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By Jeremy Glaser | 08-04-2011 10:22 AM

Kraft Split-Up Could Add Shareholder Value

With Kraft's business separation appealing to both growth and income investors, the firm's two new entities could fetch a higher valuation in the marketplace, says Morningstar's Erin Lash.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Just like twisting an Oreo in two can make it better, Kraft is going to try to put itself into two pieces. I'm here today with our Kraft analyst, Erin Lash, to take a close look at the deal and see what it might mean for investors.

Erin, thanks for joining me today.

Erin Lash: Thanks for having me, Jeremy.

Glaser: Erin, can you give us an overview of what they are doing with the spin-off?

Lash: Yes, they are going to be spinning off their global snacks business and their North American grocery business, essentially reversing the Cadbury deal that was announced about 18 months ago.

Glaser: So the snacks business will basically be the old Cadbury and the grocery business will basically be the old Kraft. Is there any kind of cross pollination between the two old companies?

Lash: Yes, there will be some. Obviously, the U.S. snacks business will be included in the global snacks business and for Kraft that includes the Oreo brands, for instance. And for the global snacks business, as well, it will include Kraft's powdered beverage and coffee business internationally, so that includes Tang and some of the firm's international coffee brands, as well.

Glaser: So do you think that this is an admission that the Cadbury merger hasn't worked?

Lash: I wouldn't say necessarily that it hasn't worked, but obviously we have been skeptical since the Cadbury acquisition was announced regarding some of the qualitative aspects of the deal, specifically personnel retention and some of the cultural issues that Kraft had to get over. And we believe that today's announcement kind of supports our thinking.

In addition, we question now whether some of the targeted synergies and cost savings will actually be realized during the next several years that were supposed to result from the Cadbury acquisition.

Glaser: Now, what do you think that this means for shareholders? Would you be excited to own both parts of this company? One part over the other? I mean, is it really going to be one a great fast-growth company and then kind of a rump, or do you think both are going to be able to grow over time?

Lash: Well, overall we still think that this deal could unlock some additional value for shareholders, and we intend to raise their fair value slightly based on a sum-of-the-parts valuation. But looking at the individual business segments, we think that investors that are interested in growth within the packaged foods space, specifically additional exposure to emerging and developing markets, might be interested in the global snacks business post spin-off, while income-seeking investors might want to consider the North American grocery business. Although it's a more mature business, management has stated that the priority for cash generation in that business is dividend payments.

Glaser: Now looking at the competitive landscape, after this spin-off, do you think that there is chance for even more M&A activity that one or both of the spin-offs would be potential acquisition targets, or do you think that they will continue as stand-alone companies?

Lash: Overall, our initial take is that both of these firms will remain individual businesses, particularly given the sheer size of both businesses. The global snacks business generates more than $30 billion in annual revenues, while the North American grocery business generates just north of $15 billion in annual revenues, and as a result, we doubt that they will garner significant interest from potential acquirers.

Glaser: And then what are the next steps here for investors in Kraft, who are current investors in Kraft right now? What should they be in the look out for in the coming months?

Lash: I think obviously, it's still business as usual at Kraft with regard to what's going on in the underlying business. Cost inflation continues to be a headwind. In fact management this morning also raised their estimates in terms of the impacts that they expect from cost inflation this year, and as a result, they are targeting additional price increases throughout the remainder of the year. And given that consumers remain constrained, particularly developed-markets consumers, we'll be paying attention to how the firm is able to offset those cost pressures and the impact that the higher prices have on volumes for the underlying business.

Glaser: Great. Erin, thanks much for sharing your thoughts on the deal today.

Lash: Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

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