Kraft's Bid for Cadbury Not Sweet Enough

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Kraft Foods Inc.'s (NYSE: KFT) $16.7 billion unsolicited takeover attempt of Cadbury PLC (NYSE ADR: CBY) is the latest sign of consolidation in the highly competitive food industry, and will likely lead to two things: A bidding war for Cadbury and further consolidation in the sector.

The world's second-largest foodmaker went public with its bid for Cadbury earlier this week after being snubbed privately. Kraft's offer – a 31% premium to the chocolate maker's Friday closing price of $37.46 a share, but less than  – "fundamentally undervalues" Cadbury, it said. The offer is less than 15 times Cadbury's 2008 earnings before interest, tax, depreciation and amortization (EBITDA).

"Any follow-up offer by Kraft would likely involve a higher price," Moody's Investor Service senior analyst Brian Weddington said in a note. "The increased leverage that would result under the proposed transaction would be considerable."

Increased leverage could be a boon to Cadbury and its investors, as The Hershey Co. (NYSE: HSY) will likely throw its hat into the bidding ring, one person familiar with the matter told The Wall Street Journal.

"Hershey recognizes that Cadbury is the last major confectionery company potentially available and, as such, is likely to make some response," the person told The Journal. Nestle Chief Executive Officer said his company is always "open to acquisition opportunities if they fit strategically."

Some analysts have Hershey teaming up with rival Nestle SA to make a joint offer for Cadbury and splitting its business, Reuters reported.

If Kraft and Cadbury can reach an agreement, it would be "bad news" for Nestle, Icap PLC analyst Andy Smith told Bloomberg News. "[Nestle has] the firepower to counter if they want."

Cadbury and Kraft's combined sales in 2008 were $51 billion, roughly half of Nestle's in the same period.

However, Hershey's position is less flexible.

The Pennsylvania chocolate maker has $1.7 billion in net debt and a market capitalization of $8.9 billion. Cadbury is valued at $17.7 billion, so any takeover by Hershey would require serious financing, according to The Journal.

Hershey could pursue a joint effort with Nestle, but that would mean turning Cadbury's lucrative gum business over to the Swiss candy company to take to avoid antitrust issues.

Cadbury has almost 29% of the global gum market. The other big player in the sector is privately held Mars Inc., which became the world's largest confectioner last year when it teamed with Warren Buffet's Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B) to buy chewing gum icon Wm. Wrigley Jr. Company for $23 billion. Berkshire owns about 9.4% of Kraft's shares, according to Reuters.

In January 2007, Cadbury Chief Executive Officer Todd Stitzer agreed with Hershey's then-Chief Executive Officer Richard Lenny to remove that obstacle and suggested they create a "global confectionary powerhouse." But any potential merger was held back by Cadbury's beverage business, which included Dr. Pepper and Snapple.

Cadbury spun off its beverage business in May 2008, which resulted in the birth of the Dr. Pepper Snapple Group Inc. (NYSE: DPS).

Chances for a reverse scenario of Cadbury acquiring Hershey are slim, as the Hershey Trust is set on protecting the Hershey name and keeping it an American company.

"Simply put: We will not sell the Hershey Co.," Hershey Trust Chairman LeRoy Zimmerman said in an opinion piece published last year in the Patriot-News of Harrisburg, PA.

While a number of analysts expect Kraft to raise its bid for Cadbury, the foodmaker is in a tight position because it does not have that much room to maneuver without threatening its balance sheet or risking its investment grade credit rating. The company already has almost $19 billion of bonds outstanding, according to Bloomberg.

Other companies mentioned as possible suitors are Kellogg Co. (NYSE: K) and PepsiCo Inc. (NYSE: PEP).

The worst economic downturn since the Great Depression and rising commodity costs have sent consumers looking for less expensive products at the grocery store, limiting companies' ability to grow. As with Mars' acquisition of Wrigley last year, companies are looking to consolidation for growth.

"Consolidation in the food sector has long been anticipated," an unnamed merger advisor told Reuters. "Given the drop in [bottled] water revenues, Nestle and Danone are thought to look at acquisitions to spur revenue growth."

For Kraft, a successful acquisition of Cadbury would spur its growth by expanding its presence in emerging markets like China, Brazil, Russia, and especially India. Cadbury is deeply entrenched in British Commonwealth nations such as India, where it has been selling chocolate for more than 60 years.

A takeover of Cadbury India "would open up a $500 million chocolate market which is growing at 15% per year," Angel Broking Ltd. analyst Anand Shah told The Journal.

"I believe that in the current global economy, the growth prospects are constrained," said Kraft Chief Executive Officer Irene Rosenfeld.

Shares of Kraft closed at $26.85 yesterday (Wednesday), up 1.51% or 40 cents, while Cadbury closed at $51.80, down .15%, or eight cents.

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