The Art of the Kraft IPO

Kraft Foods will go public later this week in a deal second only in size to last year's AT&T Wireless Group offering. While the food sector has been resilient through the past year of stock market weakness, this is certainly not reason enough to buy in. Philip Morris has good cause for the "Kraft Singles" move, but investors will do well to proceed with caution.

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By Rick Aristotle Munarriz (TMF Edible)
June 11, 2001

If you can't kick the habit, you might as well learn to subsidize the disease. Trying to fend off a slew of tobacco-related lawsuits, Philip Morris (NYSE: MO) will be taking its Kraft Foods conglomerate public later this week. With 280 million Class A shares being offered at a price between $27 and $30 a stub, the deal could generate as much as $8.4 billion in proceeds before underwriting costs. That would make it the country's second-largest Initial Public Offering (IPO), just behind last year's debut of AT&T Wireless Group (NYSE: AWE).

As a whole, the company will be priced to command a market cap of about $50 billion. With pro-forma revenues of $34.7 billion and operating profits of $5.7 billion, the initial valuation lands Kraft just shy of the food processing industry average of 1.7 times trailing sales as well as 17.6 times the cash flow benchmark. While the stock will probably get there given a few upticks at the open, the sheer size of the IPO will limit the upside pop.

The valuations are not cheap given the slow-growth nature of the food industry. However, stocks in this "defensive" sector have earned premiums over the past few years as nervous investors flocked to its safe haven. Hype-proof and relatively recession-proof, they have benefited from the fact that everyone has to eat.  

While Kraft itself started out as little more than a Cheez Whiz back in 1903, brands it would eventually grow to acquire -- like JELL-O gelatin, Maxwell House coffee, and Post cereal -- were already establishing their consumer presence. Of course, the conglomerate's biggest purchase closed back in December when Kraft completed its acquisition of cookie and snack giant Nabisco for $18.9 billion in cash and the assumption of debt.

With an extensive product line of brands that have been consumed by 99.6% of the stateside population, Kraft is probably well represented in your cupboard. Now it has the chance to be part of your portfolio, too. Some buyers will come from the ranks of those who long wanted to take part in Philip Morris' stable food business but had ethical or legal concerns over its tobacco core. The lawsuit liabilities are real and there's no telling if Philip Morris will eventually have to flood the market with its majority stake in Kraft if money ever gets too tight to mention.

Some buyers will also come chasing the new issue spotlight as the shares come to market. Despite a tech stock sector that was lard-hardened over the past year, Krispy Kreme (Nasdaq: KREM) proved to be a hot performing IPO. No, this issue won't have that Krispy Kreme glaze. It's just not viable to consider Kool-Aid or Oscar Mayer high-octane growth brands given their already extensive market penetration. While Kraft certainly has room for growth overseas -- where it generates barely a quarter of its total revenues -- folks buying in have to come in with proper expectations.

This is Kraft. This is stodgy yet steady top-line growth in the low single digits. That means that subtle net margin fluctuations will separate the feast from famine -- but often not by much. The sector itself has become vulnerable as stock gains have outpaced the fundamentals in recent years. Kraft itself is no different than a sector where the upside is limited and corrections warranted. Yes, Kraft makes Temp-Tee cream cheese, but chasing this to the mid-$30s come Wednesday is not the most enriching of ideas. If you want a sweet return, crack open an Oreo instead.

Rick Aristotle Munarriz doesn't take apart his Oreos before eating them. What is it with those people, anyway? Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.