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Berkshire Hathaway
Cheesed about Cadbury

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By Tode
January 25, 2010

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I wish that on February 14, when the 13F comes out it would show that Berkshires position in Kraft had been reduced to zero.

That would indeed send a message, but of course WEB also might be shooting himself in the foot by selling the position for well under what he thinks is its intrinsic value. As I am sure you know, he was asked in the CNBC interview, after he ripped apart the Cadbury deal as a huge capital allocation error, if he intended to sell his position. He said that while the deal decreased the value by perhaps $2 or $3 a share, he thought it still was undervalued.

He damned Irene Rosenfeld with faint praise by calling her a "good operator," as opposed to a good allocator of capital, which has always been what WEB considers the CEO's primary role to be.

Kraft owns some terrific brands, and is selling for less than IV, but its future IV growth will depend on the skill of management in allocating capital. When Irene Rosenfeld was hired as CEO, there was all kinds of buzz and excitement that she was going to "restructure" Kraft by selling low margin, low ROE brands and building a portfolio of high margin, high ROE brands through savvy spinoffs, acquisitions and buybacks. Over WEB's strenuous objection, she demonstrated her incompetence in this critical role by her decision to sell a growing pizza business in a tax-inefficient manner that destroyed value, by paying a very rich multiple for Cadbury and then compounding both sins by issuing undervalued Kraft shares as currency. I have to think that this makes WEB wonder what value-destroying transactions she may engineer next.

Even worse, Cadbury's loyal British customers are outraged that a 200-year-old British institution is being taken over by the Yanks, and are waiting for the pink slips to be handed out. In my view, there is a strong possibility that many of these customers (who have already been listening to Cadbury management trash Kraft over the last four months) are going to be outraged when Rosenfeld begins to "rationalize assets," and that this outrage could be manifested in lower sales of Cadbury products in its core market.

So what does WEB do? I guess his choices are:

1. Lobby to replace Rosenfeld with a competent CEO who knows how to allocate capital (normally not WEB's style);

2. Sell KFT for less than its (reduced) IV and move on to something else;

3. Hang on and pray that the stock will rise somehow and enable him to bail out at (or at least nearer to) IV later (like he did with Moody's).

None of these alternatives is very attractive. A fourth option might be to hang on and hope that Rosenfeld will learn from her mistake (unlikely). Or that Cadbury proves to be such a colossal mistake that her board eventually forces her out. I think that may be a distinct possibility but it usually takes two or three years before a board admits the deal was a mistake and fires the CEO. And the board also knew WEB was against the deal and pursued it anyway, so who is to say that the next CEO won't persuade them to do something stupid again.

Here's my favorite scenario (but probably also unikely). WEB sits and watches as unfolding events prove that he was right and that Irene was wrong. In a couple years, as KFT stock continues to disappoint, and after Berkshire builds up its cash reserves, it makes KFT its next elephant acquisition. Irene saves face by continuing as CEO, but WEB calls the shots on KFT's capital allocation going forward. And we all dip our Oreos in our milk happily ever after.