Kraft Foods Inc.: To Make Offer for Cadbury PLC

Northfield / IL. (kf) In September Kraft Foods Inc. announced the terms of a possible offer for Cadbury PLC. Since that date, Kraft Foods has continued to evaluate the benefits of a possible combination with Cadbury and has considered carefully all publicly available information, including Cadbury´s interim management statement released on 21 October. In the light of this evaluation, Kraft Foods is pleased to announce the terms of an Offer to acquire the whole of the issued and to be issued share capital of Cadbury as set out below.

The Offer

Under the Offer Cadbury Shareholders will be entitled to receive:

  • for each Cadbury Share 3,00 GBP in cash and 0,2589 New Kraft Foods Shares
  • for each Cadbury ADS 12,00 GBP in cash and 1,0356 New Kraft Foods Shares

Based on the closing share price of 26,78 USD per Kraft Foods Share on 06 November, the Offer values each Cadbury Share at 7,17 GBP and values the entire issued share capital of Cadbury at approximately 9,8 billion GBP (based on an exchange rate of 1,6609 USD per 1,00 GBP). All payments of cash will be made in Pounds Sterling.

The Offer represents a substantial premium

The Offer represents a substantial premium to the unaffected share price of Cadbury. The Offer price equates to a premium of:

  • 37 percent over Cadbury´s share price of 5,24 GBP on 03 July, prior to analyst suggestions regarding potential sector consolidation;
  • 29 percent over Cadbury’s 90-day average share price of 5,55 GBP in the period up to 04 September, the last Business Day preceding the announcement by Kraft Foods of a possible offer for Cadbury; and
  • 26 percent over Cadbury´s closing share price of 5,68 GBP on 04 September, the last Business Day preceding the announcement by Kraft Foods of a possible offer for Cadbury,

in each case based on the closing share price of 26,78 USD per Kraft Foods Share on 06 November and an exchange rate of 1,6609 USD / 1,00 GBP.

The Offer represents an attractive multiple

The Offer equates to:

  • a multiple of 28,9 times Cadbury´s diluted underlying earnings per share; and
  • an enterprise value multiple of 13,9 times Cadbury´s underlying EBITDA,

in each case based on the closing share price of 26,78 USD per Kraft Foods Share on 06 November and an exchange rate of 1,6609 USD / 1,00 GBP.

Given Cadbury´s mix of businesses, there are no previous transactions which are perfectly comparable with Kraft Foods´ proposed acquisition of Cadbury. However, as highlighted by Cadbury at the time, Cadbury paid 12,8 times historical EBITDA for Adams in 2002. At the time of the Adams acquisition, the price to historical earnings ratios of the Dow Jones Industrial Average and the FTSE 100 were 22,4x and 18,4x respectively. They currently both stand at 17,4x, reflecting the significantly altered economic and stock market climates.

Kraft Foods´ current trading and prospects are strong

On 03 November, Kraft Foods released its Q3 report in which Kraft Foods delivered strong continued momentum in its underlying business. Organic revenue growth of 0,5 percent was driven by continuing improvements in volume/mix, despite the dampening impact of several strategic decisions made to improve the long-term prospects of Kraft Foods´ business. This volume/mix trend underpinned strong gains in margins and earnings per share, with a 470 basis point improvement in operating margins and a 62 percent rise in earnings per share from continuing operations, including a nine cent or 26 percent gain from operational sources. Kraft Foods also raised earnings per share and cash flow guidance for the year. Kraft Foods increased its guidance for 2009 diluted earnings per share to at least 1,97 USD versus the prior expectation of at least 1,93 USD. Continued momentum in cash flow performance reflected strong operational performance, with Kraft Foods raising its discretionary cash flow outlook for the year by 400 million USD to at least three billion USD. Kraft Foods expects to achieve this guidance while continuing to increase investment behind its brands, with advertising and consumer marketing spending expected to grow to approximately seven percent of sales from 6,7 percent of sales in 2008.

