A decade ago, investing guru Warren Buffett helped torpedo a $15.3 billion Coca-Cola Co. (NYSE: KO) bid for Quaker Oats Cos., arguing that the terms were lousy and the proposed price way too high.
Now Buffet is causing similar complications with a Kraft Foods Inc. (NYSE: KFT) plan to buy Britain's Cadbury PLC (NYSE ADR: CBY), announcing that he's wholly opposed to a plan to issue as many as 370 million Kraft shares to get the deal done. As Kraft's largest shareholder – Buffett's Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B) owns 9.4% of Kraft's common stock – his opinion is likely to carry the day.
Wall Street is furious: Deal fees are not as easy to come by as they used to be, and this transaction promised to be especially juicy – thanks to the spin-offs and share issues Kraft is doing to get the buyout done. Some of those maneuvers won't now be necessary, and if the transaction does get done it will be finalized at a lower price.
From the outset it was clear to me that the Kraft/Cadbury deal represented "managerial capitalism" more than it did shareholder capitalism. And in that battle, I know which side I am on.
I'm with Warren.
In a takeover bid, the interests of management and the shareholders are almost never in synch. On the buyer's side of the deal ledger, you'll find that the suitor's management team very much wants to do the deal and to aggrandize its empire (justifying even higher pay). These managers may also have a grand strategic vision for the company that they have come to believe in and want to carry out during their tenure – after all, it's no fun being Napoleon if you don't invade anywhere!
For the seller, the ethics are somewhat the other way round. Yes, in the 1970s there were some self-perpetuating country-club managements who deserved to be thrown out and the assets redeployed. However, those guys had all lost their jobs by about 1986 – even in Britain (ever heard of Thatcherism?).
These days, the management you want to get rid of is the impossibly greedy sort, which pays itself a higher percentage of every year's profit and dilutes your holding through excessive stock options. Takeovers typically don't solve that problem. By and large, the suitor's management team will be even greedier than the seller's.
If – as a selling shareholder – you see that both sides are equally greedy, you sit back and hope the buyer overpays. If that happens, just smile and pocket your profit.
Usually, however, the buyer is greedier than the seller. In those cases, the world would generally be better off economically if the buyer lost. The reason is clear: Instead of serving as a conflict of economic benefit, the takeover becomes a conflict in which there's rarely a real winner.
The buyer pushes to get the target company's shares into the hands of "arbs" – the Wall Street vultures who more or less have to sell out to someone, or risk losing their bonus. The seller, by contrast, wants to find some legal or political means of gumming up the deal. Under those circumstances, the chances of an economically optimal outcome are slight, indeed.
The people who really ought to be making these decisions – the shareholders of both companies – don't get much consideration. Shareholders of the suitor have little power individually, so tend to go along with management's expansion plans. And shareholders at the buyout-target firm are basically paid to sell out to the arbs and then just forget about it.
This problem has become much worse since shareholders became institutionalized – the middle-level bureaucrats who manage billions of other people's money have neither the ability nor the interest in making waves in companies they own part of. Dealing with that stuff is simply above their pay grade, unless there's some suitably fashionable political or environmental issue involved.
So management gets to do what it pleases.
In the Kraft case, the target company has considerable justification in wanting to remain independent. Cadbury's is a 200-year old confectioner, and for most of its history was run by Quakers, with high ethical standards and a notably employee-friendly management. Before Dominic Cadbury retired in 2000, this takeover would have been impossible – even though the Cadbury family only owned a minority of the stock.
Since 2000, the company has become more aggressive and has overpaid its management. Even so, there is little reason to suppose that Cadbury would be better or cheaper run as part of something else.
As for Kraft, it's primarily in the cheese and snack business – although it does own Nabisco, which makes biscuits and it has a small chocolate operation, Milka. Still, for a cheese and snack company to sell Tombstone Pizza to a chocolate company (Nestle) because it wants to leverage itself to the eyeballs and buy another chocolate company makes little strategic sense.
And you know Kraft will end up paying too much for Cadbury, thus diluting its own shareholders. Guys, if you're in the cheese business, pizza is what you have synergy with, not chocolates. Nobody has ever managed to make a truly commercially successful cheese-flavored chocolate, or even a chocolate-flavored cheese – and believe me, it's been tried!
It's at this point that grown-ups need to intervene and take management's toys away. Huge amounts of shareholder money are being wasted on Wall Street fees and lawyers' fees (not to speak of PR agents and lobbyists), to no good end.
The problem, of course, is that there's only one Warren Buffett. We need more like him – as well as a system of shareholder capitalism in which the shareholders are individuals, not pension funds, and where those individuals provide managers with a good smack when they misbehave.
We had this as late as the 1950s; why haven't we got it now?
I believe a major culprit is the estate duty, or "death tax," abolished in 2010 but due to come back at the obscene rate of 55% in 2011. Rich people can't hand their money on to their families, so they put it into foundations and trusts, to be managed by professionals and given away to dodgy "charitable" causes. If this wealth could be passed on from one generation to the next, as it used to, families would have no need to sell control of their family companies, and in most companies individual shareholders would remain firmly in control – at least firmly enough to stop this kind of nonsense.
So let's not bring back the estate tax – or maybe bring it back at some low civilized rate of 15% or so, with high exemptions. Estate lawyers and charities would lose out, but I bet the revenue for the U.S. Treasury would actually increase because the tax wouldn't be worth dodging.
Best of all, we'd once again see a return to the time when individual shareholders owned 30% to 40% of even the largest companies. The goal of capitalism would once again be the creation of wealth for all shareholders – not just for greedy corporate managers.
As shareholders ourselves – even small ones – that's what we should want. And it's what we deserve.
[Editor's Note : Pundits often refer to the post-credit crisis financial system that's manifesting itself in this country as "Bernanke's Folly." And with good reason. With all the debt the United States has taken on, the country is facing a financial mess that will take years to fix. But investors who are willing to act boldly and invest decisively will find an unparalleled profit opportunity hidden behind the piles of financial refuse.
With his Permanent Wealth Investor trading service, longtime global investment banker Martin Hutchinson has time and again demonstrated the ability to ferret out those profit moves. With a combination of gold, hefty dividend payers and stocks that are ready to rocket, Hutchinson has already secured windfalls for subscribers. To hear Hutchinson's latest views on the world's economies and stock markets – and to read about his latest investment calls – please click here.]
News and Related Story Links:
- Bloomberg News:
Buffett Reins In Kraft, Recalling Coke's Retreat on Quaker Oats
- The Wall Street Journal:
What Buffett's Vote Means for Kraft's Cadbury Bid
- The Wall Street Journal:
Warren Buffett's M&A 101 Lesson for Kraft
Other People's Money
Above My Pay Grade
Official Web Site
- The Chicago Tribune:
Kraft to sell pizza unit in push for Cadbury
Surprise: ABC Investigates Frivolous Laws, Impact of Estate Tax Return in 2011