Tuesday, January 5, 2010

Berkshire on Kraft Bid

From today's Berkshire Hathaway News Release on the Kraft bid for Cadbury:

Berkshire Hathaway has voted "no" on Kraft's proposal to authorize the issuance of up to 370 million shares to facilitate the acquisition of Cadbury.

...The share-issuance proposal, if enacted, will give Kraft a blank check allowing it to change its offer to Cadbury – in any way it wishes – from the transaction presented to shareholders in the proxy statement. And we worry very much that, indeed, there will be an additional change from the revision announced this morning.

To state the matter simply, a shareholder voting "yes" today is authorizing a huge transaction without knowing its cost or the means of payment.

What we know with certainty, however, is that Kraft stock, at its current price of $27, is a very expensive "currency" to be used in an acquisition. In 2007, in fact, Kraft spent $3.6 billion to repurchase shares at about $33 per share, presumably because the directors and management thought the shares to be worth more.

Does the board now believe those purchases were a mistake and that Kraft's true value is only the current price of $27 per share – and that it is therefore fine to structure a major acquisition based upon that price? Would the directors use stock as merger currency if the price were, say, $20 per share? Surely the true business value of what is given is as important as the true business value of what is received when an acquisition is being evaluated. We hope all shareholders will use this yardstick in deciding how to vote.

Our understanding is that Kraft must announce its final offer for Cadbury by January 19th. If we conclude at that point that the offer does not destroy value for Kraft shareholders, we will change our vote to "yes."


Management teams (and directors) at the acquiring company do this all too often. An undervalued currency (in this case Kraft's stock) ends up being used to buy an asset for "strategic reasons". As the battle unfolds to capture that asset the "animal spirits" kick in and before you know it the management team overpays.

Buffett is attempting to keep this process in check. Asserting some influence to avoid potential destruction of Kraft shareholder value by overpaying with a temporarily weakened "currency".

He obviously knows the game well.

If the transaction goes through at current prices, use of that undervalued stock to buy Cadbury functions as a wealth transfer from Kraft to Cadbury shareholders.

Adam

Long Berkshire Hathaway and Kraft

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