Packaged-foods player Kraft (NYSE:KFT) has drawn plenty of unsavory attention lately. Now, it looks like the company's latest move was an even bigger gaffe than it initially appeared.
Kraft recently sold its frozen-pizza business to industry behemoth Nestle (OTC: NSRGY), while also requesting a larger share issuance, all in support of its protracted bid for U.K.-based confectioner Cadbury (NYSE:CBY). The latter move drew ire from near-10% shareholder Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), but it appears that the Warren Buffett-controlled company would've been equally justified to call out the pizza transaction.
I briefly cast a doubtful eye on Kraft's pie flip in a previous article, but after drilling down on this issue, I'd say Kraft ceded an even stronger business than I initially judged.
Don't take my word for it. Give the key facts a look-see yourself:
- Kraft's frozen-pizza business, which includes the DiGiorno, Tombstone, and California Pizza Kitchen brands, is the strongest franchise of its kind. DiGiorno is the leading North American name in frozen pizza.
- The company's pizza line enjoyed category-beating compound annual sales growth of 10.7% in the 2005-2009 period. And 2009 sales growth clocked in at an estimated 17%!
- Kraft's brands are strongly weighted toward the premium category, which has been the fastest-growing segment of the frozen pizza category in recent years. Additionally, the premium segment allows ample opportunity for future product innovation.
Cheese on Kraft's face?
On the last point, I'd add that the pizza line's expected 2009 sales jump has likely been driven by consumers trading down from dine-out eating.
Kraft, meanwhile, played off the deal as an opportunity to refocus efforts on "priority global brands and categories." Yet I find it hard to believe that the transaction would've occurred in the absence of Kraft's pursuit of Cadbury, a deal to which it can now allocate a larger percentage of cash versus stock. Moreover, Kraft's tenacious commitment to the Cadbury bid raises a larger and more important question: the extent to which management believes in the company's ability to grow organically.
Confident or not, Kraft may well be forced to continue on its own -- albeit without the outperforming pizza business. Cadbury has once more rebuffed the company's offer, while simultaneously reporting strong sales and operating profit growth.
So who wins?
With rival bidders such as Hershey (NYSE:HSY) possibly out of the picture at this point, Cadbury could of course end up regretting its hardnosed attitude, especially if its shares fall precipitously after a deal fails to materialize. That's why Nestle looks to me like the only clear winner thus far.
Nestle picked up the pizza biz at a reasonable 12.5 times estimated 2009 earnings before interest, taxes, depreciation, and amortization (EBITDA), or an even more attractive 10.6 times when considering deal-associated tax benefits. Management expects the transaction to be earnings-accretive in the first full year, no doubt supported by cost-based synergies.
Some, however, see Nestle's acquisition as a departure from both its geographic footprint and its strategic focus on "nutrition, health, and wellness." To an extent, those are probably valid critiques. But in my view, a good deal's a good deal, even if it breaks the style box.
As for Kraft, I wouldn't yet peg shares as a sell. However, investors who are sitting on large gains after buying near the March 2009 lows wouldn't be crazy to follow management's lead -- by taking some dough off the table.
We'll be back tomorrow to look at Kraft's fourth-quarter earnings.
Review deal-related developments:
