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Kraft: Is Cadbury the Missing Global Ingredient?

If you boil down the motivations behind Kraft Foods' (KFT) hostile bid for Cadbury (CBY), you reach an undeniable fact: People all over the world love candy, gum, and chocolate. They love their chosen confection brands so much that they're unwilling to accept generic substitutes. "When someone gets attached to a favorite candy or chewing gum, that loyalty lasts for a long time," says George Van Horn, senior analyst at industry research firm IBISWorld. People are willing to pay for their treats, even during a recession. Confections are "viewed as an affordable luxury," says Morningstar (MORN) analyst Erin Swanson. Because confections have little store-brand competition and sales stay steady even during downturns, food companies such as Kraft envy Cadbury's profit margins. A further factor makes them envy its growth prospects: Candy travels well. Cadbury: access to emerging economiesKraft macaroni-and-cheese may be an American favorite, but it won't necessarily catch on in China or India. Sweets are different. Around the world, "candy seems to attract consumers who want to try new things," Van Horn says. As people in emerging economies earn more, they are eager to try Cadbury's global brands, which include chocolate bars, as well as Dentyne and Trident gum. Cadbury has built a global business with access to the emerging economies that Kraft wants to penetrate. The question, however, is how much Kraft is willing to pay for all this. On Nov. 9, Kraft submitted a hostile bid for Cadbury on the same terms as a September offer that was rejected. The offer valued Cadbury at £9.8 billion, or $16.4 billion in cash and stock. But because the value of Kraft's shares has been falling, the offer of 717 British pence per share was worth about 4% less than it was two months ago. Cadbury chairman Roger Carr called the offer "derisory." "The repetition of a proposal, which is now of less value and lower than the current Cadbury share price, does not make it any more attractive," Carr said in a statement recommending that shareholders reject Kraft's bid. Investors in both companies are in a difficult spot. Kraft's announcement on Nov. 9 begins what could be a long process of posturing and negotiation by executives on both sides. Shareholder Buffett: Don't overpayOn the one hand, a Cadbury acquisition would bring benefits to Kraft. But Kraft has said it doesn't want to pay so much that it risks its credit rating or dividend. On Nov. 9, Standard & Poor's said that Kraft's credit rating remains on "creditwatch with negative implications," due to the bid. Warren Buffett, chairman of Berkshire Hathaway (BRKA), is a Kraft shareholder. The famous value investor has publicly pushed Kraft not to overpay. Cadbury's stock—boosted by Kraft's bid—could sink again if no acquisition occurs. Further weakening Cadbury's negotiating strength is the fact that no other bidders have emerged. Kraft's bid has encountered resistance in Britain from those who don't want to see a U.S. buyer for a treasured company. One Cadbury heir has called Kraft "an American plastic cheese company." All this could come down to an argument about size. In the last 12 months, Kraft Foods had revenue of about $40.3 billion while Cadbury had sales of £5.7 billion, or $9.5 billion. By combining her company with Cadbury, Kraft Chairman and Chief Executive Irene Rosenfeld would achieve the size and global reach to compete with such rivals as Nestlé (NESN). She says the new company could find $625 million in savings and synergies and would help Kraft better access markets in India, South Africa, and Mexico. economies of scale in food businesses"Purchasing Cadbury would fast-forward Kraft's bid to build a larger emerging-market presence and would no doubt offer an infrastructure [in key countries] that would take years to build and perfect on its own," wrote Stifel Nicolaus (SF) analyst Christopher Growe on Nov. 9. Size is an advantage in the food business, where economies of scale can be significant, says Steven Rogé, portfolio manager at R.W. Rogé & Co. Size also helps a company negotiate with giant retailers and suppliers. "In an age when you're trying to sell to the Wal-Marts (WMT) of the world, you need size and scale," Rogé says. It's an argument that has swayed other companies. A year ago, Mars completed a buyout of Wrigley. In his statement, Cadbury's Carr made an effort to rebut the big-is-better argument. By itself, Cadbury has "a sharp category focus," Carr said. A merger "involves the unattractive prospect of the absorption of Cadbury into a low-growth conglomerate business model." It could be early in 2010 before Cadbury's fate is known. "This is simply the first concrete step in what we expect to be a protracted process," wrote JPMorgan (JPM) analyst Terry Bivens. The dealmaking will test the future of Kraft's growth strategy as it determines the value of Cadbury's global reach and lucrative confection brands. Meanwhile, Cadbury shareholders must decide if they're willing to risk a loss in stock price to keep the company independent.
Steverman is a reporter for Bloomberg News in New York.

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