Assignment MACR

Merger of Cadbury and Kraft

LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT,

NEW DELHI

Submitted to

Submitted By

Dr. Anshu
Agarwal

Shubham Agarwal126
Adwitiya Singh- 137
Akshay Mann- 160
Shreyansh

Pre-Merger History of Kraft and Cadbury

Kraft Foods
Kraft Foods is an American public firm, listed on NASDQ (NASDAQ: KTF),
operating on the Food & Beverage Industry. In 2009, Kraft Foods was the worlds
second largest food products manufacturer and packager firm with operations in more
than 70 countries, 97.000 employees worldwide and selling for almost 160 countries.
Its products are dispersed into five consumer sectors:
Snacks: primarily biscuits, salted snacks and chocolate confectionery;
Beverages: primarily coffee, packaged juice drinks and powdered beverages;
Cheese: primarily natural, processed and cream cheese;
Grocery: primarily spoonable and pourable dressings, condiments and desserts;
Convenient Meals: primarily processed meals, frozen pizza, packaged dinners and
lunch combinations.
Kraft Foods is geographically segmented in North America, Canada, Europe and
Developing Countries, such as Brazil, Russia, China and other regions of Southeast
Asia. Kraft Foods started focusing on emerging markets as a strategy to grow its
operations, market share and profitability, since emerging markets face growing
population and rising income levels followed by a shift in demand for more expensive
products.
In 2009, Kraft Foods presented Net Revenues of $ 40.39 billion, 3.6% less than the
previous year, an Operating Income of $5.52 billion, 43.7% more than in 2008 and
Net Earnings of $3.03 billion, 4.7% more compared with the previous year.

Cadbury
Cadbury is a British firm and the worlds second largest confectionery firm after Mars
Wrigley (merged in 2008) by revenue. Operating in more than 60 countries with
over 45.000 employees Cadbury is global in 20 of the worlds top 50 confectionery
markets.
Cadbury is divided into three consumer sectors and its largest brands are:
Chocolate (brand: Dairy Milk)
Gum (brand: Trident)
Candy (brand: Halls)
Cadbury is dispersed in many countries especially in emerging markets, such as
Argentina, Brazil, Egypt, India, Mexico, Russia, South Africa, Thailand, Turkey and
Venezuela, with a CAGR (2003-2005) of 12% and 11% overall market share.

In 2009, Cadbury presented revenues of 5.98 billion, 11% more than in the previous
years and earnings of 510 million, 39% more than the previous year.

Type of the Merger Deal

The Kraft and Cadbury merger was a hostile horizontal acquisition. As the Cadbury
declined several offers from Kraft, however after grueling negotiation and term
amendments Cadbury finally gave in to what appeared to be the best and only offer on
the table at the time. In this case, it is suggested to Kraft Foods acquires Cadbury
through a tender offer, where Kraft Foods commits itself publicly to buy Cadburys
outstanding shares at a specific price. Both firms benefit if the acquisition is friendly,
in terms of acculturation process, and for that Kraft Foods proposal offer for Cadbury,
should be higher enough to send a friendly message to Cadburys board.

Important dates in Kraft-Cadbury Merger

Dates
August 28,
2009

Activity
Kraft's Chairman and CEO Irene Rosenfeld meets Cadbury's
Chairman Roger Carr offer to buy Cadbury in a cash and share
deal which valued Cadbury's shares at 755 pence each, but Carr
dismissed the approach, the Kraft bid was worth 300p in cash
and 0.2589 new Kraft shares for each Cadbury share

September
7, 2009

Kraft goes public with the bid, but by this time the value of the
same offer had slipped to 745p per Cadbury share, or 10.2
billion pounds. Cadbury promptly rejects the bid.

September
12, 2009

Cadbury's Carr in a letter to Rosenfeld again rejects the bid

saying it was an "unappealing prospect" being absorbed into
Kraft's "low growth conglomerate business".

September
16, 2009

Warren Buffett, the world's second richest man and a leading

shareholder in Kraft with a 9.4 percent stake, warned the U.S.
food group not to overpay for Cadbury.

