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Wsj reported that activist investor Nelson Peltz had acquired a 3% Kraft stake. Peltz wanted the company to divest Post Cereal and Maxwell House. He was able to convince Cadbury's CEO to lay low until the board could discuss the plan.
Wsj reported that activist investor Nelson Peltz had acquired a 3% Kraft stake. Peltz wanted the company to divest Post Cereal and Maxwell House. He was able to convince Cadbury's CEO to lay low until the board could discuss the plan.
Wsj reported that activist investor Nelson Peltz had acquired a 3% Kraft stake. Peltz wanted the company to divest Post Cereal and Maxwell House. He was able to convince Cadbury's CEO to lay low until the board could discuss the plan.
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ID#080310 PUBLISHED ON JUNE 1, 2012
Restructuring Kraft
BY ENRIQUE R. ARZAC *
ABSTRACT On June 21, 2007, The Wall Street Journal reported that activist Nelson Peltz had acquired a 3% Kraft stake and wanted the company to divest Post Cereal and Maxwell House. Krafts depressed margins, large- scale, potential divestitures value, and underleveraged balance sheet made it ripe for restructuring. CONTENTS Introduction ......................................... 1 Kraft Foods .......................................... 1 Kraft Foods Segment Analysis .......... 2 The Food Industry ............................... 3 A Possible Restructuring Proposal... 3 Acquisition of Groupe Danones Biscuit Business ................................. 6 Whats Next? ........................................ 8 Cadbury Schweppes ........................... 8 H. J. Heinz Company ........................... 9 Exhibits...............................................10
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Introduction On Thursday, June 21, 2007, Krafts CEO Irene Rosenfeld learned that Nelson Peltzs Trian Fund Management had bought 3% of Krafts stock. Krafts shares surged 6.6% that same day, putting almost $3.5 billion in investors pockets. That would have been good news to Krafts management, except that Peltz was an active investor known for throwing his weight around. In fact, calling Peltz an active investor was an understatement. In mid-March 2007, with only a 3% equity stake in Cadbury Schweppes, he had gone to London and successfully convinced the companys CEO, Todd Stitzer, to split Cadburys drinks and candy businesses. Stitzer had reportedly asked Peltz to lay low until the CEO could discuss the plan with his board, saying, no white paper, please, 1 in reference to the critiques of Heinz and Wendys that Peltz had filed with the Securities and Exchange Commission. Peltz also owned stock in Heinz; its CEO, William Johnson, said, There are weeks I speak to [Peltz] two or three times . . . including on weekends and late at night. 2
Rosenfeld was having a busy year as the new CEO of Kraft Foods. She was no stranger to the challenges and possibilities of the second-largest food company in the world, having spent 22 years at the company before heading PepsiCos Frito-Lay unit. Rosenfeld knew that pressure was mounting for Kraft to improve its sluggish sales and decreasing margins. Having split from parent company Altria in March 2007, Kraft had finally acquired the freedom to manage its own destiny, but it had to do so under the scrutiny of Peltz and other impatient investors. As Rosenfeld waited for Peltzs call, she contemplated the best way to deal with him and his ideas. As a Morningstar analyst said, The last thing she wants is somebody rankling up the masses, in this case, the money managers and institutions who own the stock. 3
Part of Rosenfelds plan was to increase Krafts presence in high-growth emerging markets with high-margin product categories. To that end, she had just concluded the acquisition of Danones biscuit business. However, the real problem was what to do with Krafts existing brands. Peltz was sure to have some ideas about that.
Kraft Foods Kraft Foods was one of the largest food and beverage companies in the world. In 2007 Krafts revenues exceeded $35 billion; its $1 billion brands included Kraft, Nabisco, Philadelphia, Oscar Mayer, Maxwell House, Post, and Jacobs. The company led in numerous product areas, including cheese, coffee, biscuits, meat, beverages, confection, and frozen pizza. These products were sold in 155 countries to supermarket chains, club stores, convenience stores, and other retail outlets. Well-
1 Julie Jargon, A Bite at a Time, Peltz Reshapes Food Industry, The Wall Street Journal, November 7, 2007. 2 Jargon, A Bite at a Time. 3 Brad Dorfman, Kraft in Deal with Peltzs Trian, Reuters, November 7, 2007. D o
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Restructuring Kraft | Page 2 BY ENRIQUE R. ARZAC* known Kraft products included Carte Noire, GrandMre, and Jacobs coffees; Cte dOr, Milka, and Toblerone chocolates; Philadelphia cream cheese; and Oreo cookies. Based in Northfield, Illinois, Kraft managed its business through two units: Kraft Foods North America (KFNA), which held 65% of sales and 80% of profits; and Kraft Foods Intl. (KFI), which held 35% of sales and 20% of profits. As one of the top producers of consumer nondurables in the world, Kraft was in the same class as Unilever, Nestl, Danone, PepsiCo, and Coca-Cola. Kraft went public in 2001 and became a fully independent company on March 30, 2007, when Altria spun off its 89% stake to its shareholders.
