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Erin Steuber/ MEDILL

Kraft executives are speculating revenues will jump to $50 billion in 2010 after the Cadbury acquisition.

Kraft, Cadbury not such a sweet deal?

by Erin Steuber
April 15, 2010

 When Kraft Foods Inc. finally closed its $19.6 billion acquisition of U.K. candy maker Cadbury PLC, management exuded optimism about the company’s growth potential in 2010 and beyond. But analysts are not convinced, and they worry that Kraft executives have greatly exaggerated the benefits of the merger.

Edward Jones analyst Matt Arnold commented in an interview, “it will take some time to make these businesses truly combine and operate as one.” He cautiously rates Kraft shares a hold.

Arnold acknowledges that in a three-year restructuring prior to the acquisition, the maker of Nabisco cookies, Philadelphia cream cheese and Maxwell House coffee made significant progress in improving its existing business. Neverthless, “We have a hold because we have some concerns about the Cadbury acquisition for two reasons,” stated Arnold. “The integration may not go smoothly and the price they paid for Cadbury” was high, making it “challenging to justify financially."

Kraft has estimated one-time merger implementation costs to be $1.3 billion to achieve $675 million in cost synergies by the end of 2012.

Similarly, RBC Capital Markets analyst Edward Aaron said in a research note that investors have been “perhaps too quick to look past a choppy 2010” while focusing on the potential long-term growth as a result of the Cadbury acquisition.

“We are still on the sidelines with Kraft shares,” said Aaron.

Wall Street analysts collectively are expecting Kraft to post earnings per diluted share of $2.07 for 2010 and $2.33 for 2011, up from $2.03 per diluted share earned in 2009.

Kraft executives contend that Cadbury will transform Kraft’s portfolio and enhance its long-term growth prospects. It means, they say, the new Kraft Foods will have expanding footprints in developing markets and will have a more commanding presence in growing trade channels.

But it's no secret that Kraft faces a challenge in combining two well-established companies in diverse markets, with sales in more than 160 countries and operations in more than 70.

The acquisition has put a lot at risk financially, said Bob Goldin of Chicago consulting firm Technomic. “It really behooves them to make one plus one equal more than two.”

Tim Cofer, former president of Kraft's pizza business, and Mark Reckitt, Cadbury’s former chief strategy officer, have been named as senior leaders who will jointly lead the integration process, said Michael Mitchell, Kraft spokesman.

Kraft executives say that the integration process is meant to capture the “best of both” while maintaining business momentum.

They project combined global revenues of approximately $50 billion. Cadbury reported revenues of 5.38 billion pounds ($8.32 billion at today's rate of exchange) in 2008 while Kraft posted revenues of $40.38 billion for 2009. However, to avoid antitrust violations, Kraft agreed to sell its pizza business, which generated $1.6 billion in 2009, to Nestle S.A. for $3.7 billion.

“The acceleration of our growth is captured in the raising of our long-term targets for both the top line (to 5+ percent growth from 4+ percent growth) and bottom line (to EPS growth of 9 to 11 percent from 7 to 9 percent),” Mitchell stated in an e-mail.

But Wall Street revenue estimates are more conservative at $48.27 billion for 2010, and $51.36 billion in 2011.

In its restructuring, Kraft, the world’s second largest food company, rejuvenated top-line growth in 2007, then in 2008 increased both revenue and profit. In 2009 it built profit margins and market share, targeting a long-term growth in earning per diluted share of 7 percent to 9 percent annually.

Kraft earned $3.03 billion, or $2.03 per diluted share, in 2009, up 4.7 percent from $2.89 billion, or $1.21 per diluted share, in the year earlier.

“Having successfully reinvigorated our base business we’re now ready to write the next chapter in our transformation,” said CEO Irene Rosenfeld at the 2010 Consumer Analyst Group of New York conference Feb. 16.

“The time is right for us to accelerate our transformation from a position of strength. We can leverage our strong financial momentum to accelerate our progress,” she declared.

According to Kraft executives, Kraft and Cadbury are a “perfect, strategic fit,” which will create a “global powerhouse.” With Cadbury, they say, Kraft will be able to benefit from their complementary strengths in sales and distribution.

The new Kraft Foods will control 14.8 percent of the global confectionery market, making it the world’s largest.

The company will have 11 billion-dollar brands; confectionery and snacks will make up a majority of its portfolio; more than half of the business will be outside of North America-- more than any North American competitor; and 80 percent of its revenues will be from No. 1 industry share positions.

Warren Buffet, the company’s largest shareholder, publically opposed Kraft’s takeover of Cadbury, warning Kraft against overpaying for the company and underpricing its pizza business. 

After the pizza deal, Arnold of Edward Jones “does not anticipate any meaningful contribution to earnings per diluted share for at least two years.” His earnings estimate for this year is only $2.05.

Similarly, the pizza transaction influenced Aaron’s 2010 estimate, which is $2.06.

In the past Kraft has proven it's capable of making successful acquisitions, including Nabisco in 2000, which increased worldwide revenues by 30 percent, noted Goldin.

The transition to the new Kraft is already underway, and Kraft says it will work aggressively and very quickly.

However, Goldin suspects there won't be much to show in the first six months, and he wouldn't be surprised if Kraft sells off a few other brands as it sharpens its focus. Progress may become evident within 12 to 18 months, he thinks, but growth acceleration will take a bit longer.

“They have a lot at stake and can’t put all their energy towards new business,” Goldin said. “They must protect their core business.” It’s a big company, he added, forward moving and effective, and will protect what it already has. 

While Kraft is managing the integration, competitors undoubtedly will try to gain ground, but analysts doubt they will dislodge Kraft from its leading positions.

In a note, Arnold said the merger makes sense “as it vaults Kraft to a position of global leadership in the attractive snack and confectionery categories.”

Kraft stock is trading just shy of its 52-week high of $30.98 per share. Its price-earnings ratio is about 15, a bargain when compared to the 22 P/E of the Standard & Poor’s 500 Index stocks.

On May 6, Kraft will announce its first quarter earnings, along with guidance for 2010 and 2011.