September
21, 2009

Cadbury contacts the UK Takeover Panel to request a "put up

or shut up" request be sent to Kraft, which would give a time
frame for Kraft to come up with a formal bid

September
30, 2009

UK Takeover Panel rules that Kraft has until 1700 GMT on

Nov 9 to make a formal offer for Cadbury or walk away for six
months. Cadbury reiterates its rejection of the Kraft bid

November
3, 2009

Kraft's third-quarter results disappoint investors with weakerthan-expected revenue and as it cut its 2009 sales forecast.
CEO Rosenfeld says she will not overpay for Cadbury

November
9, 2009

Kraft formalizes its bid at the same terms for Cadbury as the
original approach -- 300p in cash and 0.2589 new Kraft share
for each Cadbury share -- valued at 717p
Both Italy's Ferrero and Hershey said separately they were
reviewing a possible bid for Cadbury but gave no assurance
that either would make an offer

November
18, 2009

December
4, 2009

Kraft posts its offer document to Cadbury shareholders starting

off a two-month fight for the British group under UK takeover
rules. Kraft says its bid is now worth 713 pence a share or 10.1
billion pounds

December
18, 2009

Cadbury CEO Todd Stitzer tells Reuters in an interview that a

significant number of its major shareholders do not believe
Kraft's bid reflects Cadbury stand-alone value

January 3,
2010

Kraft sweetens bid with 60p more cash but cuts shares on offer
to keep offer price unchanged

January 14,
2010

Cadbury releases it final defense document, attacking Kraft's

management and revealing that it beat its own target for
operating margins in 2009

January 18,
2010

Cadbury board recommends 12 billion sale to Kraft

Rationale behind the Deal

Entering Emerging Market: India, China, Mexico , Brazil & South Africa are
among the strongest emerging markets and Kraft has very little footprint in these
places apart from China. Most of its revenues come from North & South America &
Europe which have very slow growth. Cadbury is a cross-border acquisition to enter
into growth markets in Asia, Middle-East & Africa
Overcoming Entry Barriers: ITC, Pepsico etc. are already established in
food & beverages and Kraft alone would have to spend a fortune on S&M to
enter those markets. So Strong brand name of Cadbury in emerging markets would
result in cost saving & easy penetration. Also Fragmented supply chain in developing
countries Cadbury sales out of 1.2 million kirana stores in India. 98% of food
purchase done through these stores. Access to this huge network which from scratch
would have taken millions of dollars & years of time.
Economies of Scale: It is necessary to scale to grow sales and distribution in new and
existing markets. $1 billion in incremental revenue synergies & $750 million in cost
synergies - by 2013
Diversification and Risk Reduction: Coverage of more diversified & promising
markets. Along with High margins of Chocolate & chewing gum. 14% confectionary
market: Gum, highest growth rate. Increased presence in the Gum market as Cadbury
is the market leader with share 29%, Kraft: share 0.1%
More value to shareholders: Kraft believed that the merger could target long-term
organic growth in excess of 5% and sustainable long-term EPS growth of 9 to 11%
whereas Kraft targets long-term organic revenue growth of 4% and EPS growth of 7
to 9% on a standalone basis. Term growth rates in revenues and bottom lines will be
driven by revenue synergies and $625 million identified annual cost savings.
Increased Cost and Revenue based Synergies: As it is Horizontal acquisition so it
will have Economies of scope and More bargaining power vis-a-vis customers &
suppliers. Joint portfolio of more than 40 confectionary brands, each with annual sales
in excess of $100 million and making the world's biggest confectionary company.

Kraft Foods became the undisputed world leader in Snacks a high-growth, highmargin category

Expected Synergies from the Deal

The market shares of Kraft after Cadbury's acquisition reached 14.9% in the
global confectionery market, pushing Mars-Wrigley, with a market share of
14.5%, to second position.

This enabled the company to offer Kraft brands such as Oreo biscuits and
Maxwell House Coffee with Cadbury's Dairy Milk chocolate and Trident
chewing gum.

The total value of synergies for the merger between Kraft Foods and Cadbury
was $4.26 billion. This value represented 25% of Cadburys market value as of
9th November, 2009.

The costs-related synergies were more reliable to be computed. It was

estimated that cost-related synergies accounted for more than 50% of total
synergies.

