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January 20, 2010

COMMENT: Cadbury’s sweet surrender leaves bitter taste

Cadbury's acceptance of Kraft Foods' takeover bid raised eyebrows yesterday (19 January) not least because of the UK confectioner's fierce criticism of the US food giant's business and management. Dean Best argues that, despite the Dairy Milk maker insisting Kraft's higher offer is "good value" for the company's investors, Cadbury's board was presiding over a business worth much more.

By Dean Best

Cadbury’s acceptance of Kraft Foods’ takeover bid raised eyebrows yesterday (19 January) not least because of the UK confectioner’s fierce criticism of the US food giant’s business and management. Dean Best argues that, despite the Dairy Milk maker insisting Kraft’s higher offer is “good value” for the company’s investors, Cadbury’s board was presiding over a business worth much more.

“There is no strategic, managerial operational or financial merit in combining with Kraft.”

“Looking at who can extract the best performance of the business, the current Cadbury management team would have, without any doubt, a very real edge over the Kraft alternative.”

“Kraft’s management team has a long track-record for over promising and under delivering.”

A selection of quotes from Roger Carr, Cadbury’s chairman, amid Kraft Foods’ five-month pursuit of the UK confectioner.

Kraft’s hunt for Cadbury, the maker of brands including Dairy Milk chocolate, Trident gum and Halls candy, came to an apparent conclusion yesterday (19 January) when the US food giant won the backing of the UK firm’s board with a higher takeover bid.

Kraft has not formally sealed the deal but, with Hershey unlikely to launch a counter offer and with just a bare majority of Cadbury shareholders needed to back the higher bid, the finishing line is within the reach of the US group.

However, the apparently cordial end to Kraft’s quest should not mask the fact that this takeover saga was one of the most bitter M&A battles in recent years.

Since Kraft went public with its approach for Cadbury and until the UK firm’s second formal defence against the Toblerone and Milka maker’s initial bid, Carr has been very vocal in his opposition to a takeover.

Just last week, the Cadbury chairman again went on the offensive, labelling Kraft “an unattractive business”.

Carr told analysts: “Kraft is over exposed to large, low-growth developed markets, has an unfocused conglomerate business model and a range of products and categories that have significant competition from private-label products.

“More importantly they have been inconsistent in their commitment to their major categories, including confectionery, buying and selling businesses and unable to develop their market shares.”

Just five days later, after Kraft upped its offer for Cadbury by 9%, Carr said the revised bid was “good value” for the company’s investors and added the board was “pleased with the commitment that Kraft Foods has made to our heritage, values and people throughout the world”.

So, why the volte-face? In fairness to Carr, amid the brickbats he has thrown at Kraft, he has long argued that his role was to listen to bids that represented “fair value” for the Wispa maker.

Carr clearly believed Kraft’s higher offer – which valued Cadbury at 850p a share, including a one-off 10p dividend – offered fair value.

But, given Carr’s stringent outbursts against Kraft’s business model – notwithstanding the comments from Cadbury CEO Todd Stitzer apparently comparing the UK firm’s “principled capitalism” with the US group’s “unbridled capitalism” – does the increased bid represent the full value of the 186-year-old business?

On Monday, Cadbury shareholder Standard Life said Kraft would have needed to bid over 900p a share to win its support.

The same day, Stitzer told The Daily Telegraph that Cadbury could be worth GBP10 a share if it met its profit margins targets in 2013.

Sanford Bernstein analyst Andrew Wood, who long argued that Cadbury was worth 900p a share, believes Kraft has secured a “bargain”.

“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,” Wood said. “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.”

Wood added: “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.”

While some see Kraft’s success as something as a steal, the US food giant has had to borrow around GBP7bn to finance the takeover. What will happen to jobs at Cadbury? Will Kraft be able to fund investment in Cadbury’s brands or further expansion in emerging markets with such a debt pile hanging around its neck?

Kraft’s management was quick to dismiss concerns that its proposed acquisition of Cadbury would result in job losses or site closures in the UK despite union fears that cuts will be made.

Kraft’s reputation in the UK has been dented by its treatment of local chocolate maker Terry’s after buying the business in 1993. Twelve years later, Kraft closed Terry’s factory in York and shifted production to continental Europe.

There has been an element of protectionism in some of the anger in the UK press over Kraft’s success in winning over the Cadbury board. However, it is important not to over-play the patrotism or nostalgia cards. Just two years ago, Cadbury was the bete noire of the unions over plans to close its Somerdale site and move production to Poland.

Concerns should centre on Kraft’s debt mountain and its ability to invest to grow Cadbury, especially when Carr and Stitzer have been keen to insist the business had a bright future as an independent company.

Debt ratings agency Fitch has today cut its credit ratings on Kraft and Cadbury, while rival Moody’s has placed the US group under review.

With heavier debts, Kraft will be sure to look to drive down costs. The company has already earmarked “synergies” of US$675m.

Kraft may have created the world’s largest candy maker but a focus on reducing costs could slow investment in Cadbury’s brands, dampen sales growth and lead to a round of rationalisation that hampers the confectioner.

Cadbury’s recent performance has been buoyant, particularly in chocolate, and, where the recession was dampening its growth, for instance in the US gum market, the company has been quick to use innovation to boost sales.

The Cadbury board’s apparent surrender to what it has long dubbed “a low-growth, American conglomerate” has left a bitter taste in the mouth.

The indications are that Cadbury’s vociferous criticism of Kraft were bluster and hot air. The board could argue that they were trying to maximise the offer they received but much of its criticism of Kraft focused on the US group’s entire business and management, which still remains in place.

However, it appears that Cadbury’s carping at Kraft and belief in its future as an independent, thriving business, melted away amid pressure from the UK group’s largest investors to sell.

Carr told the Wall Street Journal that he feared investors would sell for a price below what the Cadbury board thought the business was worth. “We could not settle for an inappropriate price,” Carr insisted.

However, Cadbury’s board lacked confidence and resolve. The confidence to convince investors that they should hold out for an even higher bid and the resolve to stick to its guns in believing the business could provide higher returns as an independent company.

And, in the end, the UK confectioner’s management may indeed have surrended the business at an inappropriate price.

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