Kraft Foods believes that this performance provides further evidence of its long-term sustainable business model and the attractiveness to Cadbury Shareholders of holding Kraft Foods Shares. Should the combination with Cadbury be completed, Kraft Foods would expect to revise its long-term growth targets to more than five percent for revenue and nine to eleven percent for earnings per share, from its previously announced more than four percent and seven to nine percent respectively.

Kraft Foods´ estimated synergies have been carefully evaluated
and are in line with precedent transactions

Kraft Foods´ previously announced estimated pre-tax annual cost savings of at least 625 million USD are expected to be achieved over and above the current performance improvement programmes at each of Kraft Foods and Cadbury (including Cadbury´s Vision into Action (VIA) programme). Kraft Foods believes that, as both companies have been actively rationalising their cost bases over the last few years, the most easily achieved cost saving initiatives have already been implemented and VIA represents a significant cost cutting programme in its own right. Further, Kraft Foods will take on the risks associated with delivering the remaining margin improvement associated with VIA.

Notwithstanding this, the expected cost savings have been carefully evaluated, are in line with other relevant transactions and are greater, as a percentage of revenues, than the 6,5 percent estimated by Cadbury at the time it announced its acquisition of Adams in December 2002.

Cadbury has since stated that it achieved synergies representing 14 percent of revenues from its acquisition of Adams. It should be noted that this level of synergies was achieved approximately four years after the transaction was announced and includes revenue synergies equating to six to seven percent of revenues.

Given the complementary nature of Kraft Foods and Cadbury, Kraft Foods believes that there is potential for meaningful revenue synergies from a combination of the two businesses. Such synergies will, however, take time to be realised and will require significant investments in distribution, marketing and product development.

Cadbury Shareholders who accept the Offer will be able to share in all synergies resulting from the combination of Kraft Foods and Cadbury through the Kraft Foods share component of the Offer.

Kraft Foods is a unique fit for Cadbury and is the only offeror

As set out more fully in «Background to and reasons for the Offer» below, Kraft Foods believes that Cadbury and Kraft Foods represent a uniquely complementary fit. Accordingly, Kraft Foods believes that it is the most logical acquiror of Cadbury. No other potential offeror has publicly declared its interest in acquiring Cadbury.

Kraft Foods will remain financially disciplined

Kraft Foods will continue to maintain a disciplined approach with respect to an acquisition of Cadbury in line with four key criteria:

  • accretion to earnings in the second year following completion on a cash basis (which excludes the one-time expenses related to the transaction and the impact of non-cash items such as the amortisation of intangibles after acquisition);
  • a return on investment in excess of Kraft Foods´ cost of capital within an acceptable timeframe;
  • retention of Kraft Foods´ investment-grade credit rating; and
  • maintenance of Kraft Foods´ dividend.

Background to and reasons for the Offer

Over the past three years, Kraft Foods has built strong operating and financial momentum. Among other actions, Kraft Foods has strengthened its senior leadership team, decentralised and empowered its business units, invested in its core brands, built upon its scale in the marketplace and improved product quality.

As a result of the above actions, Kraft Foods is now in a position to pursue its long-term strategy from a position of strength. Four priorities have shaped this strategy:

  • focusing on growth categories to transform Kraft Foods into a leading snack, confectionery and quick meals company. This is being achieved through exiting lower-growth, lower-margin businesses and reinvigorating high cash flow businesses to fund growth;
  • expanding its footprint in rapidly growing developing markets to benefit from trading up by consumers and achieving the scale to establish cost-efficient infrastructure in key geographies;
  • increasing its presence in the instant consumption channels as they continue to gain share versus grocery channels in the US and European Union; and
  • enhancing its margins by improving the portfolio mix and reducing costs while investing in quality.

Kraft Foods believes that a combination with Cadbury would accelerate the achievement of these priorities. Thus, the combination has compelling strategic and financial rationale for shareholders of both Kraft Foods and Cadbury.