The combined company could target long-term organic revenue growth in

excess of 5% and sustainable long-term EPS growth of 9 to 11%, whereas
Kraft targets long-term organic revenue growth of 4% and EPS growth of 7 to
9% on a standalone basis.

These cost savings were expected through regional overlapping in operational

activities

However, both Kraft Foods and Cadbury benefitted from the merger, since it
was possible to enter in new and already existent markets by taking advantage
on both brand image and sales force.

Financial synergies were estimated due to a new debt capacity by the merger
of the two entities. It was estimated that the new entity will maintain the credit
rating at Baa2.

Acquisition Analysis
Acquisition
It is important to highlight, that in reality Cadburys acquisition by Kraft Foods
occurred in February of 2010, however this valuation process is independent from
what happened in reality. For this dissertation only public available information about
Kraft Food and Cadbury were used. No detailed information about the deal after it
was realized was used. This means that the results in this valuation are not comparable
to the real deal occurred in 2010.
To briefly summarize, Kraft Foods was the worlds second largest manufacturer and
packager food products and Cadbury was the worlds second largest confectionery
firm, with a market capitalization of $ 39.69 billion and 10.35 billion ($
17.31billion), respectively.
Each standalone valuations the net present value of expected future cash flows
estimate that Kraft Foods and Cadburys Enterprise Values are $ 62.12 billion and
8.50 billion ($ 14.20 billion). Combined without synergies both firms values $ 75.86
billion. With synergies the combined firms value $76.32 billion using the WACC
approach and $76.31 billion using the APV approach, generating synergies of $4.26
billion and $4.27 billion, respectively.
Cadburys Enterprise Value represents 18% of the Enterprise Value of the merger
entity without synergies. Following the criteria already mentioned, Cadbury shall
receive 18% of the value of total synergies. In this way, Kraft Foods shall give to
Cadbury an additional $632 million.
th
Cadburys market value at 9 of November of 2009 was $ 17.31 billion and
Cadburys valuation identifies an equity value of $ 5.89 billion. With the percentage of
synergies belonging to Cadbury (19%), the new equity value is $ 6.68 billion (13%
upside potential of the old equity). To summarize, according to Cadburys market
th
capitalization at 9 of November of 2009, the total premium offer is 39% (in relation
to the new equity value) and the real premium offer is 21%.

Deal Structure
Kraft Foods is going to pay 21% of premium over Cadburys Enterprise Value and
pretends to pay primarily in cash. Cadburys acquisition price of $ 18.10 billion
corresponds to an offer of $13.25 (7.93) per share. This acquisition is going to be
paid with cash and debt more specifically with 88% of Debt and 12% with cash. This
value of cash amounts to $2.2 billion and corresponds to an emission of almost 90
million new shares conversion rate corresponds to Kraft Foods price target ($30.39
per share). The value of debt corresponds to $15.90 billion.
Cash sale : 10$ per share of Cadbury
13610 million $
Stock sale : .1874 Kraft share @ $27 per Cadbury share
6631.36 million $
Dividend : 10 pence per Cadbury share
272.2 million $
Total price paid approx. 20 billion $

Exchange Ratio

Investment Banks Involved:

Kraft was advised by Lazard, Citi, Deutsche Bank and Center View Partners, and
Cadbury by Goldman Sachs, Morgan Stanley and UBS
Delisting and re-registration:
At 1.00 p.m. (London time) on 2 February 2010, Kraft Foods had received valid
acceptances of the Offer in respect of a total of 987,684,041 Cadbury Shares
(including those represented by Cadbury ADSs), representing approximately 71.73 per
cent. of the existing issued share capital of Cadbury.
Following receipt of sufficient acceptances (i.e. 75 per cent.), Kraft Foods intends to
procure that Cadbury will apply for the cancellation of the listing of Cadbury Shares
on the Official List and the trading on the London Stock Exchange for listed
securities. Kraft Foods also intends to procure that, as soon as practicable, Cadbury
will apply for the delisting of Cadbury ADSs from the NYSE and that Cadbury
terminates its ADS program and the Deposit Agreement.

