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March 16, 2007

Cadbury’s desire for efficiency may open door for takeover

Cadbury Schweppes’ announcement that it plans to separate its confectionery and Americas Beverages businesses has been roundly cheered by investors, with share value rising as the market salivates over the prospect of a big payout. But Katy Humphries questions whether the deal has potential downsides.

Cadbury Schweppes’ announcement that it plans to separate its confectionery and Americas Beverages businesses has been roundly cheered by investors, with share value rising as the market salivates over the prospect of a big payout. But Katy Humphries questions whether the deal has potential downsides.

In theory, Cadbury Schweppes’ news that it will split its confectionery and Americas Beverages divisions will strengthen both divisions by allowing both units to focus on their core competencies.

But, despite the jump in share price that has accompanied the announcement, there has been a suggestion that the move may make Cadbury more susceptible to a hostile takeover bid – rumours of which have circulated for some time.

Cadbury Schweppes, the maker of Dairy Milk and Trident, announced yesterday (15 March) that it will divide into two separate businesses. The move will see the parting of Cadbury’s Americas Beverages unit, which accounted for 35% of total Cadbury sales and 54% of its operating profit last year, from its confectionery arm.

The world’s largest confectionery company said that the decision was the result of “two or three years” deliberation as well as a stakeholder consultation following the release of the company’s lacklustre results last month.

“We believe now is the moment to separate and give both management teams the focused opportunity to extract the full potential inherent in these excellent businesses,” the company’s chairman, Sir John Sunderland, said.

However, the timing of the announcement – just two days after it emerged that activist investor Nelson Peltz had amassed a 2.98% stake in the group – fuelled rumours that the move was knee-jerk response to increasing pressure from shareholders to boost returns.

According to Investec analyst Martin Deboo, while Peltz was not directly responsible for Cadbury’s decision to divide, his investment and the market speculation it sparked may well have acted as a catalyst. “Nelson Peltz’s service to shareholders was to accelerate a decision that would have been reached regardless of his investment,” Deboo told just-food yesterday.

Cadbury management has been looking to increase returns to stockholders for some time now. A four-year-old initiative has seen Cadbury striving to improve margins, aiming to cut the company’s workforce by 10% and save GBP360m (US$695.6m) by the end of the year. These efforts have produced negligible results, and in October CEO Todd Stitzer scrapped the original 2003 plan to improve operating margins by 0.5-0.75% annually. The company instead insisted that it would seek the more general target of “growth in operating margins over time”.

With steps to maximise shareholder value by improving operational efficiencies coming to very little and a costly UK salmonella recall and Nigerian accounting scandal damaging last year’s results, Cadbury’s shares have underperformed its peers in the food industry throughout 2006.

Cadbury has therefore opted for an alternate route to increase shareholder payouts. Expounding on the strategic rationale behind the move, Cadbury said that it stemmed from its ‘Managing for Value’ philosophy, adopted in 1997. In order to deliver superior shareholder returns, Cadbury said it has strengthened both its confectionery and beverages portfolio through acquisitions, disposals and organic investment, to the point where the company now believes each business will operate more effectively on a stand-alone basis.

“Separating these two great businesses will enable two outstanding management teams to focus on generating further revenue growth, increasing margin, and enhancing returns for their respective shareowners,” Todd Stitzer, CEO, said.

Investors are already reaping rewards from the announced split. Stock in the company jumped from an opening value of 546 pence yesterday to close at 602 pence on the London Stock Exchange.

Cadbury has said it is still considering various options for the divide, which will take the form of a sale, demerger or partial floatation. The company will provide more information as part of a trading update to be released on 19 June.

The most likely outcome, Deboo told just-food, is a sale of the beverage business to private equity interests. With a strong brand portfolio, stable and profitable growth “private equity interest in Americas Beverages will be high,” Deboo said. “It is the sort of business private equity will look favourably on.”

Indeed investment firms Lion Capital and Blackstone Group, who were involved in the purchase of the company’s European drinks business last year, are already rumoured to be showing interest in the US beverages business, which has been valued at between GBP6.5bn and GBP8bn.

A trade buyout is widely regarded as less likely, as it is felt that few would want to take on a company that is dwarfed by Coca-Cola and PepsiCo in the US market, despite its big brands – Snapple, Dr Pepper and 7-Up.

If the company goes ahead with a sale, the proceeds generated are likely to be returned to shareholders and used to invest in strengthening the confectionary portfolio. However, with the diminishing bulk of Cadbury Schweppes, it has also been suggested that the confectionery business itself may become a takeover target.

For some time before the announced split, rumours that Kraft Foods or Hershey could potentially work with a private equity buyer to secure a purchase have periodically cropped up. In this scenario, analysts foresaw Cadbury’s assets being divvied up between the groups, with the trade partner taking on the confectionery business.

If this is a serious possibility, the division of Cadbury into two units has made it that much easier for a trade buyer to make a move on the confectionery arm. Standing alone, the market capitalisation of Cadbury will be reduced: the confectionery business has been valued at about GBP9bn. Names raised in connection to this eventuality have included US giants Kraft, Hershey and Wm Wrigley.

In separating its American drinks business, Cadbury has pacified shareholders hungry for quick returns. According to management, the move will also enable the core confectionery business to operate more efficiently. But in doing so it has become that much more attractive to competing food groups eager to lay their hands on Cadbury’s portfolio of iconic confectionery brands.

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