Divide and Conquer: The way forward for Kraft

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Kraft Foods Inc. recently released a statement in Thursday saying that it was splitting in two.

The worlds largest global-food company has decided to divide its snack and grocery businesses. The statement came as a surprise, especially since Irene Rosenfeld, the companys chief executive told investors 18 months ago that, scale is a source of competitive advantage.

Erin Lash, food analyst at Morningstar sated that, It seems like the firm is reversing course. He said, They spent the last year or two telling everyone about the benefits of size and scale as a reason for merging Cadbury with the legacy Kraft business, only to split it up. Kraft released a statement saying, “These two businesses would now benefit from being run independently.

Bigger is not always better

Indeed, Kraft has proved to always gain on bulk and working with a principle based on the bigger, the better. Last year it purchased Cadbury PLC for $19 billion. Rosenfeld said that it was after the company had closed this deal along with Danone’s LU Biscuits, “it was clear we had very different businesses in the portfolio.”

This move did not generate the required support,as shareholders began to advocate a break up. The company has acknowledged that it cannot increase its shares by mixing brands such as Cadbury chocolate that have higher growth rates with refrigerator staples such as Oscar Mayer lunch meats.

Several analysts believed that the split was around the corner, although the companys mantra was different for a long period of time. For the past year, its share performance lagged behind that of other competitors including Nestle and Group Danone SA.

Rosenfeld stated that the separation was not fueled by pressure from investors and that it would allow the company to be more focused and it will provide greater opportunities.

The break up could help Kraft get ahead of at least one investor, Nelson Peltzs Trian Fund Management LP.

The split is expected to take place before the end of the next year.

Investor Activists

Trian

Since September, last year, Trian has kept it no secret that it has been considering the separation of the two businesses. The firm owns less than 1% of its stake in Kraft. However, its next public filing about its holdings in the latter company will be released in a week, and it is expected to show a significant increase in its stake.

Pershing Square Capital

Along with Trion, Bill Ackman’s, Pershing Square Capital Management, had discussed with Kraft’s management on a split of the company. The break-up plan has also attained the support of billionaire investor Warren Buffet, who owns 6% of the shares.

The Split

Kraft had previously considered making this move but the idea was put on hold in 2009 and instead it made an unsolicited offer to buy Cadbury. The company said: “Cadbury’s brands, which are highly complementary to our portfolio, would benefit from Kraft Foods’ global scope and scale and array of proprietary technologies and processes.” A Kraft spokesman said that, Creating two strong independent operating entities was not feasible before today. The Cadbury deal helps give the snacks business enough heft to stand alone.

Kraft’s European business and developing-markets units, as well as snacks and confectionery businesses in North America, will make up the snacks business. There is about $32 billion in estimated revenue. The other company will hold the North America grocery business including Kraft cheeses and Jell-O. This company is expected to be a dividend-payer, but lacks the same growth potential. However, it comes with stronger margins and more-reliable sales and has been estimated to have a $16 billion in revenue.

The Impact

The break-up could allow Kraft’s businesses to bulk up on their own by pursuing acquisitions of smaller food makers such as ConAgra FoodsInc., which recently made a so-far unsuccessful bid to buy Ralcorp HoldingsInc.

This could help avoid raising any antitrust concerns in U.S.

Kraft’s snack business primarily reaches retailers through direct-store-delivery, with Kraft deliverymen placing products onto the shelves. Grocery products, meanwhile, are primarily shipped to stores from warehouses. “There’s not a lot of overlap in selling and distribution between our two businesses,” said Ms. Rosenfeld. It says the deal won’t generate too many duplicate expenses. Analysts believe that it is possible that the move could weaken Kraft’s leverage with major food retailers or affect how much shelf space it gets for its cheese products and other foods.

On Thursday , while reporting its second-quarter earnings, Kraft revealed a rise in sales by 13% as the company benefited from raising prices sooner than peers to fend off inflation fears. These results also led it to raise its sales and and the company was able to report profits of $976 million up from $937 million, a year earlier.

Overview of the Companies in the Two Businesses

Global Snack Company

Oreo Cookies, Chips Ahoy!, Cadbury Adams and Tang.

Grocery Products Company

Oscar Mayer, Kraft Macaroni and Cheese, Maxwell House Coffee, Miracle whip and Jell-O.

Both companies are expected to be headquartered in the Chicago area but the names of the businesses and management teams are currently undecided.

 

Sources: Wall Street Journal, Financial Times, International Business Times

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