Kraft: The Saga

I'm sure you guys have heard about Kraft (KFT) attempted takeover of Cadbury. If you haven't, I'll give you the skinny.

In Sept 2009, Kraft proposes to buyout Cadbury for a total of USD 16.7B, in a mixture of cash and KFT's shares. Cadbury flatly refuses the offer, saying that it is way too cheap. The figure Cadbury has in mind is somewhere around USD 21B. So instantly, the takeover becomes hostile.

Let's examine Cadbury a little more. Cadbury is an iconic British confectioner, with extensive global reach. They manufacture chocolates, gum and candy. Being a British firm, they have 30% of the chocolate market share in the UK and 42% of the market share in Ireland. They have a large presence in France with 43% of the gum and 17% of the candy market. The key part of their business is their presence in Asia. They have very strong brand recognition in India, Thailand and Malaysia. In India, they are the leading chocolate manufacturer. Their presence in China is also growing. The reason Asia is so important is that Asia is the next growth frontier. India and China are where confectioners want to be. In 2008, they made an operating profit of GBP 370M, approximately USD 592M.

Let's look at valuation of Cadbury. What sort of discount rate would give us a USD 16.7B? A discount rate of approximately 3.53%. To put that in context, the US 10 Year Treasury bill is yielding 3.8% right now. That would imply that Cadbury should have a Treasury Bill like income, meaning stable, certain and extremely predictable. If you were to look at the Cadbury's last 5 years of income, you'd see that it's anything but predictable or stable.

Op Profit (In GBP, in Millions)
2008 - 370
2007 - 149
2006 - 176
2005 - 347
2004 - 198

As you can see, it's all over the place. Not a good sign. Esp if KFT were to pay USD16.7B for the company.

Furthermore, KFT is using its own undervalued shares (at $27 per share) to pay for Cadbury. Just an example of how undervalued KFT's shares are. KFT IPOed in 2001 at $31 per share. It's now trading at $28 per share. Meanwhile, KFT has bought back USD 5B worth of shares at an average price of $33 per share. So in effect KFT is buying high ($33) and selling low ($27). Buffett pointed this out in a statement released 5 Jan 2010.

I'm going to continue this saga at a later date. Things sure are interesting. And potentially profitable if you are long KFT. I'm not sure about shorting Cadbury. It is possible that Cadbury's price may not fall after the takeover. Witness Comcast failed takeover of Disney.

Disclosure: I am long KFT.