Kraft Foods Segment Analysis KFNA, which operated in Canada, Mexico, and the United States, had four subsegments: cheese and food services, convenient meals, grocery, and snacks and cereals. KFIs two subsegments were the European Union and developing markets: Oceania and North Asia. Krafts revenues and operating income by segment are shown in Exhibit 1 and Figures 1 and 2. FIGURE 1 KRAFT FOODS SEGMENT BREAKDOWN 2006 revenue in $ billions
Beverages, $3.09 9% Cheese & Food Service, $6.08 18% Convenient Meals, $4.86 14% Grocery, $2.73 8% Snacks & Cereals, $6.36 19% European Union, $6.67 19% Developing markets, Oceania & North Asia, $4.57 13% D o
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FIGURE 2 KRAFT FOODS SEGMENT BREAKDOWN 2006 operating income and gross margins in $ billions
The Food Industry After the wave of consolidation that rippled through the packaged foods industry in the early 2000s, restructuring and cost-cutting activities had become that sectors main focus. Food companies, including Kraft, Heinz, Cadbury, ConAgra, Sara Lee, and Unilever, were restructuring their programs both to improve the efficiency of supply chains and centralized procurement and to reduce overhead. They were also disposing of noncore businesses via sales or spin-offs. In particular, Kraft shed its sugar confectionary business in 2005 and its rice and pet-snack brands in 2006. Heinz shed peripheral units and focused on four core businesses: ketchup, condiments and sauces, meals and snacks, and infant nutrition. The packaged-foods industrys challenges in 2007 resulted from (1) a shift in pricing power to retailers due to the consolidation of those businesses, (2) the growth of private labels, which had brought considerable price pressure on established brands, (3) low-volume growth in home markets because of decreased population growth in developed countries, (4) consumers shifting away from home-prepared meals to outside-prepared meals, and (5) the increase in input costs.
A Possible Restructuring Proposal At 4 p.m. on June 21, 2007, in New York Stock Exchange composite trading, shares of Kraft climbed $2.26, or 6.6% (vs. +0.6% for S&P 500), to $36.48. They had already increased 2.9% since January Beverages, $0.025 4% Cheese & Food Service, $0.886 19% Convenient Meals, $0.914 19% Grocery, $0.919 20% Snacks & Cereals, $0.829 18% European Union, $0.548 12% Developing markets, Oceania & North Asia, $0.416 9% D o
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Restructuring Kraft | Page 4 BY ENRIQUE R. ARZAC* 1, 2007. The reason for the most recent climb, as noted above, was investors reaction to the news that Trian Fund Management, the investment vehicle of billionaire investor Nelson Peltz, had accumulated a 3% stake in Kraft Foods, making Trian its largest investor. Peltz, who in the recent past had successfully prevailed upon the managements of Cadbury Schweppes, Tiffany, Heinz, and Wendys to undertake restructuring actions involving the disposition of assets and share repurchases, was expected to press for similar changes at Kraft. Though Peltz hadnt presented a plan for Kraft, an analysis of his approach to the restructuring of other consumer- goods companies (and of Heinz in particular) provided an indication of what he would propose. Like Heinz, Kraft had a collection of prestigious but weary brands that were discounted at supermarkets to keep products moving and were in need of refreshment or disposition. FIGURE 3 KRAFT FOODS EBIT MARGIN AND REVENUE HISTORY
Source: Company reports Krafts subpar performance (see Figures 3 and 4) had been attributed to a number of issues, 4
including poor category exposure, system-wide complexity, mistargeted innovation, failure to seize scale advantages, underinvestment in core brands, and the lack of a coherent international strategy. A restructuring plan needed to be directed at exploiting Krafts competitive advantages: scale, a superior retail presence, and a first-class sales force.
