Thursday, 21 January 2010

Krafty cuts 2

A few random thoughts on the deal...

1. The real issue for me is, as always, ownership but I have a slightly different take on this than others. My problem is that no-one in the system really seems to be representing the interests of the ultimate owners. The management of both companies, as is well understood, are agents so we shouldn't be too surprised if Kraft's management wants to empire build. The Cadbury board is in the same agent position. They no doubt know the disastrous track record of much M&A, but they've got a good price, hence they can claim to be acting in the owners' interest in the short term.

Many of the fund managers likewise are saying that they would rather that Cadbury stayed independent but there's good money on the table. Again they probably expect the deal to have a lowish probability of really delivering, but in the short term the cash is there. The punters who sit behind the fund managers - ie the real owners - are nowhere involved, despite Unite's efforts. They might well think that the long-term success of both companies is more important (since their shares are probably held via a pension which will pay out for decades). And personally I would question if in future the firm-specific investments made by employees should hold more sway.

2. A simple point but a fundamental one - this deal probably won't deliver. Lots of studies demonstrate that many deals destroy rather than create value. Kraft shareholders may well lose out in the long-term just in these terms.

3. Lots of people will actually be on both sides of this deal. For example, UK pension funds typically invest the biggest chunk of their overseas equity exposure in the US. Many surely will hold both Kraft and Cadbury. This is a bit of a problem for those who play down concerns about the deal by arguing that it's a good deal for Cadbury shareholders, and it's Kraft shareholders' problem if they're overpaying. Actually it can be both for some investors. In this case the deal surely looks like a pretty stupid thing to back, especially given all the cash leaking away to various advisers.

4. And those fees... As I've argued before, I think any radical reform of the financial system must focus on fees. Because no-one is really acting in the ultimate owners' interest, no-one challenges all the money leaking out to advisers of various kinds - because it's not their money. According to one estimate £250m will have been peed away on fees in this deal. Yet oddly some people are more annoyed that RBS is involved (what do investment banks do?) than the amount. Again I think it's partly that we've just got used to deals costing a lot of money. But why doesn't someone try and exert pressure on the fees?

UPDATE - Andrew points out that Warren Buffett is still not impressed by the deal.


Andrew Curry said...

One Kraft shareholder who's pretty sure he's going to lose out is Warren Buffett, of course:

"Buffett's "new" argument is that, far from getting the advertised $3.7bn (£2.3bn) from the sale of its pizza business to NestlĂ©, Kraft will receive only $2.5bn – the taxman will consume the rest. And, given that this pizza business makes annual profits of $280m, Kraft is really selling at nine times earnings. That's a strange way to help fund the purchase of Cadbury at 13 times annual top-line earnings. Or, rather, 16 to 17 times earnings, reckons Buffett, once depreciation, restructuring costs and $390m of bid expenses are included. "It's hard to get rich that way," he concludes." (From today's Guardian City pages.

Tom Powdrill said...

cheers Andrew - will add a link at the bottom to Buffett's comments