While many of us were greedily piling our Labor Day burgers high with gooey Kraft Singles, Kraft (NYSE: KFT) management was busy launching a takeover bid for the confectionary goodness of Cadbury (NYSE: CBY). Cadbury rejected the offer, but an eventual deal under revised terms could be sweet for Kraft shareholders -- at least on a long-term basis.
All about growth
Kraft's recent performance hasn't been terrible, but it's no cause for a celebratory feast, either. In fact, I recently urged investors to consider peer companies' more compelling growth prospects. But a successful deal with Cadbury, which owns the Trident, Halls, and namesake Cadbury brands, would definitely make me rethink that view.
Why? For starters, the global confectionary business is surprisingly resilient, with steady historical growth throughout developed markets, and double-digit expansion in emerging economies. Call it a sugar high with no subsequent crash. Cadbury's revenue growth has outpaced the broad category in recent years, while market-share gains have bested the confectionary businesses of Kraft, Nestle (OTC: NSRGY), Hershey (NYSE: HSY), and the privately held Mars-Wrigley.
Let's face it, large-cap packaged-foods companies don't make for rocket stocks, and the U.S. consumer is no growth engine these days. That makes international regions, particularly emerging markets, ultra-attractive for such companies. Cadbury dominates the competition here as well, both in total ex-U.S. market share and emerging markets leadership.
Finally, private-label and store-brand goods -- an advancing threat to traditional name brands -- register a deliciously meager presence in Cadbury's categories, which likely draws a Pavlovian response from Kraft management.
Thanks, but no thanks
If all this makes the Confection King sound mighty attractive, well, Cadbury management certainly echoed that sentiment when it described Kraft's proposal as "fundamentally undervalu[ing] the Group and its prospects." Kraft, meanwhile, believes that its cash-and-stock offer, which represents a 34% premium to Cadbury's 90-day average share price, is fair, asserting that Cadbury's future progress will be difficult without greater industry scale.
Of course, we may see a higher offer from Kraft. That'd be good for Cadbury shareholders for obvious reasons, but the picture is slightly more complex for Kraft investors. Longer-term, the potential acquisition would offer operational synergies and enhance growth prospects. But over the next few years, there'd be steep integration costs weighing on cash flow and earnings. Moreover, an upwardly revised offer would likely push back the date at which the deal becomes accretive to Kraft, and it could mean greater reliance on debt financing -- a move that tends to magnify any operational missteps that follow.
In the meantime, Unilever (NYSE: UL) is large enough to swallow Cadbury in a single candy-sized bite, and further M&A action in the space could target the easily digestible H.J. Heinz (NYSE: HNZ) or the pint-sized, fast-growing Smart Balance (Nasdaq: SMBL). Given the uncertainties, I don't recommend trying to mine any potential deal for easy profits. Rather, take out your excitement out on a stick of Trident, and let's see what develops over time.
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