Kraft's Acquisition of Cadbury – A Financial and Ethical Highlight

LLM 865
Introduction 3
.
1. The Underlying Facts 3

1.1 History and the nature of the transaction 3

1.2 The Acquirer and the Target's Points of View 4

2 The Moral Dilemmas Post Acquisition 5

Conclusion 6

Appendix 8

References 10

2
Introduction

In its March 30th 2010 report pertaining Kraft Foods Inc.'s acquisition of Cadbury Plc., the House
of Commons – Business, Analysis and Innovation Committee concluded that "the Kraft takeover
of Cadbury has been marred particularly by controversy […] and has heightened the feelings of
mistrust in which Kraft is held. Kraft now faces a significant challenge to restore its reputation in
the United Kingdom". On the other hand, Marc Firestone executive vice-president of Kraft in his
reply to the committee's concerns regarding its ethical and moral obligation towards Cadbury
stakeholders stated that "we are committed to maintaining Cadbury's traditions and, more
importantly, to carrying those in the future in a way that is to the benefit of our colleagues, to the
scientists, to the employees and the management". In light of the mentioned acquisition, the
dichotomy between both statements is intriguing and raises questions about the financial as well
as moral obligations the acquirer has towards the target firm.

The short paper below tackles the acquisition of Cadbury Plc. (the target) by Kraft Foods Inc.
(the acquirer) from the financial and ethical angles. In the first part, we highlight the history of
both companies, the timeline of the hostile take-over and the key drivers behind the transaction,
whereas in part two we discuss the actual performance of Kraft post acquisition from a financial
and moral angle. Finally, we conclude by addressing the Committee's ethical concerns in context
of the acquisition of Cadbury.

2. The Underlying Facts:

1.1 History and the nature of the transaction:

In its 10K form filed with the SEC for the fiscal year ended 31 December 2010, Kraft Foods
states that it is the world's second largest food company with revenue amounting to USD 49.2
billion and EBT (earnings before tax) amounting to USD 3.6 billion. Incorporated in the
Commonwealth of Virginia, the Company disclosed employing over 127,000 employees, selling
products in 170 countries and having around 223 production facilities worldwide. As of the
period ended 31 December 2010, the company had six consumer sectors (biscuits, confectionary,
beverages, cheese, grocery, and convenient meals).

On the other hand, in its 10 – K form, Cadbury Plc. stated that the company and its subsidiaries,
i.e. the Group, are an international confectionary company with over 200 years of experience in
the industry. Local brands include but are not limited to Trident, Halls, and Cadbury. The group
had operations in Europe, North and South America, Africa, the Far and the Middle East. The
company has adopted a growth and expansion model especially in Europe and emerging markets
(Cadbury, 2011). For instance in its 2009 annual reports, the company declared 11% growth in
revenue in the Middle East segment relative to the comparative year.

According to Feltman (2010), in September 2009, Kraft approached Cadbury with an offer of
745 pence per share; it then filed the required form (8 –K) to notify its shareholders and the SEC

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of its intentions. As a result, Sir Roger Carr, the Chairman of Cadbury assembled an advisory
team to fight the hostile takeover. He stated that the offer was "unattractive" and urged
shareholders to reject it. Deborah Cadbury (2011) recounts the strategy meeting held by key
executives by asserting that "the plan to bring Cadbury into Kraft's low-growth conglomerate
business was an unappealing and unattractive prospect. The offer did not reflect Cadbury's value
or its growth prospects compared to Kraft's less focused business mix and historically lower
growth." In a hostile response, Irene Rosenfeld took her offer directly to the shareholders. As
such, since around 31% of the company's shares were held with hedge funds and other
arbitrageurs, who were looking to maximizing their short term profits, the company's fate was
directly tied to the decisions of such institutional investors (Cadbury 2011, and Moeller,
Financial times 2012). According to the ACCA journal published in 2015, to fend of the hostile
takeover Cadbury was incurring around £2 million a day in advertising campaigns. These
expenses were eroding the company's bottom line, but were necessary if the firm wanted to
survive this takeover. Furthermore, as a result of the rapid change of ownership in Cadbury's
structure, the company asked the UK Panel on Takeovers to give Kraft an ultimatum regarding
drafting an official offer for the acquisition of Cadbury which is known as "put up or shut up".
As a defense tactic to stabilize the company's share price and ownership, its CEO Todd Stitzer
"declared on December 14, 2009 an improvement in sales targets with prospects of 5% annual
growth and double digit dividends" (Cadbury, 2011). On January 18 2010, Irene's final offer
consisted of £8.4 and 10 pence in dividends. On that day, the board of directors of Cadbury
unanimously recommended that the shareholders accept the offer. When the transaction was
secured and in response to the Kraft PR team wanting to take a picture to commemorate the deal,
Carr interjected by saying "I said no because I had never changed my position that I did not want
to sell the business to Kraft. So why do I want to sit there having a glass of champagne on an
outcome that on any other reason than value I would have preferred not to happen?
(Cadbury, 2011)"

