Sweet dreams

Kraft/Cadbury: Kraft’s ballsy proposal to buy Cadbury for £10.2 billion probably spells the end of the UK confectioner’s independence. But it is less clear that the acquisitive US food group will succeed in becoming its owner — and, to get there, it will certainly need to offer more.

The market’s reaction to Kraft’s cash-and-shares proposal, pushing Cadbury shares almost 8% above the mooted 745p offer by midday on Monday, rightly assumes that the target company will play a role in a consolidating confectionary market. Cadbury’s performance is improving thanks to a cost-cutting programme initiated after the demerger of its drinks business amid pressure from activist Nelson Peltz. But it is hard to see how it could on its own generate the same value as could be had from a tie-up.

That said, Kraft’s opening pitch - a 31 per cent premium to the previous closing price - is far from a knock-out. That's especially so given that 60 per cent of the offer is denominated in foreign stock.

Justifying a higher offer should not be too hard. Kraft is probably substantially understating the likely synergies here. The stated cost savings of $625 million annually have a present value of £1.94 billion when taxed at 30 per cent, capitalised on a multiple of 10 and net of $1.2 billion of one-off costs. That does not even cover the £2.43 billion premium in Kraft’s £10.2 billion proposal. Not only are cost savings likely to be higher but there will be revenue synergies too.

But if Kraft can justify a higher offer to its own shareholders, it may still struggle to win over Cadbury’s.

The share component is the trickiest issue. True, Kraft is a $42 billion company so daily trading could probably absorb flowback from the $10 billion stock component of the current offer without much indigestion. And Cadbury has a more international register than most UK corporations. But still some two-thirds are UK funds. Cash will be far more appealing to these institutions. It is not as if Kraft paper has been such a success – the shares have modestly underperformed Cadbury over the last year.

But Kraft’s capacity to add more cash into the mix is limited. The current proposal would see it take on more debt and retain only small additional capacity within its triple-B-plus rating, lifting its debt-to-ebitda ratio from 3.3 to about 4. Kraft cannot afford to sacrifice that rating as it is a regular user of the commercial paper market. Kraft can presumably bump up the cash component a bit — but it won't be able to improve the overall value decisively and simultaneously switch it mainly into cash.

These constraints create favourable conditions for a counteroffer. Hershey, the US chocolate maker, is too small to do a deal by itself but a break-up bid with Switzerland’s Nestlé, which would otherwise face regulatory obstacles, is possible. Roger Carr, Cadbury’s newish chairman, and Todd Stitzer, the chief executive, have the market on their side in rejecting this particular deal — but not any deal.