By Michael Corkery
Buffett, whose Berkshire Hathaway owns 9.4% of the U.S. food and beverage conglomerate, said he thinks Kraft’s shares are undervalued, making them an “expensive” currency to use for a bid.
In fact, Buffett has long been wary of using stock to acquire companies. Deal Journal dug up this passage from Roger Lowenstein’s 1996 biography, “ Buffett: The Making of an American Capitalist,” in which the Oracle of Omaha sounds off on companies that used stock for acquisitions during a wave of M&A during the early 1980s.
Citing a 1982 letter to Berkshire’s shareholders, Lowenstein explains that Buffett thought CEOs ought to think of stock deals as their selling part of the company in order to acquire another. Here’s the relevant passage:
“With the issuance of new shares, each outgoing stockholder would up owning proportionally less of the company than before . The CEOs disguised this fact by using the language of a buyer: ‘Company A to Acquire Company B.’ However, ‘clearer thinking about the matter would result if a more awkward but more accurate description were used: ‘Part of A sold to Acquire B.
“Why was this disguise employed? Most stocks, including most acquirers stocks, were cheap. In such a case, an acquiring CEO was shopping with an unattractive currency, like an American in Paris when the dollar was undervalued. ….
“Buffett suggested that such managers and directors could ’sharpen their thinking’ by asking if they would be willing to sell all of their company on the same basis as they were selling part of it. And if not, why were they selling part of it.”
Fast forward to Buffett’s statement today on Kraft’s Cadbury bid. He thinks Kraft is undervalued considering where its shares were trading when the company did a big share buyback in 2007 :
“Kraft spent $3.6 billion to repurchase shares at about $33 per share, presumably because the directors and management thought the shares to be worth more,’’ according to Berkshire Hathaway. “Does the board now believe those purchases were a mistake and that Kraft’s true value is only the current price of $27 per share — and that it is therefore fine to structure a major acquisition based upon that price?”
Indeed, Kraft’s price to earnings ratio of 17.51 lags behind that of rivals PepsiCo (P/E of 18.60) and even that of the much smaller Hershey (P/E of 21.77), though Kraft has a higher P/E than consumer product conglomerate Proctor & Gamble’s 14.27.
Thus, if Kraft management had to answer Buffett’s 1981 question about whether it was a good time to sell the whole company, the answer would probably be no. Buffett says he isn’t opposed to a deal for Cadbury. Raising $3.7 billion in cash from the sale of its pizza business and lifting the cash component of its Cadbury offer may have helped alleviate some of Buffett’s concerns. Now Kraft just needs its share price to rise and help do the rest of the work of making the bid more attractive to Cadbury’s shareholders.Share Investor Links
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