Valuation of Cadbury

The first multiple P/E is considered one of the most important multiples, since it
shows the investors expectations of how much they are willing to pay. Kraft Foods
P/E is trading at a reasonable fair value but the lowest comparing with its peers.
Looking at P/B ratio, Kraft Foods has a lower ratio compared with its peers, meaning
that the stock could be undervalued and no growth expectations are taking into
account by investors.
The next multiples are enterprise-value multiples what have the advantage of not
being easily manipulated as equity multiples are.
To better analyse the peer group, multiples were divided into minimum (min), average
and maximum (max). As is possible to observe in the graphics the range given by
EV/EBITDA is that Enterprise-Value should be between 6.72 billion and 10.79
billion and using EV/Sales, Enterprise-Value should be between 10.10 billion and
12.81billion.
In EV/EBITDA Cadburys valuation seems to be above the average of its peers, but
inside the range. In turn, in EV/Sales Cadburys valuation is underperformed
comparing with its peers.
As already mentioned, it is important to highlight that multiples should give a range or
a rough idea of what the Enterprise-Value should be and must not be taken as the main
valuation process, since comparable firms are very difficult to find, because there are
no two similar firms as said before.

Cost Of Acquisition

The Cadbury acquisition was valued at $18,547 million, or $17,503 million net
of cash and cash equivalents.
Incurred transaction related fees of $218 million in 2010 and $40 million in
2009, which was recorded in selling, general and administrative expense.
Also incurred acquisition financing fees of $96 million in 2010, which were
recorded in interest and other expenses, net. As a condition of acquisition, the
EU Commission required that Kraft divest certain Cadbury confectionery
operations in Poland and Romania.
The divestitures were completed in the third quarter of 2010 and generated
$342 millions of sale proceeds. The impact of these divestitures was reflected
as adjustments within the Cadbury final purchase accounting.
During 2010, Cadbury contributed net revenues of $9,143 million and net
earnings of $530 million from February 2, 2010 through December 31, 2010.
We acquired Cadbury to create a global snacks powerhouse and an unrivalled
portfolio of brands people love.
The Final Offer represents an attractive multiple of 13.0 times Cadbury's
underlying 2009EBITDA.

Merged Valuation without Synergies

In this section no synergies were considered. The model assumes the individual
assumptions of each firm Kraft Foods and Cadbury - and it is equal to sum of each
part.
It is important to highlight that this is a cross-border merger where Kraft Foods is an
American firm and Cadbury is an English firm, in which its statements are expressed
in dollar and pounds, respectively. Since the acquisition is bidden by Kraft Foods it is
assumed that the deal is going to be done in dollars. Cadburys cash flows were
estimated and discounted according to Cadburys discounted rate and the Net Present
Value of its valuation was converted to US Dollar at the spot exchange rate of 1.6719
(GBP/USD) from 9th November of 2009, following Method A as presented in section
6.2 of this dissertation.
The Income Statement and the Free Cash Flow (Appendix 24 and 25) of the combined
firm were estimated as the direct sum of Kraft Foods ($ 62.12 billion) and Cadbury ($
14.20 billion) independent valuation.
The total value of the merged valuation without synergies using WACC is $ 76.32
billion.

Merged Valuation with Synergies

By merging both firms a creation of a certain number of opportunities that would not
be generated independently are expected. Both Kraft Foods and Cadbury operate in
the Food Industry and share the same consumer segment of confectionery, so it is
possible to analyse some functional strength that can be transferred and shared across
both firms.
These firms compete in a global highly competitive market, where not only price
matters for consumers, but also products diversity, quality and innovation.
To be able to deliver those characteristics to consumers, a cyclical process of
managing input costs to improve brand equity is necessary, to invest in R&D and to
drive progress in every geographic region setting solid objectives to explore sales
opportunities and reinvest to maintain future growth.
To obtain that it is important to achieve a certain operating income margin to release
funding for efficiency-improvement projects.
Merging with another firm can allow the creation of operational and financial
synergies. Operating synergies are those synergies that allow firms to increase their
operating income from existing assets and/or increase growth.58 There are two types
of operational synergies: revenue- enhancing and cost-related. Revenue-enhancing
synergies are quite difficult to measure, since it is not possible to evaluate with
precision how much sales are going to increase in a certain period of time. In that way
it turns out to be easier to quantify cost-related synergies, such as economies of scale
and overlapping of operational activities, and build it in valuation models.
Financial synergies are related to the impact on the cost of capital of the merger entity
or in a form of higher cash flows. The combined firms should have a cost of capital
lower than separately, also if its cash flows are not perfectly correlated, it reduces its
volatility and it should reduce bankruptcy risk. In addition, there are also financial
synergies in tax benefits and cash slack, as mentioned in the Literature Section, but
those are not going to be deeply focused.
Despite this merger being made in 2010, Kraft Foods intentions for Cadbury started
in the beginning of 2009 and most equity analysts started their estimations
immediately, updating them as the quarterly results of both firms were published
during that year. For a matter of simplicity and since the annual results of 2009 for
both firms are already released, it is assumed that synergies started in 2010 due to the
potential cost savings resulting from the regional overlap in the operational activities.
Revenue-enhancing Synergies

