Cadbury Shareholders Losing Potential Gains

In waiting for a higher bid, Cadbury shareholders have been injured twice recently by not accepting the Kraft offer. The first comes from the decline in market price. The second comes from the loss of potential future gains from holding KFT shares, which had been underpriced, and likely remain so. By changing the mix to include more cash and less stock, Kraft has reduced the future bonus that CBY shareholders might gain from selling to Kraft.

References:
Reuters story, from Yahoo Finance: Cadbury shares dip below Kraft bid for first time
BusinessWeek, citing Bloomberg story: Cadbury Price Falls to Near Kraft Offer

Some shareholders see any price under 800p as "horrible." If Kraft walks away, CBY will likely drift below 800p, since no other suitor will be seen as emerging. As I have written before, this is a dominant strategy for Kraft, with no options that Cadbury currently sees as workable available to it to counter a Kraft departure from its offer. Kraft can thrive in the absence of Cadbury.

Odds of Hershey bid: 10%
Odds of Ferrero bid:
Odds of Nestle bid: 5%
Odds that Kraft abandons offer: 35%
Odds of other offer (e.g. private equity): 5%
Odds of a reduction in the Kraft offer price: 15%

Cadbury Stamps its Feet at Buffett's Remarks

It bears repeating that Cadbury's response to Kraft's merger offers is like that of a woman who feels insufficiently worshipped. On Tuesday Warren Buffett publicly stated his opposition to Kraft issuing new shares to pay for a Cadbury bid, fearing that Kraft would overpay. In response, Cadbury Chairman Roger Carr said that Kraft's comments about fiscal discipline is really "about management weakness" and that the offer was limited by "powerful Kraft shareholders restricting the stock content."

Rarely before has a business manager so clearly stated his opposition to the careful stewardship of capital. Over and over again in many companies over the past hundreds of years, managers have believed that they should be paid proportionally to the number of people employed or by the top line, while shareholders are correctly and properly concerned about per-share performance. This conflict is always present, but generally management keeps their share-dilutive aspirations to a dull roar, hoping to make acquisitions that accomplish both goals or which sneak under the radar. Granted, Carr is in the to-be-acquired company, but by so deliberately insisting that Kraft overpay, he has shown a spotlight on the degree to which Kraft shareholders are being asked to hurt themselves in voting for the acquisition.

Indeed, Carr's position directly disparages Kraft shareholders, either in the way that he insists that they be forced to throw money away, or that they must be stupid enough to throw the money away of their own free will, all because of an infatuation with Cadbury.

Quite clearly, Cadbury is not worth the emotion that is being requested of American shareholders. The bid price is already rather full, as has been stated by a number of competent capital managers, and Cadbury's management behavior has been rather emotional, as was stated here earlier.

Kraft shares are undervalued at recent prices. KFT has already been moving up, as I predicted in previous postings. The profitable course of action for capital managers is to be long KFT and short CBY. If the Kraft bid fails, KFT shares will continue to move up and the company will have avoided a dilutive action. If the Kraft bid succeeds, KFT likely will not fall much, as management would need to contradict Warren Buffett in order to raise their bid further.

If Cadbury had wanted American shareholders and management to have fallen in love with it, maybe it should have made itself more accessible over the past 100 years. Figuratively, it has presented itself to American investors while wearing slouchy jeans, sneakers with holes, and a sweatshirt. If you go into any U.S. supermarket, convenience store, buying club, or gas station, do you see Cadbury products? No. Does Cadbury show up at Halloween, Thanksgiving, or Christmas? No. So there is no basis for any emotion, even IF you were to accept the questionable premise that an investment decision should be made on emotion.

There is more: Today Reuters and the The Financial Times ran articles with headlines of substantially opposite meaning, although the articles both made vague reports about Cadbury approaching Hershey, or vice versa, or indicating that a Hershey bid would be more welcome. The difficulty with the scenario is that Cadbury is twice Hershey's size, so Hershey is in no position to be a white knight. In fact, meeting the bid price for CBY would be even worse for HSY shareholders, who would likely even greater dilution than KFT shareholders would.

Then there is the emotional problem: Cadbury's management doesn't really want to consummate a merger. They would prefer that Hershey compete in the bidding process, but they wouldn't want Hershey to win the auction. Suppose that Hershey's managers aren't blinded by their love for Cadbury. In this case it is likely they can see the awkwardness of agreeing to a shotgun marriage where neither bride nor groom are in love, and no one is pregnant. It's likely that Hershey isn't emotionally committed, otherwise they would have made a bid earlier. Therefore, Hershey will probably stay out of the bidding. After all, their worst case would be accidentally winning the auction.

