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January 19, 2010

Can Kraft capitalise on sweet Cadbury deal?

After a five-month siege, Kraft Foods today (19 January) all but won the highly-publicised battle for Cadbury, turning its hostile approach friendly and securing the support of the UK confectioner's board by sweetening its takeover bid. As the dust settles, Kraft claims the combined entity will benefit from US$675m in annual synergies, improved global distribution and a stronger presence in multiple retail channels. However, concerns linger over the company's debt levels and the impact this will have on investment. Katy Humphries reports.

After a five-month siege, Kraft Foods today (19 January) all but won the highly-publicised battle for Cadbury, turning its hostile approach friendly and securing the support of the UK confectioner’s board by sweetening its takeover bid. As the dust settles, Kraft claims the combined entity will benefit from US$675m in annual synergies, improved global distribution and a stronger presence in multiple retail channels. However, concerns linger over the company’s debt levels and the impact this will have on investment. Katy Humphries reports.

Kraft Foods finally appears on-track to become the world’s largest chocolate and confectionery company, having won the support of Cadbury’s board for its bid to takeover the Dairy Milk maker.

After a protracted – and increasingly heated – takeover battle, last minute overnight discussions ahead of today’s deadline for Kraft to finalise its offer saw the US food giant increase the value of its bid to GBP11.5bn (US$18.8bn), up from GBP10.5bn.

Kraft is offering Cadbury shareholders 840 pence per Cadbury share, consisting of 500 pence in cash – up from 300 pence cash previously on the table – with the rest made up of shares in the US group. In addition, Cadbury shareholders will be entitled to receive a special dividend of 10 pence per share.

By raising the cash component of the offer, Kraft is likely to increase its appeal to UK-based investors. The company is also circumventing the need for its own shareholders to vote on the move because it is issuing less than 20% share capital.

The deal, which represents 13 times Cadbury’s 2009 EBITDA, is a 50% premium on the UK firm’s share price prior to Kraft’s declaration of interest in September.

“We believe the offer represents good value for Cadbury shareholders and are pleased with the commitment that Kraft Foods  has made to our heritage, values and people throughout the world,” outspoken Cadbury chairman Roger Carr said.

Having won the backing of the Cadbury board, which had previously been vociferous in its opposition to the deal, Kraft now requires 50.1% of Cadbury shareholders to accept the offer by 2 February.

According to Jon Cox, an analyst with Kepler Capital Markets, Cadbury management negotiated the “best possible deal” for shareholders in the circumstances.

“No counter bidder emerged and that was always going to be tough hand,” Cox told just-food. “Kraft has got a great asset at a reasonable price.”

Bernstein analyst Andrew Wood went one step further in his characterisation of the deal, insisting that Kraft snagged a “bargain”, despite increasing its offer.

“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. 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,” he observed.

Speaking during a conference call, Kraft management said that the combined entity is expected to benefit from its increased scale, which will generate synergies and allow access to new markets for both Kraft and Cadbury confectionery brands.

Kraft CEO Irene Rosenfeld said the agreement would help transform Kraft’s portfolio, with greater focus on higher growth and margin categories and brands, and accelerate the group’s organic sales growth.

Cadbury has indicated that it expects organic revenue growth to hit 6.5% this year, up from 4.8% in 2009, while its operating profit margins have also been rising and should reach 14.7% this year, up from 13.5% in 2009.

The Trident gum maker has seen an increasing contribution to profits from its gum business, and the categories in which it operates generally generate higher margins than staple grocery items, which constitute the majority of Kraft’s business.

Cadbury is also growing more rapidly than Kraft in emerging markets and the deal provides the US group with an enlarged footprint in developing countries such as India, Mexico, Turkey and South Africa. The acquisition is expected to increase the overall revenue Kraft generates in high-growth developing markets from 20% to 25%.

Meanwhile, Cadbury brands will benefit from improved distribution in continental Europe and the US.

Cadbury and Kraft will also benefit from each companies presence in various distribution channels – with Kraft gaining from Cadbury’s strong presence in the impulse and convenience sector and Cadbury gaining listings through Kraft’s “wall-to-wall” presence in the conventional grocery retail sector, particularly in the US, Rosenfeld claimed.

As a result, according to Rosenfeld, the merged company is “well positioned” to drive strong growth across the chocolate, gum and sugar confectionery categories.  

Significantly, Kraft increased its synergy targets from US$625m to US$675m.

Management said that it expected to generate $300m in annualised operational savings, $250m in general and administrative costs and $125m in marketing and selling expenses. One-off costs associated with these savings are expected in the region of US$1.3bn.

While the deal is expected to be dilutive to earnings in fiscal 2010, it is expected to be accreditive to EPS by five cents in fiscal 2011, providing a percentage return on the deal in the mid-teens.

However, there is some concern that the focus on reducing costs will slow investment in the Cadbury’s brands and dampen sales growth.

“I suspect that a focus on cost savings means that the two companies may take their eyes off the ball regarding sales for a while – which might benefit peers for the next 18 months or so,” Cox warned.

The need to reduce costs could be given added urgency by Kraft’s rising debt levels. The company will take on an additional GBP7bn in debt to finance the deal, bringing its debt ratio to close to four times earnings.

Kraft management indicated that it was “confident” it could retain its investment-grade debt rating, at BBB or BBB- levels, as long as it brings its debt-to-earnings ratio down within the next 24 months.

Management said that it was not currently planning any further disposals in the near-term, instead insisting that the higher sales and earnings, which will be further boosted by synergies, will help improve its debt ratio.

Despite the need to cut costs, Rosenfeld said that Kraft would remain focused on driving growth at Cadbury.

“This deal is about growth. Our increased scale will allow us to increase investment in Cadbury brands,” Rosenfeld said. 

What remains to be seen is whether Kraft will put its money where its mouth is, especially given the challenges of integrating the supply chains, manufacturing plants and global operations that lie ahead.

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