Behold, The Power Of Cheese... And Chocolate

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Behold, The Power Of Cheese… And Chocolate

Tony Daltorio, Investment U Research

The typically sleepy world of food makers woke up this week to the loud sounds of Kraft’s bold takeover offer for Cadbury.

Cadbury, the confectionery company that makes Britain’s best known chocolate, has sold cocoa and chocolate since John Cadbury founded it in the early 1830s.

Across the ocean and some seventy years later, Joseph Kraft started his own business by selling wholesale cheese. Now into the twenty-first century, that entrepreneur’s dream has grown into the largest food company in the US. And on the global market, it comes second only to Switzerland’s Nestle.

Forget apple pie; Kraft’s well-known brands – from Ritz’s crackers to Jell-O, Oreo cookies to Maxwell House – can be found in over 99% of American households.

That naturally translates into high sales… of more than $40 billion annually.

Kraft’s $16 Billion Bid For Cadbury

But there’s always room for improvement, and Kraft’s $16 billion bid for Cadbury reflects a need to find the kind of growth it can’t easily find in the saturated North American market, which accounts for around 60% of its sales. That’s why it paid $7.2 billion to acquire French-based, global biscuit business Danone in 2007 (Which incidentally fit perfectly with the Nabisco and Oreo brands).

And Cadbury would work nicely with Kraft brands Milka and Toblerone, both of which it took over back in 1990. In addition, the chocolatier would benefit from improved distribution. Kraft’s strength in Russia, Brazil and China would automatically complement Cadbury’s strengths in Britain, India and Mexico.

And the takeover would help the British brand better compete with privately-held Mars, which became the number one global confectionary business last year with its $23 billion acquisition of gum maker Wrigley.

The merged company would combine Kraft’s clout with grocers and major retailers such as Walmart, with Cadbury’s mastery of sales at convenience stores, not to mention creating a new global powerhouse in snacks and confectionary.

That would give investors nearly 15% market share in the world’s largest confectionary company.

But despite those perks, Kraft probably needs the deal more out of the two. It admits that obtaining the smaller company would increase it revenue growth target by 5% and earnings per share by 2%, even though Cadbury is only a quarter of its size.

That’s partially because Cadbury brings a large amount of emerging market strength to the table – something that Kraft has long lacked – thanks to its British Commonwealth heritage and its 2003 acquisition of Adams, a gum business and big player in the Latin American markets.

Party Crashers Or Party Poopers?

Cadbury has other suitors too.

Just don’t count Mars in that number. It’s still busy digesting the Wrigley acquisition and would probably incur serious antitrust concerns if tried to sweet talk Cadbury as well.

Pepsico might be interested in adding chocolates to its salty snacks, but that seems like a long-shot, and other European suitors such as Ferrero and Perfetti simply don’t have the size or strength to make a bid for such an expensive acquisition.

If the Kraft-Cadbury deal went through, Nestle would become a distant third in global confectionary, a threat that could stir the company into action. And while antitrust concerns would prevent Nestle from buying the chocolate business, it might target the fast growing, emerging market Adams gum business.

So that mainly leaves Hershey in the running, and boy could they use this one. A partnership with Cadbury would represent perhaps its last big chance to escape an unhealthy reliance on the slow-growing US market.

Then again, a conservative trust calls the shots at the “sweetest place on earth,” and they might balk at going deeper into debt to finance the bid. The company has asked JPMorgan to assess its options, so we should know one way or the other later on.

Cadbury Deal Not Sweet Enough?

But even if nobody else shows up to butter up Cadbury, Kraft will doubtlessly have to sweeten the price for the deal to go through, something it might want to think twice about as that could risk endangering the company’s investment grade credit rating.

However, investors should keep in mind that Warren Buffet does own 9% of the company, so perhaps he might still assist Kraft in its bid… just like he assisted Mars last year during its acquisition of Wrigley.

And if he does, man, but that would be sweet.

Food jokes aside, Cadbury is a jewel in the food business, especially with its emerging markets footprint. And Kraft still stands as the most likely suitor at this point.

Mark my words: If this deal goes through, both Cadbury and Kraft shareholders will be eating out for weeks on the profits.

Good investing

Tony Daltorio

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