Cadbury’s Kraft sugar rush overdone

September 8, 2009

KRAFT-CADBURY/Kraft’s offer for Cadbury got off to a sticky start on Tuesday when the U.S. food group’s stock fell 6 percent, taking some of the buzz out of Cadbury’s bid-fuelled share price.

Kraft’s initial offer has raised expectations of a higher bid, but while it is likely to have to pay more to win, the take-out prices now being touted are stretching the value of the British confectionery group further than a Curly Wurly.

The multiple paid by Mars to Wrigley — some 17.5 times EBITDA — has encouraged analysts to look for a valuation of 15-16 times forecast 2009 EBITDA, implying a price of 10 pounds or more, against Kraft’s 7.16 pound per share offer after the fall in the Kraft price. The Cadbury share price also gave up some of its gains, but is still well above the value of the bid.

But comparisons with the Wrigley takeover and recent deals — the average multiple for big food deals has been 14 times EBITDA over the last 10 years — do not adequately factor in the higher cost of capital since the Mars deal. As a private company, Mars could also pursue a fully-priced bid without rattling its shareholders.

Cadbury’s shareholder base is now heavily skewed towards the United States and there will certainly have been changes since the offer was announced, with arbs leaping in at the prospect of a rare bidding war. Cadbury may be a British institution, but British institutional investors are conspicuous by their absence from the share register. This raises the chance of the company’s fate being decided by these newly-arrived shareholders.

But while Cadbury is a natural fit with Kraft, those expecting more cash in a raised bid may be disappointed.

Kraft is going to be constrained in how far it can push without ringing alarm bells at the ratings agencies. Analysts estimate Kraft’s net debt/EBITDA would rise from three times to four times based on the price it has already offered.

Kraft’s expected annual pre-tax cost synergies of $625 million go some way to repay the premium it may pay for Cadbury, but it will need to find more cost and revenue savings to justify a significantly higher bid. These synergies won’t come for free. Kraft anticipates one-off implementation costs of $1.2 billion in the first three years.

Expectations that the world’s largest food group Nestle could team up with Hershey for a counter-bid have also helped the Cadbury share price. But the regulatory risk would be far greater, and the unhappy experience of the takeover of British brewer Scottish & Newcastle by Heineken and Carlsberg showed the pitfalls of a consortium bid.

 So Kraft may not have to raise its bid that much further to shake out enough Cadbury shareholders to win control and become the world’s biggest sweet and chocolate group. It would do well to wait until the initial sugar rush has passed before making its next move.

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