Deal making is back!
That was the general reaction from the press when US food giant Kraft launched its first bid for British confectioner Cadbury less than two months ago. Pundits spewed out potential target prices like bingo numbers - £8, no £10, no £12! and analysts scribbled out scenarios involving white knights and rival bidders from across the globe.
Reality has been a little more disappointing. Despite attempts to talk up the deal, no rival bidders have come forth. And yesterday Kraft came back to the table with an offer that can only be described as as Cadbury's board put it 'derisory'.
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It's just another sign that there's a vast gap between conditions in the financial world and those in the 'real' world...
Market hopes are stretched far beyond reality
The Cadbury / Kraft bid saga shows just how far market hopes are stretched beyond reality.
Right up to yesterday's bid deadline, analysts and investors were clearly expecting Kraft to pull some rabbit out of the hat that would give them an excuse to drive the confectioner's share price higher from its already optimistic level of around 760p.
Instead, Kraft came back with an offer that suggested that, frankly, they can take Cadbury or leave it. The bid terms were exactly the same, which because Kraft's share price has fallen since the original bid was made meant that the actual per share value had fallen, from the equivalent of 745p to 717p.
Yet, the Cadbury share price is still hovering pretty much exactly where it was yesterday. You can read more about the background to the story, and what we reckon Cadbury shareholders should do now, in my colleague David Stevenson's blog on the topic.
What's perhaps more interesting about this bid battle is what it says about the bigger picture and the market's psychology right now. When this deal was first announced, the excitement in the City pages was palpable. This was the return of big deals, a sign that the recovery was on track.
Suddenly, Cadbury was a sleek national treasure, being stalked by this hideous, lumpen, American manufacturer of stringy cheese. Never mind that the confectioner had been trading at less than £6 a share before Kraft made its approach.
Sure, it's easy to uncover a new-found appreciation for something when it looks as though it's going to be taken away from you. And Cadbury's may well be worth a lot more than Kraft is offering, over the long run which is a good argument for keeping it independent.
- Why UK property prices are going to fall 50%
- When it will be time to get back in and buy up half price property
The truth: Kraft can't afford to bid much higher
But there's a big difference between what you believe an asset is fundamentally worth, and what someone else is willing to pay for it. And the truth is that Kraft can't really afford to go that much higher.
As Rob Cox points out on Breakingviews.com, Kraft wouldn't have gone through with the formal offer if it wasn't serious about bidding. And there was no reason for Kraft chairman Irene Rosenfeld to up the offer in the absence of any rival bids this "would have amounted to [Kraft] negotiating against itself". So there may well be a higher bid, or one with a bigger cash component, awaiting Cadbury's shareholders further down the line.
There's also the temptation, once a bid battle kicks off, to get suckered into ego-driven over-paying. When bosses lose out on a deal, they tend to end up with egg on their faces, even if it's the most sensible option.
But practically speaking, there's not much chance of egotistic overpaying in this case. For one thing, the highly value-conscious Warren Buffett is a key Kraft shareholder, and he won't be keen to overbid for Cadbury's. And, as Cox points out, "Kraft can't raise its bid by much without destroying value or losing its investment-grade debt rating."
That's the last thing Kraft wants to do right now, with the global economy in the state it's in. For example, the reason its offer for Cadbury is worth less now, is because Kraft's third-quarter sales were disappointingly weak, sending its share price down. The group also cut its sales forecasts for the year. You don't want to overstretch your balance sheet in that sort of environment.
The City might be betting on the good times coming back, but companies like Kraft which can see how badly the consumer particularly in the US is suffering, have to take a more cautious view. That suggests that getting the bid up to even 800p might be a stretch. And persuading Cadbury's investors to accept that may also be tough.
Cadbury's shareholders should take profits now
So as David suggests, if you bought Cadbury's before the bid was launched, taking your profits now might be the safest option. If you have bought it since, hoping for a better deal, you might want to hang on for the next phase of talks. But bear in mind that there's an awful lot of potential downside if the deal falls through. Cadbury's shareholders might be talking up its value right now, but I suspect their new-found affection for the stock will vanish as rapidly as it appeared if no more suitors appear on the horizon.
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