Ref:
FT, "Cadbury denies pursuing Hershey"
Reuters, "Cadbury talks to Hershey for rival bid - sources"

Nestle Share Repurchase; Cadbury Bid Prob Decreases

Bloomberg reports today that Nestle has set a $9.6B share repurchase. Although less than the $28.1B it will receive from selling its Alcon stake, this event diminishes the likelihood of a bid for Cadbury that competes with Kraft's. Indeed, KFT is up 1% today as I write this. CBY is also up 1%, but if KFT were to win the auction, then CBY's stock moves would be correlated to KFT. Hence, the market believes KFT will win CBY.

CBY market cap is $70B. The $18B remaining after the Alcon sale isn't sufficient to cover the price of a CBY bid higher than KFT's.

Cadbury's Todd Stitzer is Asking for a Lower Price

Yesterday I wrote that Cadbury's (CBY-NYSE ADR) CEO seemed rather impassioned about his attacks on Kraft Food's (KFT-NYSE) merger offer. I pulled my punches, though. The background data on my thesis is better than I let on.

On December 15 WSJ.com published a comment ("Cadbury's CEO Is a Real Paine" by Dana Cimilluca) about Paine's statements on a conference call Cadbury held to describe its case against the Kraft offer. Stitzer quoted Thomas Paine: "What we obtain too cheap, we esteem too lightly; it is dearness only that gives everything its value." To my ears, this has much more the tone of a woman who has failed to obtain sufficient obsequiousness from a potential mate than of anything to do with Revolution.

It is clear that Cadbury esteems Kraft rather lightly, Cimilluca writes, reporting that Stitzer said "Kraft is trying to buy Cadbury on the cheap to provide much needed growth to their unattractive low-growth conglomerate business model" (emphasis added).

Stitzer, likely facing a dimished role or unemployment if Kraft succeeds at acquiring Cadbury, has upped his target for long-term annualized revenue growth by 1%, from 4-6% to 5-7%. Targets for operating margins and dividend growth were also increased to make Cadbury appear more attractive.

Kraft's shares are stuck in a multi-year slump, currently trading for more than 10% less than their average price in 2006. Earnings have recently improved, with S&P estimating EPS of $2.00 for 2009 (ending 12/31). That puts KFT shares at a PE of less than 14, below its peers and potential. Perhaps Kraft's recent gains have made it anxious to begin spending its money on acquisitions?

This acquisition is a litmus test for Kraft management. If they do pay up for Cadbury, it is a sign that the company is willing to discard shareholder equity in exchange for top-line growth. Holding the line on price sends a far better signal to shareholders. So far, the signals appear to have been that KFT has made its only offer for Cadbury. If this holds true, expect an increase in KFT to $29 or $30 in the next few months.

Cadbury's Derisory Opinion of Kraft

Were you the Kraft CEO, would you stick with your offer for Cadbury? Cadbury's chief has made it quite clear through his repeated use of the word "derisory" that he doesn't think much of Kraft, its products, or its shareholders. Or its offer, which even Warren Buffett was quoted as saying was "quite full." Cadbury would like Kraft to overpay, and insists that unless Kraft does indeed overpay, that the offer is an insult.

Kraft shareholders have been insulted. Cadbury clearly thinks that they are stupid enough to overpay for the acquisition, and in fact that unless the Kraft side is stupid, that there should be no deal. There is even a moral overtone to the objections, as though Kraft had violated one of the ten commandments by making a bid for Cadbury that did not contain extra fluff.

Now that Hershey's trust has decided to discard its highly regarded conservative stance and possibly make an offer for Cadbury, it is said (by the New York Times today) that Cadbury would be leaning toward a Hershey offer. It all makes sense now: Cadbury is willing to fall in love and marry the first company that loses its rationality and becomes hyperemotional. Obviously, Kraft is not emotional, as it made a rational offer. No wonder Cadbury feels so betrayed, no, disparaged, jilted, so unappreciated and unloved! Cadbury doesn't want a merger or a partnership. It wants to be courted by a suitor that proves first that it can't think straight for all its lust to consummate a deal with Cadbury, and only Cadbury...

Kraft can do without a partner that wants the chocolate business to be just like a dirty romance novel. Walking away is the best option for KFT.