4 Equity Research: Kraft Foods Inc. (Charlotte, NC: Wachovia Capital Markets, LLC, June 22, 2007).
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FIGURE 4 KRAFTS VERSUS P&G AND S&P 500
As part of the restructuring plan, Trian was likely to propose carrying out a large share buyback financed by borrowing and asset disposition. Note that with the acquisition of Danones biscuit business, to be financed by borrowing $7.2 billion, Krafts pro forma debt-to-EBITDA ratio would increase from about 1.7 to about 2.5. However, there would still be room for increasing the use of debt to about 6, based on Krafts reliable cash flows. That increase would permit a material addition to the companys announced $5 billion share buyback. Although the tax-free nature of Altrias recent spin-off of Kraft shares allowed Kraft to repurchase only about $10 billion of stock, or 20% of its market capitalization, a special dividend would be possible. Asset proceeds combined with additional debt could add some $20 billion ($7.2 billion of which would be used to pay for the purchase of Danones biscuit business), thus leaving about $8 per share for distribution. The EBITDA/interest-expense-coverage ratio would fall to about 3 (equal to Dean Foods) from about 11. The Total Debt/EBITDA ratio would jump to about 5-6, below 7 for Dean.
selling aging, second-tier brands when there is no hope of them becoming market leaders. Since Kraft had more brands than both Nestl and Procter & Gamble, there was plenty of room for pruning tired brands and concentrating on high-margin winning ones. Disposing of the Post cereal businessa distant No. 3 to Kellogg and General Millsseemed an obvious choice. Posts 2008 EBITDA was estimated at $249 million. It is also rumored that Peltz would push for the sale of Maxwell House, which had slipped to the number two position behind Procter & Gambles Folgers, although reinvigorating Maxwell House rather than D o
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Restructuring Kraft | Page 6 BY ENRIQUE R. ARZAC* selling it was an option. The combined 2008 EBITDA of Maxwell Hose and Jacobs was estimated at $1.8 billion. Based on previous divestitures and the pricing of food companies, Wall Street analysts estimated that Krafts Post cereal, Maxwell House, and Jacobs assets could be sold for 10 to 11 combined EBITDA, whichgiven their low tax basiswould yield after-tax net proceeds of about 80% of sale proceeds. 5
increasing spending on high-margin product lines like frozen foods to reach consumers directly, making Krafts brands must-buy items, and diminishing discounts and promotional payments to supermarkets. (According to data from TNS Media Intelligence, Kraft slashed its ad spending on Maxwell House nearly in half between 2004 and 2006.)
improving Krafts flagship cheese business, which accounted for roughly a quarter of the companys overall earnings. Krafts $4 billion cheese business was overly dependent on processed low-margin slices that were vulnerable to high commodity prices and private-label competition.
executing a three-way merger between Kraft, Heinz, and Cadbury Schweppes plc. This was an intriguing possibility. Trian owned about a 3% stake in each of these companies. Given the experience of previous large mergers in the food industry, the merger could generate cost synergies of approximately 6% of the sales of each target within three years.
