on how quickly we think the company will delever, and whether more cushion is needed in the rating to accommodate future deals,” added Weddington.
Update II:
Legal & General are distinctly unimpressed by the recommendation from the Cadbury board.
From Reuters:
LEGAL & GENERAL – INCREASED AND FINAL OFFER FOR CADBURY PLC BY KRAFT FOODS INC. FAILS TO FULLY REFLECT THE LONG TERM VALUE
LEGAL & GENERAL SAYS DISAPPOINTED CADBURY MANAGEMENT HAVE RECOMMENDED KRAFT OFFER.
Update III:
Martin Deboo also thinks Kraft have won this encounter on points.
For Kraft, the capture of Cadbury looks to us like a fulsome reward for a piece of striking opportunism and a well-conducted bid strategy. By playing a long game, they laid bare the absence of any credible counter-offers and drew event-driven investors onto the Cadbury share register, who were prepared to contemplate a much thinner control premium than the long-only community. We will not be offering to play poker with Irene Rosenfeld anytime soon.
What was telling for us was that, as the end-game unfolded, Cadbury found themselves wrestling with two paradoxes. The first was that, despite their purported ‘trophy asset’ status, there appears ultimately to have been only one willing bidder. The second was that, despite being a ‘national treasure’, c.50% of the shareholder register was based in the US. In the end Cadbury could count on neither an auction nor residual national sentiment to extract value
The end result is that Kraft have acquired a prime global asset for scarcely more in EV:EBITDA terms than what they realised for a US-only Frozen Pizzas business. And, mapped against the now-famous valuation ‘barometer’ in the defence document, Cadbury will need to come to terms with the fact that their exit valuation will rank as the lowest in the confectionery space by some margin (at 13.0x trailing EBITDA versus the next lowest, Cadbury/Adams, at 14.3x). Good business, Kraft.
Related links:
Cadbury board rolls over too cheaply – Nils Pratley
Krafty – FT Alphaville
Cadbury melts away – FT Alphaville
Cadbury and Kraft agree £11.9bn deal – FT