Kraft Foods believes that a combination with Cadbury would build on a global powerhouse in snacks, confectionery and quick meals, with an exceptional portfolio of leading brands around the world.

Combining the Kraft Foods and Cadbury businesses would create a global confectionery leader, with a portfolio including more than 40 confectionery brands, each with annual sales in excess of 100 million USD. Globally, the Combined Group would be number one in the chocolate and sugar confectionery segments and a strong number two in the high growth gum segment. Cadbury´s leading brands such as Cadbury, Trident and Halls, are highly complementary to Kraft Foods´ portfolio and would benefit from Kraft Foods´ global scope, scale and array of proprietary technologies and processes.

Kraft Foods believes that confectionery markets are consolidating and scale is becoming increasingly important, in part due to retailers´ increasing bargaining power, control of the supply chain and growing portfolio of their own retailer brands, which have benefited from the global economic climate. The combination of Kraft Foods and Cadbury provides the necessary scale to compete even more effectively in the confectionery sector.

As Kraft Foods´ customers grow and consolidate, Kraft Foods believes that there are benefits to growing along with them. This allows Kraft Foods to act as a stronger partner, creates efficiencies for both partners and maintains balance as the customers increase their scale.

Cadbury´s geographic footprint is complementary to that of Kraft Foods. Importantly, a combination would increase scale in developing markets for both companies. Kraft Foods´ operations in developing markets currently deliver revenues twice those of Cadbury. Kraft Foods´ businesses in Brazil, China and Russia are, in aggregate, about three times larger than Cadbury´s businesses in those countries. Conversely, Cadbury would provide Kraft Foods with a meaningful entry into India and South Africa and would be transformational in Mexico. The Combined Group would also have improved positions in several developed markets, such as France and Spain.

Kraft Foods´ and Cadbury´s routes to market are also highly complementary. Kraft Foods is particularly strong in the grocery channel in North America and Western Europe. Cadbury is well positioned in instant consumption channels, which have become increasingly important in both developed and developing markets. A combination provides an enhanced platform for the Combined Group to distribute both Cadbury´s and Kraft Foods´ products through both channels and creates an attractive opportunity for higher growth and margins.

Estimated cost savings

Kraft Foods believes a combination with Cadbury will provide the potential for meaningful revenue synergies over time from investments in distribution, marketing and product development. In addition, Kraft Foods believes there is a significant opportunity to realise pre-tax cost savings of at least 625 million USD annually.

Kraft Foods expects that it will achieve the run-rate on these cost savings by the end of the third year following completion. Total one-off implementation cash costs of approximately 1,2 billion USD are expected to be incurred in the first three years following completion.

The expected sources of the expected annual pre-tax cost savings of at least 625 million USD are:

  • potential operational cost savings of 300 million USD per annum resulting from efficiencies and economies of scale in the areas of procurement, manufacturing, customer service, logistics and research and development;
  • potential general and administrative cost savings of 200 million USD resulting from efficiencies in the areas of central, regional and country level administrative expenses; and
  • potential marketing and selling cost savings of 125 million USD resulting from efficiencies and economies of scale in the areas of marketing, media and selling expenses.

The estimate of cost savings set out in this announcement was announced on 07 September and was reported on for the purposes of the Takeover Code by Ernst + Young LLP and by Lazard + Company Limited. For copies of their reports, see the announcement released by Kraft Foods in September and available on Kraft Foods´ website. There are various material assumptions underlying the cost savings estimate which might therefore be materially greater or less than that estimated. The estimate of cost savings should therefore be read in conjunction with Appendix II of the announcement released by Kraft Foods in September, which contains, among other information, certain key assumptions underlying the estimate.

Info: The complete press release «Offer by Kraft Foods Inc. for Cadbury PLC» (PDF, 51 pages, 187 KB) is available on Kraft Foods´ web server.