Last updated at 10:01 PM on 23rd January 2010
Warren Buffett: Agreed share price is 'a bad deal'
Warren Buffett told the business TV channel CNBC on Thursday that the 850p a share Kraft agreed to pay for Cadbury is a ‘bad deal’ and, given a chance, he would vote against it.
From the perspective of a Cadbury shareholder, this dismissal from the American investment genius – and Kraft’s biggest single shareholder – may seem astonishing.
Cadbury’s iconic status in Britain parallels Coca-Cola’s status in the US.
Buffett, 79, one of the world’s richest men, is a longtime Coca-Cola share-holder. He knows the value of the customer loyalty expressed in the UK anger at the prospect of the Cadbury sale.
And he’s a chocolate aficionado – I’ve often seen him enjoy eating it at his desk at breakfast time.
He has studied the business of confectionery ever since he first traded cocoa futures in the Fifties.
Chocolate offers what Buffett calls a ‘durable competitive advantage’: a protective moat filled with customer loyalty which rivals cannot get across to storm a business’s castle walls.
Confectionery has few peers for such product loyalty. This is why, in 1971, Buffett’s investment firm Berkshire Hathaway bought See’s Candies, a luxury confectioner that dominates the market in California. He called it ‘the prototype of a dream business’.
It is an all-weather product: people both celebrate and comfort themselves with chocolate. Importantly, it gives high cash-flows without requiring additional capital investment. Yet if Buffett is so fond of the business, why does he so dislike the Kraft takeover of Cadbury?
He says the Cadbury deal makes him feel ‘poorer’. On the surface, this has to do more with Kraft’s financial management. Yet it adds up to this: Buffett thinks Cadbury is not worth the price agreed.
Kraft upset Buffett after it bought back its own stock at a higher price than the stock issued to buy Cadbury – buying dear and selling cheap. Buffett had harsh words, too, about Kraft’s decision to sell its frozen pizza business to Nestlé for an after-tax price of £1.5billion.
The cash Kraft received will help pay for Cadbury, but Buffett considers it a bad trade.
Annual earnings for the pizza business amounted to 11 per cent of the sale price, by Buffett’s estimate, whereas Cadbury’s earnings will equate to 6.25 per cent. ‘You don’t get rich that way,’ he said.
Poor returns: Cadbury's earnings will equate to just 6.25 per cent of the sale price, said Buffett
Buffett has ‘a lot of doubts’ about the deal. Some must concern Kraft’s £20billion debt load, newly increased to pay for Cadbury.
The great investor also doubts Kraft CEO Irene Rosenfeld’s ability. He complimented her as a business ‘operator’, implicitly criticising her as a financial manager.
Buffett has a near-moralistic view of executives’ duty to steward investors’ money. Failure is, for him, a sin that could be termed ‘theft by incompetence’ (or indifference).
He criticised Kraft directors for admitting their stock was under-valued only after he said so. He fears Rosenfeld succumbed to ‘deal momentum’ that drove up the price.
That no other bid than Kraft’s arose buttresses his view. However painful for fans of Cadbury, Kraft’s bid was not ‘derisory’.
Buffett stewards money by avoiding auctions and negotiating in private. He is utterly inflexible, waiting patiently for the other party to become desperate and talk his own price down.
I call this ‘Buffetting’ the seller. We saw it in action during the financial crisis when only one investment bank, Goldman Sachs, dangled a high enough reward to make him bite on their stock, even though all of their peers were in danger of bankruptcy. Buffett has made an estimated £2.5billion profit on that £3billion deal.
Of such discipline is Buffett’s great fortune made. Behind it lies a mind incapable of succumbing to deal momentum over Cadbury.
Case in point: when Buffett bought See’s Candies, he would have walked had the seller wanted just £60,000 ($100,000) more on a £15million deal. Inflexibility over trivial amounts has saved him billions in losses over the years.
With See’s, it almost turned a triumph into one of Buffett’s greatest mistakes. Could he be wrong this time?
The way Buffett is talking about Cadbury, he doesn’t seem to think the difference in value trivial here. Still, he says it takes five years to know whether a deal worked out.
Until then, Cadbury fans, don’t take Buffett’s reaction personally.Share Investor Links
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