Hershey: Hershey is smaller and brings less to the table than Kraft Foods in a potential takeover battle for Cadbury. But the U.S. chocolate and gum maker may have one distinct advantage in the battle for the UK confectioner: a potentially irrational owner.
The Milton Hershey Trust, which controls the Pennsylvania maker of Twizzlers and Reese’s Pieces, has exhibited a different set of priorities than, say, Warren Buffett, the big Kraft shareholder, who has counselled Kraft not to overpay. It would be a mistake to think Hershey wouldn’t trump Kraft’s near-$17 billion offer for Cadbury.
Strict economic rationality says the chocolatier’s management should steer clear of a bid. Hershey currently has $1.7 billion of debt. If it were to add debt equal to five times operating cash flow it might be able to raise another $3.7 billion. That’s not enough to fund a deal on its own – but it’s sufficient to put the company financially at risk.
Moreover, though sweets are a stable business, Hershey hasn’t ever acquired a company as large and global as Cadbury. Even if a Hershey-Cadbury combination could handle more debt, Hershey would still have to come up with another $13 billion or so, though it could also reduce that by raising debt against Cadbury’s earnings.
Still, that would require changes that might disrupt the Trust, established by the company’s Mennonite founder. The company could sell assets – Italy’s Ferrero is said to covet some Cadbury brands. It could issue shares to Cadbury holders or bring in new investors in the way rival Mars did with Buffett when it bought Wrigley. If it issues too much equity, though, the Trust could put its super-voting stock at risk.
The returns on this potential investment don’t look especially sweet, even assuming Kraft wouldn’t top a higher competing offer (and it probably would). Hershey has fewer opportunities to cut costs since it only overlaps in half as many Cadbury geographies as Kraft, Credit Suisse estimates. It would struggle to get a return on investment higher than its cost of capital.
But Hershey’s trustees and managers may not just be thinking, Buffett-style, about the bottom line. They are staring at a combination in Kraft-Cadbury which would potentially make them bit players in the global confectionery business. Faced with such a picture, any response – even an irrational one – can’t be entirely discounted.