As already mentioned, it is difficult to quantify revenue-enhancing synergies. In this

valuation, revenues synergies were not explored due to the lack of information.
However, the merger between Kraft Foods and Cadbury allows the potential of crossselling for both entities. Kraft Foods will benefit from Cadburys larger international
presence and growth in emerging markets, especially in India, Mexico and South
America, to spread its own products, such as powdered soft drinks, sheltered by
Cadburys brand image and distribution channels. At the same time, Cadbury will
benefit from the merger by enjoying Kraft Foods distribution channels, especially in
the U.S., allowing an increase in Cadburys market share. So, an increase in revenues
in almost every consumer segments is expected, especially in snacks (that incorporates
confectionery) and beverages.
Together, Kraft Foods and Cadbury will lead market share by revenues and, at the
same time, both firms will reduce their competition, allowing better revenues margins.
Cost-Related Synergies
Differently from revenues-enhancement synergies, cost-related synergies are easiest to
compute and to model.
Kraft Foods estimates through Cadburys operating costs of 2008 synergies of $625
million what represents 8% of Cadburys cost base. Kraft Foods expected to create $
300 million in operational synergies (procurement, manufacturing, logistics, R&D and
costumer services), $ 200 million in G&A savings and $125 million in marketing and
selling expenses. In the same report, JP Morgan estimates that cost synergies could be
$1.7 billion due to a significant regional overlap in operational activities.
As it is possible to observe my perspective about cost savings is more conservative,
only exceeding Kraft Foods estimates starting from 2014.

In terms of product the overlap is minimal, not only chocolate is the only product in
common between Kraft Foods and Cadbury, the markets where both are located with

the same product are minimal too, just in Western Europe. According to JP Morgan60
only 12% of Kraft Foods total sales in 2008 ($ 5.3 billion) are respected to
confectionery.Cadburys G&A could be partially absorbed by Kraft Foods own G&A
in some regions during the five years and after this period be totally absorbed. For
Europe (EU) and North America (NA), I assumed, based on the presence of Kraft
Foods and Cadbury in those countries, a cost saving of 30% in each year and after
2015 a cost saving of almost 50%. For other regions (L/A, EE, Asia and ME&A) it
was assumed a cost saving of 15% in each year and after 2015 a cost saving of almost
100%.

Distribution costs is the cost area where less cost savings are expected, since Kraft
Foods is a giant in the food industry with several consumer segments, other than
confectionery, and with hundreds of different brands. It is difficult to believe that
Kraft Foods could be easily filled with Cadburys products. For NA, Asia, L/A and EE
it was assumed a cost saving of 40% in each year and after 2015 a cost saving of
almost 50%. For Europe and ME&A a cost saving of 20% and 10%, respectively, in
each year and after 2015 a cost saving of more than 50% for both.

Cadburys marketing costs, that are mainly selling expenses, in some regions can be
absorbed by Kraft Foods sales force, especially in NA, L/A, EE and Asia where Kraft
Foods presence is meaningful. In Europe and ME&A, the cost savings are inferior,
since Kraft Foods sales force in those regions is not quite strong. It is assumed for
NA, L/A, EE and Asia a cost saving of 20% in each year and after 2015 a cost saving
of almost 80%. For Europe and ME&A, a cost saving of 20% and 10%, respectively,
in each year and after 2015 the same base cost saving it is going to be maintained.

