* Kraft to play long game before final cash sweetener
* Most see current Kraft bid for Cadbury as too low
* Gap between bid and Cadbury shares 50-pence plus
(For more Reuters DEALTALKs, click [DEALTALK/])
By David Jones
LONDON, Nov 13 (Reuters) - Warren Buffett's warning to Kraft (KFT.N) over using its undervalued stock to bid for Cadbury (CBRY.L) may return to haunt Irene Rosenfeld as the Kraft CEO ponders an increased bid to win over the British confectioner.
The U.S. food giant formalised its low-ball bid earlier this week hoping that the lack of any counter bidder would pressure Cadbury shareholders into accepting its offer rather than see the share price of Cadbury fall sharply if Kraft walked away.
But analysts and investors say Kraft will need to raise its bid to stand any chance of success with a 50-pence plus gap between Cadbury's share price and the Kraft bid, and that sweetener is likely to be cash to win over shareholders.
And the closer to the day 46 deadline [ID:nLD681421] it gets, the likelier investors are to grab any raised offer, absent a counterbid.
"Irene knows she can get Cadbury, it's a matter of waiting for expectations to come down. Then she will sweeten the deal with cash to get talks with them," said one banking source with knowledge of the bid situation. [ID:nL9380032].
Cadbury shares were trading up 0.3 percent at 777p by 1320 GMT, well above the 716p current value of Kraft's cash and shares bid. Many investors and analysts say it will need an 800p bid to win over Cadbury's shareholders.
"She's had to play a hard game, with the tricky task of offering enough to get Cadbury to talk while not alienating her shareholde1rs, such as Buffett," the source added.
Buffett, the world's second richest man and a 10 percent shareholder in Kraft, warned Rosenfeld not to overpay for Cadbury in mid-September and raise doubts over whether Kraft had enough shareholder support to raise its bid significantly.
"Anytime you're in a takeover, animal spirits run high and all of that. But Kraft has the disadvantage of using an undervalued stock," the highly influential Buffett -- known as the Sage of Omaha for his investment expertise -- said then.
Analysts say that Rosenfeld is likely to use Kraft's recent $9.2 billion loan to boost the cash element of its bid as issuing more new paper will undermine Kraft's share price.
Analyst Martin Deboo at Investec Securities said Kraft would not need to pay much above 800p to win Cadbury, but with no rival bidders likely, it will take its time to discover Cadbury shareholders' true reserve share price.
He said Kraft could raise the cash portion of its bid up to 400p from the current terms of 300p in cash and 0.2589 new Kraft shares for each Cadbury shares.
SNIFFING A HIGHER PRICE
Hedge funds have taken big positions in Cadbury shares, suggesting they anticipate a deal at a higher level. U.S. hedge fund billionaire John Paulson's eponymous firm twice increased its stake this week, spending about 161 million pounds to buy stock at just under 760p, and take its stake to 2.54 percent.
Eric Mindich's Eton Park has upped its stake 10 times since September, using American-listed Cadbury stock and contracts for difference priced from 748.3p to 804.6p, and owns 2.4 percent.
Analyst Andrew Wood at Bernstein Research said Kraft's current bid values Cadbury at 11.1 times forecast 2009 EBITDA underlying profits and no major global food deal has been done at under 13.6 times over the last decade.
He calculated Kraft would need to pay 900p a share for Cadbury to match this minimum multiple paid when Kraft bought Danone's biscuits in 2007. The average for big food deals is 16.2 times and even stripping out two expensive deals, Mars/Wrigley and Danone/Numico, the average is 14.8 times.
Most analysts and investors don't see Kraft bidding that much for Cadbury, JP Morgan analysts believe 780p might be enough, but most are dismissive of Kraft's current offer.
"Asking Cadbury's shareholders to give away the company at Kraft's bid is about as appropriate as asking the Queen to give away the Crown jewels for the price of a bag of chips," said Robin Geffen, managing director at Neptune Investment Management which hold 0.3 percent of Cadbury shares.
When Rosenfeld met Cadbury chairman Roger Carr in late August to discuss a deal, Kraft's cash and share offer was worth 755p, when it went public in early September it had fallen to 745p and to 717p by Monday when it formalised its bid.
The Kraft offer terms of cash and new Kraft shares never changed, what changed was the Kraft share price and also the weakness of the dollar compared to the pound.
This surprised many analysts as Britain's FTSE 100 index has risen around 7 percent since early September and some had upgraded earnings forecasts 10 percent after Cadbury's upbeat third-quarter trading update in October.
"Therefore, in our eyes, Cadbury's intrinsic value has risen since the first approach was made, while Kraft's share price has fallen," said Investec's Deboo. (Additional reporting by Raji Menon and Quentin Webb) (Reporting by David Jones; editing by Sitaraman Shankar)
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