An analyst’s report related to Kraft’s first bid on Cadbury extracted from http://quicktake.morningstar.com/Stocknet/san.aspx?id=307322 dated 9 Aug 2009
BY ERIC SWANSON
On Monday, Kraft KFT announced that it made an unsolicited bid to acquire Cadbury CBY for 745 pence per share, a 27% premium to our 585 pence per share fair value estimate. Despite this offer, we’re leaving our fair value estimate for both firms in place, as we doubt a deal will be completed at this price. However, we are raising our uncertainty rating for Kraft, as the bidding may become competitive given the number of large potential suitors, possibly causing significant dilution for the unfortunate winner.
Strategically, we believe this acquisition makes sense from Kraft’s perspective. In our opinion, the confectionery industry is attractive, as it offers some of the highest margins in the packaged-foods industry while also being relatively fragmented, providing larger firms plenty of room to grow. We believe this fits in line with the strategy that CEO Irene Rosenfeld has implemented over the past several years, as the firm has been focused on selling off less profitable brands and making acquisitions to drive growth. In addition, while Kraft is highly exposed to private-label competition (particularly due to its cheese and packaged meat offerings), private-label competition is minimal in the confectionery space, as private-label firms control only about 5% of the market–which is also appealing for Kraft. Further, this purchase would increase Kraft’s international presence, while also providing a platform over which it could expand the distribution of some of its existing brands, in our view.
From a financing perspective, we believe that Kraft maintains the financial flexibility to acquire Cadbury. Kraft’s debt amounts to about 45% of capital (average for a packaged-food firm). In addition, the firm operates with more than $1.7 billion of cash and $4.5 billion of funding available under its existing credit facility. Further, Kraft’s ability to service its debt has not been an issue, as its earnings before interest and taxes covers interest expense comfortably at nearly 5 times.
However, given the attractive nature of Cadbury’s portfolio, we believe that other bidders could emerge. Kraft is the largest packaged-foods company in North America and the second largest in the world, behind Nestle NSRGY. Although Nestle has not been focused on growing its confectionary portfolio, the firm could decide that it would rather make a bid for Cadbury than let one of its largest competitors gain this valuable asset.
Although Cadbury does not appear to be interested in any acquisition at this point, we don’t believe Kraft is willing to close the book on this deal. Kraft’s initial offer values Cadbury at just under 15 times the firm’s 2008 EBITDA. While this is less than the 19.5 times earnings that Mars paid for Wrigley just last year, we believe Wrigley was a better business and that the price paid was too high. Given that Kraft’s initial offer is already at a premium to our fair value estimate, we believe that if Kraft sweetens its offer, it runs the risk of overpaying for Cadbury–a move that would lead us to lower our fair value estimate for Kraft. Because the dust has yet to settle, we believe it is appropriate to raise our uncertainty rating for Kraft to high, meaning we recommend waiting for a large discount before purchasing the shares. We will update our analysis as we gain more details on any potential transaction.
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