Hershey + Cadbury = Chocolate Bliss?

Talk of a Hershey (NYSE: HSY  ) and Cadbury Schweppes (NYSE: CSG  ) merger is nothing new. A year ago, merger speculation was sparked by Cadbury's plan to delink its beverage and candy business. Fast-forward, and Cadbury is still in the process of legally separating the two businesses, even though they operate separately internally. Hershey is trying to revitalize profits and sales after a recent management shakeup. Is the marriage of two leading candy makers too sweet, or is it destined for a bitter end?

Prelude to a merger?
Cadbury's strong European market presence would certainly compliment Hershey's North American strength. And the combined Hershey-Cadbury could use its joint strength to expand in emerging markets, including China and India. Cadbury's Trident, Dentyne, and chocolate products (not to mention those yummy Sour Patch Kids) line up well with Hershey's chocolate products, Jolly Ranchers, and Twizzlers Licorice.

But just because two companies have distribution networks and product mixes that could work together doesn't necessary mean that the new company will succeed (look at DaimlerChrysler). The big question is whether these cultures can join together to become a productive industry leader.

The initial signal is that the companies should fit together well since Hershey and Cadbury have existing, successful business partnerships in place. Hershey sells Cadbury and Caramello products in the U.S., and York, Almond Joy, and Mounds products worldwide. Actually, if you ask some retailers, these candy companies are working together too well.

Milking profits?
Pittsburgh-based grocer Giant Eagle recently filed suit against Hershey, Cadbury, and competitors Nestle and Mars, claiming a $200 million overcharge on chocolate from 2002 to 2007. This is the fourth such lawsuit this year where grocers asserted that the candy companies are fixing their sweets prices.

Price fixing is one thing, but we all know that food inflation is real, as prices of staples, including milk, continue to rise. Cadbury admitted that it has recently boosted prices again, contributing to its 7% first-quarter revenue growth for confections (although an early Easter certainly didn't hurt). Cadbury isn't the only foodie raising prices. ConAgra (NYSE: CAG  ) and General Mills (NYSE: GIS  ) are among companies that have recently raised prices to protect profit margins.

It's hard to compare chocolate and candy to peanut butter and cereal as far as having pricing power. Especially in today's weight-conscious world, people are looking for ConAgra's Healthy Choice and General Mills low-calorie cereals to round out their diets. It remains to be seen whether chocolate makers can continue to raise prices without real sales and volume ramifications.

One thing is certain -- Hershey and Cadbury need a spark to trigger stock price growth. Both stocks have taken a hit, with a 34% drop for Hershey, a 19% decline for Cadbury, and the stock prices lingering near 52- week lows.

This isn't the first time that Hershey has been the subject of acquisition talks. Wrigley (NYSE: WWY  ) proposed a $12 billion acquisition deal in 2002, which Hershey firmly rejected. With the recent management issues, Hershey may not be able to hold off a deal this time. And it may not make sense to.

Both Hershey and Cadbury are continuously looking for new products and partnerships to boost their market positions, expanding into sugarless candies and organic chocolate. Hershey has even set up a strategic partnership with Starbucks (Nasdaq: SBUX  ) to market Starbucks-branded candies. A combined Hershey-Cadbury would benefit from economies of scale, have the resources to grow internationally, and continue new product development efforts through internal work. Small acquisitions or business alliances would also likely be possible even in a challenging market.

And who wouldn't like the idea of Sour Patch Kids covered in Hershey's chocolate?

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