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Investors reacted negatively Tuesday to the company's $7.2 billion bid to buy Danone's biscuits biz
Are Chinese kids ready for Oreos? Kraft Foods (KFT) is poised to raise its international profile and gain a foothold in faster-growing markets after making a bid for the second largest biscuits business in the world. Investors did not appear to be enthusiastic about the deal, senidng the shares lower on July 3.
The Northfield (Ill.) maker of Nabisco cookies and Post cereals said on July 3 it has made a binding offer to acquire Groupe Danone's (DA) global biscuit business for $7.2 billion in cash. Danone is required under French law to consult with its Works Council before signing a definitive agreement, but both companies expect the deal to close by the end of this year.
The acquisition will boost Kraft's position in snacks, its fastest growing global segment, and strengthen its market presence in Europe, providing easier access to faster growth opportunities in emerging markets such as eastern Europe and China.
"When you look at the cost synergies, it looks like they're going to save 7% of Danone's cookies and crackers annual sales, or $200 million, over the next couple years," said Alexia Howard, an equities analyst at Sanford C. Bernstein & Company. That translates to eight cents a share in earnings, she added.
The premium Kraft is paying for the business -- 13.2 times 2007 earnings before interest, taxes, depreciation and amortization -- is larger than the average multiple at which other U.S. food manufacturers currently trade, about 11.6 times earnings before interest, taxes, depreciation and amortization (EBITDA), Howard said. But the $200 million in anticipated cost savings over time more than justify that premium in her view.
It's also a good strategic deal for Kraft, as Danone's business has a 27% exposure to emerging markets, compared with Kraft's 13% exposure. In addition, the markets that Danone participates in – Poland, the Czech Republic and Hungary – are growing at an average of 4.2% a year, versus 3.5% average growth in the markets where Kraft is currently is established, she said.
"More importantly, Kraft can use those distribution networks to push sales for its more iconic brands, like Oreos," she added.
Danone's biscuits business, which includes leading brands such as LU, Tuc, and Prince, generated $2.7 billion in revenue and $525 million in earnings before interest, taxes, depreciation and amortization last year. The company has 36 manufacturing plants in 20 countries.
Danone's high-margin biscuits business will enable Kraft to improve its profitability and growth profile on the international side, something the company needs to do to build a foundation for the next leg of earnings growth, said Matt Arnold, an equities analyst at Edward Jones & Co.
"International deals are a part of the long-term Kraft story. Prices and opportunities allowing, there certainly will be more deals," he predicted.
The premium Kraft will pay for the business may have spurred selling in the shares on July 3. Stocks in the U.S. foods group as a whole were down about 0.75% on July 3, with Kraft's 2.5% decline to $34.64 leading the pack, with investors probably focused on the execution risk of the deal with Danone, Arnold said.
In a July 2 research note, Goldman Sachs trimmed its forecast for Kraft's second-quarter earnings by two cents to 47 cents a share and its full-year estimate by a penny to $1.80 a share, citing higher dairy costs, "which we do not believe the company has the significant pricing power to pass on to consumers without sacrificing significant volumes." It also said that sales trends across Kraft's brands portfolio don't look inspiring.
Market speculation over Kraft's possibilities for restructuring will be a key factor in how well the stock performs in the medium term, Goldman said. There are no imminent signs of a sustainable turnaround and earnings revisions are more likely to skew lower than higher, the note added. Goldman has a neutral rating on the shares and a target price of $38.
Howard said she doesn't own Kraft shares but that Bernstein or its affiliates own more than 1.1% of the stock and provided non-investment banking services for the company within the past 12 months. Goldman Sachs or its affiliates owns more than 1% of Kraft's stock and has done investment banking with the company within the past 12 months.