1.2 The Acquirer and the Target's Points of View:

There is no doubt that to every major strategic decision there are reasons which have been
weighed by management on a cost versus benefit level against other alternatives. According to
Irene Rosenfeld "acquiring Cadbury is a significant milestone in the history of Kraft foods. The
combination of a more extensive snacking portfolio, together with an expanded global footprint
and greater penetration of grocery and instant consumption outlets, creates opportunities that will
truly set this company apart from its peers." Available data state that Kraft hoped to acquire the
brand name and customer base established by Cadbury in emerging markets such as China,
India, Venezuela, among others. In addition, the acquisition allowed Kraft to benefit from
economies of scale and diversification of product and risk. Rene is often quoted saying "what I
am arguing for is about scale as an effectiveness play, and I come back to the reality that man
cannot live by one product category alone." For instance, table 1 (refer to appendix) shows that
the segment "Kraft Foods Developing Markets" amounted to 17.10% , 23.5% and 26.9% of the

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total operating income of the company for the three years 2009, 2010, and 2011 respectively. In
assumption that no major financial, strategic, and accounting changes or treatments have taken
place during the three year period, we can generally draw the conclusion that the acquisition
although not solely had a positive correlation with the increase in emerging market segment
contribution to the total operating income of the company for the years post the acquisition. In
addition, the deal resulted in acquired assets mainly inventory, property, plant and equipment,
receivables and inventories, as well as liabilities and good will and non-controlling interests. For
example, in figure 2 we note that the value of the acquired items is, USD million 12,905 in
intangible assets, USD million 9,530 in goodwill, and USD million 9530 in property, plant and
equipment. The company also acquired the target's liabilities, mainly deferred income tax and
long term debt each amounting to USD 3,218 million and USD 2,437 million. Further financial
figures obtained from the audited financial statements show that "Net revenues increased by
USD 5,158 million (10.5%) to USD 54,365 million in 2011". As such The Cadbury acquisition,
due to the incremental January 2011 operating results, added USD 697 million in net revenues
(K-10 Form, 2010).

In addition, in the House of Commons – Business, Analysis and Innovation Committee report
raised in March 2010, the committee noted that Cadbury had excellent research and development
capabilities in the UK and other countries, mainly through the university and research center in
Reading. In response to the inquisition by the committee, Kraft's vice president said "we are
committed to it—Reading is something we see fitting very well. They do terrific research there;
they have a very energetic, enthusiastic group of people doing all sorts of great work on
chocolate and other products which services the worldwide chocolate business for both
companies."

On the other hand, the company acquired huge debt to fund the acquisition. The note pertaining
borrowing and long term debt in the audited financial statements filed under 10 – K form states
that the company acquired a bridge facility amounting to £ 807 million. This facility was later
settled during the fiscal year ended 31 December 2010. Retrospectively, Moeller (2012) in his
article in the financial times states that the acquisition was the final deal that allowed Kraft to
restructure and concentrate into two companies, groceries businesses of USD 16 million in value
and a snack market segment with a value of USD 32 billion. This vision allowed the firm to
reorganize its operations, better identify, target produce and market products to each line of
business as Cadbury-Kraft combined created a "global powerhouse” with worldwide sales of £37
billion, over $50 billion (Cadbury, 2011).

2 The Moral Dilemmas Post Acquisition

In the report raised by The House of Commons – Business, Analysis and Innovation Committee,
the main loss of faith in Kraft's management arose with the closing down of the Somerdale
production factory in the UK. Prior to approval of the deal, Rosenfeld declared that the facility
shall remain open post acquisition. One week after the acquisition, the facility was closed down

