Commentaries

A limit to Kraft’s sweet tooth

Cadbury’s swift rejection of Kraft’s $16.7 billion offer has set off widespread speculation that Kraft will bump up its bid to ensure that it becomes king of candy land.

There is a limit, however, to how much Kraft can pay if it is committed to its investment-grade ratings. The company’s ratings sit two to four notches above speculative, or junk, territory, and every dollop of extra debt to pay for the acquisition would pressure the company’s ratings, making this and future financing much more expensive.

During the last merger and acquisition boom, ratings often became secondary for many firms, since the difference in the cost of financing for investment-grade companies and junk-rated companies had narrowed.

The credit crisis and the re-pricing of risk, however, mean the consequences of losing a sterling credit rating is much greater.

Risk premiums for BBB-rated debt for example, stood at 313 basis points on average over comparable Treasuries while BB-rated junk debt sat at 568 basis points last week, according to Standard & Poor’s. In January 2007, the difference between these two categories was 68 basis points.

Moody’s Investors Service warned on Tuesday that it could downgrade Kraft’s ratings one notch should a deal be consummated.

This is something that Lazard, Kraft’s lead financial adviser, and Citigroup and Deutsche Bank who will arrange the financing, will have to take into consideration when formulating a sweetened bid.

July: It rained, the deals didn’t

With stock markets on the rise and some signs of economies steadying, if not recovering, investment bankers have recently sounded more optimistic about the prospect for deal-making for the second half of the year.

This month? Not so good.

July, with just $96 billion in announced deals around the globe, is the first month to have less than $100 billion in worldwide M&A since September 2004, reports Thomson Reuters Deal Intelligence. No deal was more than $5 billion, the first time that has happened in a month in nearly six years. (The biggest announced merger was in Japan, the $4.4 billion acquisition of Nipponkoa Insurance by Sompo Japan Insurance. The biggest U.S. acquisition was Sanofi-Aventis’ $4 billion offer for Merial.)

This August – especially after two consecutive summers of financial crisis – is certain to be slow as well as Wall Street and other financial centers go on vacation. Any pickup in M&A activity in the second half will have to start with a flurry in September.

For the entire first half, worldwide M&A totaled $1.1 trillion, a decline of 43 percent from the same period in 2008. More details from the Thomson Reuters data can be found in this post on DealZone.