In 2010, Kraft acquired British confectionery company Cadbury for $19 billion. W

Question

In 2010, Kraft acquired British confectionery company Cadbury for $19 billion. While the firm became the world’s largest snack company with the takeover, it was still entrenched in its traditional business, groceries, on the book’s at a low historical cost. The company now owned two very different product portfolios. Between January 2010 and mid-2011, Kraft’s share price grew faster than the S&P 500; however, it continued to trade at a lower price-to-earnings multiple than such competitors as Nestle and Groupe Danone. Expressing concern that Kraft was not realizing the promised synergies from the Cadbury deal, activist investors, Nelson Peltz’s and Bill Ackman, had discussions with Kraft’s management about splitting the firm.

     To avert a proxy fight, Kraft’s board announced on August 4, 2011, its intention to divide the firm into two distinct businesses. The proposal entailed separating its faster-growing global snack food business from its slower growing U.S. centered grocery business. The separation was completed through a spin-off to Kraft Food shareholders of the grocery business on October 1, 2012. The split up was justified as a means on increasing focus, providing greater opportunities, and of giving investors a choice between the faster growing snack business and the slower growing but more predictable grocery operation.  

Discussion Questions:

1. Speculate as to why Kraft chose not divest its grocery business and use the proceeds to either reinvest in its faster growing snack business, to buy back its stock, or a combination of the two?

2. How might a spin-off create shareholder value for Kraft Foods’ shareholders?

3. There is often a natural tension between so-called activist investors interested in short-term profits and a firm’s management interested in pursuing a longer-term vision. When is this tension helpful to shareholders and when does it destroy shareholder value?

Explanation / Answer

(1).

As per information of the question, it is clear that Kraft has traditional business of groceries hence divest from this traditional business will leads to various types of complexities like; unemployment of existing employees, problem of taxations on the sale, uselessness of fixed assets of this traditional business. Hence before taking such decisions management of Kraft have to consider these related factors. Apart from this it is also clear that Kraft have acquired confectionery company Cadbury on the basis of its’ traditional business hence due to short-term low margin a traditional business can not be divested. Apart from this if this firm use all its’ proceeds in a single business (faster growing snack business) then it will reduce diversification of investment hence in case of slow down of faster growing snack business, Kraft may be in great trouble. Thus buy back of shares or combination of two separate units will also create same problem that is why it is suggested that Kraft should continue with both because overall it will generate long-term benefits because in case of slow down of one unit, other can manage losses of one unit.

(2).

We know that mergers & acquisitions result some synergies effects but spin-off also have its’ own benefits that is why sometime spin-off can create value for the shareholders because it gives a chance of benefits of diversification. And we know that there is always a business cycle (like; boom and recession) hence a firm should manage each separate units accordingly so that overall values of the shareholders remain maximum.

(3).

We know that interests of both management and shareholders may clash so if they are going in just opposite direction then it will not be good for shareholders. No doubt shareholders want some short-term immediate benefits for their investment but overall value for the shareholders depend on long-term solid condtion of the firm hence manager should try to maximise long-term values of the shareholders so that real value can be improved. So if both shareholders and mangers are working for long-term advantages then it will be good for the shareholders.

If managers is working for own short-term advantages and short-term advantgaes of the shareholders then it will be dangerous for the shareholders.

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