Friday, August 05, 2011

The Kraft-Cadbury Break-Up- I Take A Victory Lap

I could scarcely believe what I heard and read in the past day or so concerning Irene Rosenfeld's new plan to split the Cadbury-dominated snack foods of the post-merger Kraft from its groceries business.

I wrote these two posts, here and here, in September of 2009 and January of 2010, respectively.

Consider this passage from the first linked post,

"Stitzer's focus, via that strategy, becomes more evident with the next passage. The piece then quoted Cadbury's CEO again,

"I think scale works to a [point]," he said. "There's a confectionery buyer in retailers and I think you can focus on that buyer, and if you can offer chocolate, gum and candy, I think that's an advantage. What more can you offer to the confectionery buyer in the grocery store? They don't necessarily and are not generally responsible for anything but confectionery."

Putting these two views together, one what seems to be a really non-delusional, focused, in-touch CEO. One that understands his direct customers, the retail food merchant's buyers.

With them in mind, he's built Cadbury out within the scope of his current customers' pervue. But he rightly notes that Kraft primarily markets to other buyers, albeit within the same grocery store.

After the requisite administrative costs are shed, what then? What organic, post-merger accounting growth will be realized?

If anything, Stitzer is really making the case, by omission, for another approach entirely.

Why doesn't Kraft offer to sell its confectionary businesses to Cadbury for stock, and a seat (or however many make valuation sense) on the British firm's board?

That way, Kraft gets the value of scale within confectionary products, but avoids the curse of oversized conglomeration. Irene Rosenfeld's management team can focus on food products, while reaping the benefits of Cadbury's economies of scale within their category. In time, subject to deal terms, Kraft can sell its stake in the market, or to Cadbury, for a premium, while relinquishing board presence.

It argues for Cadbury's management to handle the commonly-held confectionary businesses, not for Kraft to get a larger collection of assets to mismanage."

And, then, this one from the second linked post,

"I still believe, as I did last September, that both parties would have benefited from Rosenfeld's selling Kraft's businesses which resemble Cadbury's, to the latter, taking equity in exchange.

Cadbury is simply a better management team than Kraft. If anything, I guess Cadbury shareholders should thank Stitzer and the board for getting top pound for the company, and walking away with cash after selling whatever Kraft paper they receive, while Kraft will be stuck trying to make this dubious tie-up pay off."

Funny how that worked, isn't it? A former Cadbury shareholder could soon repurchase the old Cadbury, plus some similar Kraft businesses, with the premium they received.

However, looking at the nearby price chart of the S&P500 Index and Kraft for the past two years, it appears that Kraft actually outperformed the Index. Probably on account of Cadbury, since Kraft was underperforming the Index for the five years prior to the acquisition, and still headed downward.

According to this morning's Wall Street Journal article, Rosenfeld had the idea to buy Cadbury, bundle the snack businesses, then split Kraft, as long as several years ago.

Even if true, this is corporate ego and obsession with power at its worst. The story would mean that Rosenfeld squandered Kraft shareholder money on the Cadbury premium, and on investment bankers, just to get to the point of now spending more money to split up the swollen Kraft.

Wouldn't it have been simpler and cheaper in the first place to have just approached Cadbury's Stitzer about such a combination? Rosenfeld could then have declared a special stock dividend of Cadbury shares received for the Kraft snack businesses sold the the British confectioner.

To believe that Rosenfeld's approach made more sense is to be caught up in the sort of wilderness of mirrors which can occur in large corporate managements. A lot of extra expense and effort just to allow Rosenfeld to appear to be the empress of a larger set of businesses, only to separate them once more.

One thing is true, though. According to my proprietary equity research, splitting the slower-growth grocery businesses from the higher-growth snack businesses will, indeed, allow the latter to deliver a consistently higher total return to their shareholders. The combination has certainly punished the latter, while investors price Kraft to an average that accounts for the former.

Thus my point that it made no sense to effectively destroy or mix value from Cadbury into Kraft in the first place.

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