Acquisition of Groupe Danones Biscuit Business On July 2, 2007, Kraft Foods acquired the global biscuit business of Groupe Danone for 5.3 billion ($7.2 billion) in cash, which represented 2.6 2007E net revenue of $2.8 billion and 13.3 2007E EBITDA of $540 million. These multiples compared favorably with the average acquisition multiples in other large food transactions (Gerber, Adams, Ralston Purina, Quaker Oats, Keebler, Pillsbury, and Best Foods), which were 2.7 revenue and 14 EBITDA. Kraft management noted that Danones biscuit business had a 16% EBIT margin and would generate annual pretax synergies (cost reduction and margin improvements) equivalent to about 7% of Danones 2007E net revenue in years to come. It would also increase Krafts worldwide snack sales from $10 billion to $13 billion and its total sales from $35.6 billion to $38.4 billion. Danones biscuit business had a run rate of organic growth between 4% and 5%, which was consistent with the growth
5 Spinning off US businesses to shareholders can result in tax-free treatment to the corporation and its shareholders. Subject to a number of limitations, a disposal can be made via a Morris-Trust structure that consists of spinning the subsidiary off and subsequently merging it with an acquirer via a stock exchange. See E. R. Arzac, Valuation of Mergers, Buyouts and Restructuring, 2nd ed. (New York: John Wiley & Sons, 2008), 323. D o
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of Krafts own snack business and above Krafts overall target growth of 3% to 4%. Synergies were expected once the full integration of the Kraft and Danone businesses took place, and would be realized gradually over a period of three years. However, the synergies were not predicated to come from manufacturing because Kraft did not have biscuit manufacturing facilities in France. Rather, the acquisition provided the opportunity to capitalize on the scale of the joint operation, which would reduce selling and administrative expenses. The acquisition was also expected to enhance margins in Krafts EU division, and it provided infrastructure to extend Nabisco brands like Oreo, Chips Ahoy!, and Ritz beyond Iberia. In addition, Kraft would gain broader operating scale and additional reach across the globe. This included critical emerging markets, such as China, Russia, Poland, Indonesia, and Malaysia, which accounted for over 25% of the business. For example, Kraft would become the market leader in Russia, gain entry into the biscuit category in the rest of Eastern Europe, double the size of its business in China, and establish footholds in Malaysia and Indonesia. As required by French law, Danone had to consult with its works council prior to entering into a definitive agreement. Both companies anticipated that the transaction would close by the end of 2007. This proposed acquisition makes great sense for Kraft, said Rosenfeld, Kraft chairman and CEO. It will increase our presence in snacksour fastest growing global segmentand transform our international business. This growing, high-margin business will give Kraft another core growth category in Europe, a cornerstone for faster growth in emerging markets, and the best portfolio of iconic biscuit brands in the world. 6
The acquisition encompassed Danones market-leading biscuit brandsamong them LU, Tuc, and Princeas well as operations and assets in 20 countries, including 36 manufacturing facilities, which employed approximately 15,000 around the world. The transaction did not include Danones joint ventures in Latin America and India. The European headquarters of the biscuit business would remain in the greater Paris metropolitan area for the foreseeable future. Kraft did not intend to close any of the Danone biscuit manufacturing facilities in France for at least three years after the agreement was signed. This transaction will create long-term value for our shareholders, and we expect it to be accretive to earnings per share in the first year, said Rosenfeld. Our strong balance sheet enables us to finance this acquisition with debt, while preserving our ability to execute our long-term growth plan, including our previously announced [$5 billion] share repurchase program. 7
The transaction would be financed entirely with debt, by borrowing in euros against the cash flows generated in Europe to maintain a natural currency hedge. Kraft estimated the cost of financing at
6 Kraft Foods Announces Plans to Acquire Groupe Danones Global Biscuit Business, Kraft Foods Nordic, July 3, 2007, http://www.kraftfoodsnordic.com/kraft/page?siteid=kraft-prd&locale=fifi1&PagecRef=2537&Mid=1. 7 Kraft Foods Announces Plans to Acquire Groupe Danones Global Biscuit Business. D o
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Restructuring Kraft | Page 8 BY ENRIQUE R. ARZAC* about 5.5%. With the addition of $7.2 billion of debt, together with the EBITDA from these businesses, Krafts pro forma debt-to-EBITDA ratio based on the debt outstanding at the end of the first quarter would increase from 1.7 to 2.7, still a very manageable level. Kraft expected to maintain its investment-grade rating after the acquisition.
Whats Next? Some Wall Street analysts wondered how Peltzs presumed plan would produce the strong shareholder returns typical of his fund. Others thought that there would be a limited upside to a restructuring plan because of the material increase in input costs (dairy, grains, and oils) and the tax code limitations on share repurchases following the tax-free spin-off of Kraft from Altria. And still others welcomed Peltzs participation and hoped it would prompt Kraft to deal with its problems and capitalize on its strengths. Exhibit 2 presents income statement projections for Kraft, assuming no restructure. The projections do not incorporate the effect of the announced $5 billion share repurchase, or the acquisition and financing of Danones biscuit business. Exhibits 3, 4, 5, and 6 contain additional data on Kraft, Heinz, Cadbury Schweppes, and other comparable companies.
