Raising Stakes for Cadbury: How High Will Hershey / Kraft Go?

Stock price: p800.5 (US$1319)

Conclusion: We think a potential Hershey (HSY) bid or a Hershey-Ferrero alliance might prompt Kraft (KFT) to increase its offer but it is unlikely to exceed p860 (US$1417) per share or $20bn (the top end of our estimated valuation range).

Hershey and Ferrero confirmed that they are reviewing their options regarding Cadbury (CBY).

• We envisaged in a previous comment (Sept 7) that Hershey might accept to be diluted to 51% and join in a JV in order to get better access to international markets. According to the FT, Hershey would pursue a $17bn bid for Cadbury topping Kraft’s $16.2bn offer. Assuming 4x leverage and the issuance of class B stocks, we estimate that Hershey ($5bn sales) could fund $4.5bn. More funding would require the issuance of non voting shares which might be more difficult to get and the contribution of external investors.
• As to Ferrero ($9bn sales), we estimate the borrowing capacity at $6-$7bn based on zero existing debt and EBITDA margin of 19%. Our assumptions remain to be confirmed as we do not have access to financial statements. According to the FT, net debt was $3bn, which would reduce the borrowing capacity to $4bn.
• Last, Cadbury balance sheet could handle $4-$5bn debt.

Consequently, we estimate total funding between $14bn and $17bn, while Kraft could afford a revised offer estimated close to $20bn. Matching a revised offer from Kraft would probably require the financial backing of a private equity firm.
In addition, the amount of synergies should be much lower than Kraft’s estimates, given the geographic exposure of both groups.

As a result, we feel that the likelihood of offering more than 860p is low.

Based on the current stock price and assuming that Kraft would raise its offer to 860p, Cadbury offers less than 10% upside potential. Based on the low end of our range (790p - US$1301), the stock looks fully priced.