By Deal Journal
Alessandro Pasetti and Sameer Bhatia, of Dow Jones Investment Banker, report:
The spectacle offered by Kraft Foods’ proposed takeover of Cadbury just might give Warren Buffett, the U.S. food giant’s largest shareholder, the opportunity for a masterstroke.
Getty ImagesThe involvement of the Oracle of Omaha, through his Berkshire Hathaway investment vehicle, isn’t assured. But should it materialize, it could result in a corporate finance transaction able to leap capital hurdles posed by the scrutiny of credit-rating companies–one of those events rainmakers should watch live.
First, a little review. In early September, Cadbury rejected a surprise, £10.2 billion ($16.73 billion) takeover offer from Kraft that valued each Cadbury share at 745 pence–300 pence in cash, and 0.2589 new Kraft share. That leaves Kraft needing to make the bid more attractive by either raising it entirely or by sweetening the terms, say by increasing the amount to be paid in cash, or both.
Raising the bid to a range of 825 pence to 845 pence would give Cadbury a market value or $17.9 billion to $18.4 billion, a 45% to 49% premium to where Cadbury’s stock was before the Kraft approach became public. And it would mean that the ratio of Cadbury’s enterprise value to its expected 2009 earnings before tax depreciation and amortization would be 12.7 to 13, just below comparable deal multiples in the past decade.
Kraft might also raise the cash portion of the offer to 50% from 40%. All of this could be financed with a mix of debt and the sale of convertible preferred stock rather than all debt.
That is where Buffett/Berkshire come in. A private placement of convertible preferred stock to be taken up at least in part by Buffett would secure support for an improved bid, give Cadbury shareholders the premium they seek and enable Kraft to wrap the deal in its coveted investment-grade rating, which is vital to its refinancing plan as it has more than $7.5 billion of public debt to refinance by 2012. As for Buffett, his Berkshire Hathaway would secure a medium-term dividend stream from the convertible preferred stock and benefit from any Kraft’s upside once the preferred shares are converted to common shares.
An improved offer in the 825 pence-845 pence range, with a 50/50 cash-to-stock mix, would force Kraft to raise roughly $2.5 billion. It could be structured along the lines of the three billion Swiss francs of convertible perpetual securities issued by Swiss Re to Berkshire in March.
For Buffett, the downside from converting preferred stocks into Kraft’s common equity in future would likely be limited. Kraft’s stock closed at $26.05 Wednesday, or 25% to 30% below the highs of the past five years, suggesting there is potential upside for Berkshire if the Cadbury deal goes through. Kraft is also reasonably priced as compared to rivals, with a price-to-earnings ratio of 10.92, at the low end of the branded-consumer-company spectrum and well below that of rivals PepsiCo and Nestle.
Berkshire isn’t a stranger to such arrangements. In just the past 12 months it has purchased $8 billion in cumulative perpetual preferred stock and warrants issued by Goldman Sachs Group and General Electric, as well as $3 billion of convertible preferred stocks issued by Dow Chemical to back its $18.8 billion acquisition of Rohm & Haas. It also helped finance Mars’ $23 billion acquisition of Wrigley in 2008.
And for rainmakers, the deal structure could be a template to pitch clients should credit markets prospects remain uncertain.
To visit the Dow Jones Investment Banker Web site, click here.
UPDATE: One basis for seeing upside potential for Kraft’s shares is because the price-to-estimated 2011 earnings ratio of 10.92 is below rivals, not because the per-share earnings are below that of rivals as originally written.
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