SEPTEMBER 8, 2009, 5:56 P.M. ET
By BRETT ARENDS
Kraft shares tumbled about 6% to $26.45 Tuesday on news of the bid, due to worries about the potential cost. At these levels they look like pretty good value. They are less than one times annual sales and thirteen times forecast earnings, with a dividend yield of 4.5%.
It's also worth adding that they are now well below the price that Warren Buffett paid for them in the last couple years. The Oracle of Omaha, Kraft's biggest investor, owns around 9% of the company. His average cost: About $33 a share.
Mr Buffett is fallible, of course, but his track record is impressive.
Nevertheless, investing in Kraft today isn't a one-way bet.
Kraft, whose own market value is just $39 billion, offered two-fifths of that—in a mixture of cash and shares—for Cadbury. The Cadbury board rejected the offer. Wall Street now worries that Kraft chief executive Irene Rosenfeld will raise the stakes still further, and hand over even more cash or stock for a deal.
On a conference call with investors Tuesday morning, she promised to stay "disciplined," but this has no concrete meaning. In the same call, she would not rule out launching a hostile bid (although the takeover rules in London help explain her reticence). So there are reasons to be nervous that she may end up paying much more.
London is clearly betting she will. Because Tuesday saw a fall in Kraft's share price and in the dollar, the bid, initially valued at 745 British pence per Cadbury share, is only worth about 715 p. Yet Cadbury stock closed the day at 786 pence on hopes of a bid battle. That's a pretty hefty 22 times forecast earnings.
Ms Rosenfeld has insisted her first offer was "compelling value" for Cadbury, and that the British company would find it "increasingly difficult to go it alone." But Cadbury is already big enough to stand on its own. And the analysts who cover it expect the company to do just fine—they've already penciled in double-digit earnings growth over the next few years, which raises the hurdle for Kraft.
Numerous studies—and plenty of experience—have found that big company CEOs frequently overpay in takeover deals. The standard rule of thumb in investing is that in a takeover battle you are usually far better off holding shares of the company being wooed than in the company acting as suitor. Indeed it's so long established that Dan Bunting, who has been managing portfolios in London for more than 30 years, made it one of his "Bunting's Laws" to sell a company's stock after it launches a big takeover. If the company managed not to overpay, then the post-takeover integration usually cost too much, took too long, or delivered fewer benefits than expected. Over time this rule saved his clients a lot of money.
Wall Street banks encourage mergers and takeovers because these deals bring in huge business for them. And the bigger the deal, the bigger the fees.
(While the banks say they push these megadeals to create shareholder value, their own analysts will remind you that small-company stocks have usually been better investments than those of big companies.)
Meanwhile chief executives like deals because a bigger company means higher status and a beefed-up pay package.
Kraft was banging the "global powerhouse" drum hard on Tuesday. Whenever investors hear this piece of jargon they should reach for their wallets. This meaningless propaganda has been used to hail every value-destroying megadeal at least since Citigroup merged with Travelers.
Even Kraft's current bid may be too high. On Friday the considered wisdom of investors in London put fair value for Cadbury at about $12.7 billion, or 568 British pence per share. Yes, the company may genuinely be worth more to Kraft, but a third more? That puts a lot of faith in so-called synergies. Kraft themselves admit they will have to spend $1.2 billion in cash on post-merger costs, in the hope of getting about $625 million in saving…several years down the road.
Kraft shares look reasonably cheap. The biggest risk is that a higher bid for Cadbury could make them cheaper still.
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