5
with a loss of around 500 jobs. When confronted by the committee and the Unite the Union,
management explained that the operation of the Somerdale facility had no economic reasoning.
From the target firm's stakeholders' point of view "the cynical ploy" resulted in a sense of
uncertainty. When answering the committee, Feltman explained that when they planned the
acquisition, they assessed and envisioned that the manufacturing networks of Cadbury be easily
integrate into theirs. Yet, they did not know that Cadbury while moving its production facilities
to Poland was doing parallel production, meaning that both facilities, the one being built in
Poland and the one in UK were already functioning at the same time. When questioned about
their due diligence and management's shortcoming in assessing the real scale of Cadbury's
operations, Feltman assured the committee that they had Googled the site, obtained satellite
images, but the exact infrastructure of the facility was a secret to the public. Feltman asserts that
"when we envisioned the combined manufacturing network of Kraft and Cadbury, we believed
that we would be in a position to maintain production in Somerdale in the UK while also taking
advantage of the new facilities that we did know Cadbury was building in Skarbimierz in Poland.
[…] Our capacity requirements were growing tremendously. During exactly the same time as
our bid all of these tens of millions of dollars of new specific to products such as Curly Wurly
and others were going into the factories in Poland. No amount of resources would have given us
access to a physically secured site that was operating in a confidential manner." Nevertheless, the
committee concluded by stating that by closing the Somerdale facility after making promises to
keep it open Kraft acted irresponsibly and unwisely. Similarly, a company the size of Kraft and
with a long history in the industry did not act in the pretense of sound business judgment when it
came to the disclosure. "What is clear is that Kraft's actions in respect of Somerdale has
undoubtedly damaged its reputation in the United Kingdom and has soured its relationship with
Cadbury employees. It will now have to invest significant time and effort into restoring both"
(House of Commons, 2010).

Another moral aspect raised by the committee was the commitment of Kraft to maintain
Cadbury's philanthropic corporate social responsibility. The report asserts that Cadbury's
perspective on giving back to society is reflected in adopting a Fairtrade policy for dairy milk
and cacao suppliers. When products are registered as Fairtrade, this aims to support and enhance
trading with marginalized producers, and seek "equity between international traders". Feltman
argued that management is committed to retaining the Fairtrade products which Cadbury built. In
response, he interjected by stating that Kraft as well had its own commitment to CSR. The group
had aligned its objectives with the Rainforest Alliance. The committee pointed out the difference
in culture and the philosophy of philanthropy by stating that Cadbury's commitment to Fairtrade
had increased the products sale price by 25% in the country. As such it moved CSR from sideline
or marginal goals, to the center of its decision making process, whereas Kraft's CSR philosophy
does not try to encourage sustainable markets.

6
Conclusion

Throughout the paper we discussed the history of Cadbury and Kraft, the mechanisms of the
takeover as well as the financial aspect of the transaction. We noted that from a financial aspect
Kraft had sound financial reasoning in acquiring the UK giant, but certain errors in planning the
transactions had resulted in ethical questions that had to be scrutinized under the Committee
Business, Analysis and Innovation to preserve the rights of other stakeholders.

In final remarks we are drawn to Sir Roger Carr's final words when reflecting on the acquisition
"an overhaul of the city code needs to take place to ensure that there is parity between predator
companies and prey. What we don't want is a situation where one party has an unfair advantage
over the other." In addition, in retrospect, we conclude our paper with a food for thought
provided by Lord Mandelson stating "in the case of Cadbury and Kraft, it is hard to ignore the
fact that the fate of a Company with a long history and many tens of thousands of employees was
decided by people who had not owned the company a few weeks earlier, and probably had no
intention of owning it a few weeks later" (House of Commons, 2010).

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Appendix

Fig 2 – The Company's February 2, 2010, Cadbury acquisition was valued at $18,547 million, or
$17,503 million net of cash and cash equivalents. As part of that acquisition, it acquired the
following assets and assumed the following liabilities (in millions):

Receivables 1,333
Inventories 1,298
Other current assets 660
Property, plant and equipment 3,293
Goodwill 9,530
Intangible assets 12,905
Other assets 593
Short-term borrowings (1,206)
Accounts payable (1,605)
Other current liabilities (1,866)
Long-term debt (2,437)
Deferred income taxes (3,218)
Accrued pension costs (817)
Other liabilities (927)
Noncontrolling interest (33)

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Fig 3 - Net revenues increased $5,158 million (10.5%) to $54,365 million in 2011, and organic
net revenues (1) increased $3,170 million (6.6%) to $51,533 million as follows:

Change in net revenues (by percentage point)

Higher net pricing 6 pp
Favorable volume/mix 0.6 pp

Total change in organic net revenues 6.60%

Favorable foreign currency 2.4 pp
Impact of the Cadbury acquisition 1.4 pp
Impact of accounting calendar changes 1.4 pp
Impact of divestitures (1.3) pp

Total change in net revenues 10.50%

Figures obtained are copied from the 10 – K form filed by Kraft in the SEC database for the
years ended 31 December 2010, 2011, and 2012.

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