As mentioned, the only common product between both firms is chocolate, and the
impact that confectionery has in Kraft Foods total sales is almost residual comparing
with its other consumer segments. In this way, it was assumed only a cost saving of
10% in R&D in each year, since little expertise should be shared between both firms.

FinancialSynergiesandCapitalStructure
Tunlevered beta of the new merged firm (0.55) is computed through a weighting
formula of Kraft Foods and Cadburys unlevered betas. Then, according to the
formulas mentioned in section 3.5, it is possible to find the beta levered (0.93).
Assuming that the merged firm risk free is 3.84% % (US 10-year Treasury Bond) and
the total risk premium of 4.50%, the new firms cost of equity unlevered and levered
is 6.33% and 8.01%, respectively.
Regarding to the cost of debt by merging both entities, it is assumed that the debt
capacity increased, since the cash flows become less volatile. As Damodarans website

suggests, with an interest coverage ratio of 4, the respective cost of debt for the new
entity is 6.02% with a credit rating of Baa2 and a default probability of 2.00%, where
the new entitys cost of capital is 6.08%.
Also, it is assumed that the new entity will write up the assets by U.S. Tax Laws of
31.50% where it could take more advantages from interest tax shields.

Post-Merger Analysis
SHARE PRICE MOVEMENT OF CADBURY DURING MERGER

SHARE PRICE MOVEMENT OF KRAFT DURING MERGER

SHARE PRICE MOVEMENT OF KRAFT AND CADBURY DURING

MERGER

KRAFT AND CADBURY PRODUCT PORTFOLIO AND PRESENCE POSTMERGER

KRAFT MARKET ANALYSIS

KRAFT

2009
2.04

2010 (Post
merger)
2.36

2011 (Post
merger)
2.006

EPS ($)
NET
EARNING(mn
$)
No of
Shares(mn)
Market
Price($)
P/E

3028

4139

3547

1478

1748

1768

29.58

31.51

37.36

13.26686

13.30744

18.62207

Market Cap($)

40172.04

55079.48

66052.48

CADBURY MARKT ANALYSIS

CADBURY
EPS ($)
NET EARNING (mn $)
No of Shares (mn)
Market Price ($)
P/E
Market Cap ($)

2009
.592
807.037
1361
8.365
14.18
11451.17

BRAND PORTFOLIO

GEOGRAPHICAL SPREAD

CULTURAL IMPLICATION

Softer cultural problems crucial impediments to effective integration

Successful creation of leadership team is led by the CEO: requires

commitment and focus on the part of CEO to get beyond just hitting synergy
targets' and set time aside to develop the leadership team early on

Leadership team developed most effectively by involving employees from both

the merged entities in specific business planning activities

Building a leadership team following an acquisition is an important, painful

process that sets the tone for the wider integration

Fears at Cadbury

1. About taste of chocolates to work environment

2. Kraft's bureaucratic work structures
3. Orwellian feel

Kraft

Cadbury

Strengthened Brand

Damaged Heritage

Drives higher performance leading

to better revenues

Lower Moral and Performance

Better Control of organization

Staff Burnout

Better Reputation

Risk of losing benefit schemes

Efficiencies through alignment of

processes

Trust Issues

Alignment of goals

Changed Brand Personality

Problems with the Deal

Inadequate Evaluation of Target:

500p in cash and 0.1874 Kraft shares for each Cadbury share. According to

Buffet which was a pretty full price i.e. much higher than actual & Kraft
shares undervalued
Large Debt:

Debt of $ 9.5 billion. Recoverable within 13 years at the then income level
(3.25, 6, 10, 30 year bonds through DB, HSBC, RBS, BNP Paribus)

TIME

2005

2006

2007

2008

2009

2011(post
merger)

Debt/Equity

0.02

0.03

0.02

0.09

0.02

1.3

RATIO ANALYSIS

Sales per share has increased as result of synergy

Earning per increases as profits has increased

Dividend has not changed even after merger

P/E has been decreasing and even after merger

there has not been any major change

Sales has increased dramatically as market

coverage has increased

Due to increase in debt operating cost has

decrease

There is slight increase in profit margin due to

increase in sales

Return on capital has remained constant after a

slight fall during merger

Return on equity fell due to merger cost but has

again increased