Cadbury Schweppes In 2007 Cadbury Schweppes was the worlds largest confectionery company, with regional beverages businesses in North America and Australia. Its brands included Cadbury, Schweppes, Halls, Trident, Dr Pepper, Snapple, Trebor, Dentyne, Bubblicious, and Bassett. Its products were sold in almost every country around the world, and the group employed over 70,000 people. On March 15, 2007, the company announced that it intended to separate its confectionery and Cadbury Schweppes Americas Beverages businesses, after which Cadbury plc would retain Cadburys position as the worlds largest confectionery business, with number one or number two positions in 20 of the worlds 50 largest confectionery markets. It also had the largest emerging-markets business of any confectionery company. Cadburys many global, regional, and local brands included Cadbury, Creme Egg, and Green & Blacks in chocolate; Trident, Dentyne, Hollywood, and Bubbaloo in gum; and Halls, Cadbury Eclairs, Maynards, and the Natural Confectionery Company in candy. After spinning off its Americas Beverages division, the new Cadbury plc would generate about 5 billion in sales and close to 540 million in operating profit. Some 92% of its sales would be in confectionery. The group opted to hold on to its Australian beverages division (which generated 8% of sales), which was perfectly integrated into the local confectionery network. Managements strategy for the new Cadbury plc included a restructuring program for 20082011 whereby 15% of the groups sites would be shut down and its headcount reduced by 15%. The program would result in 650 million in cost savings, including an additional 200 million in capex. The group had confirmed D o
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that it would be outsourcing an additional 15% of its liquid chocolate production to Barry Callebaut. Finally, management had set itself a new set of targets: organic sales growth of between 4% and 6% and an operating margin in the midteens by 2011, versus 10.1% currently. Cadbury plc posted organic growth rates of more than 6% in 2004 and 2005. Despite a particularly poor year in 2006 in the United Kingdom and tough conditions in Nigeria, China, and Russia, the groups confectionery activities delivered 4.2% organic growth. Exhibit 3 shows the 2008 pro forma financial data for Cadbury Schweppes after the expected spin-off of its Americas Beverages division. This takes into account an estimate of the remaining net debt of the confectionery business after the expected allocation of debt to American Beverages. Exhibit 4 shows that merging Kraft and Cadbury would result in a company with almost twice the market share of each of its two following competitors, establishing the combination as number one or number two in each of the confectionery market segments.
H. J. Heinz Company Headquartered in Pittsburgh, Pennsylvania, H. J. Heinz was one of the worlds leading marketers of branded foods in ketchup, condiments, sauces, meals, soups, seafood, snacks, and infant foods. Its 50 companies operated in 200 countries. The companys brands included Heinz, Ore-Ida, Smart Ones, Boston Market, and Plasmon. Heinz was expected to have 6% organic growth in 2008 as result of both its turnaround plan, which reinvigorated existing brands, and the introduction of new products. Heinz generated about 55% of its sales and profits from international markets, including Russia, India, China, Indonesia, and Poland, where the company generated about 13% of its sales. Its sales growth in those markets had been around 20% and accounted for 20%+ of its overall sales growth. Heinz had attained significant cost savings, prompted in part by active investors (Peltz was on its board). In addition to SG&A reductions, the company had attained saving and productivity improvements in its cost of goods sold. Heinz had attained a SG&A level below its peers, and its gross margin was close to the average of the food group. The company was expected to have about $10 billion in sales in 2008 with an operating profit of about $1.6. Exhibit 4 shows the 2008 pro forma financial data for Heinz.
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Restructuring Kraft | Page 10 BY ENRIQUE R. ARZAC* Exhibits Exhibit 1 Kraft Foods Segment Breakdown, 2006 ($ in billions)
Source: 2006 company 10-K. D o
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Exhibit 2: Kraft Pro Forma Financials
For years ended December 31 (dollars in millions, except per-share data) FY06 FY07E FY08E FY09E FY10E FY11E FY12E Net Sales $34,356.0 $35,558.5 $36,625.2 $37,724.0 $38,855.7 $40,021.4 $41,222.0 Costs of Goods Sold 21,915.0
Note: FY06 operating income differs from the total reported in Exhibit 1 because it excludes pretax unusual times. Sources: Company reports and Wall Street and casewriter estimates. D o
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Restructuring Kraft | Page 12 BY ENRIQUE R. ARZAC* Exhibit 3 Revenue, Enterprise, and Equity Values of Kraft, Heinz, and Cadbury Schweppes (as of June 20, 2007, in millions of dollars, except per-share data)
Sources: Company reports and Wall Street estimates.
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