Harvard Business School 9-289-045 Philip Morris Companies and Kraft, Inc. John M. Richman, the chairman and chief exceutive oMoer of Kraft, In, concluded is ‘October 23, 1888, later to shareholders as follows: We deoply rogret the dislocation and hardships that the [restructuringl plan we contemplate wil cause, and we will seek to ameliorate these bardships as much as possible. We know that our shareholders, employees, customers, supplies and ome recognize that today's situation isnot of our making. Rather I is the product of eurrent era investment policies and firancial attitudes that favor short term finantal gatiicaton over steady, long-term growth and the need to provide a ‘sound economy fr future generations. 1 will take several years, but with the history and traditions dedication of Kraft people, we are confident that we will ebuild Ke occupies today. “The leter announced a radical restructuring of Kraft in response to a hostile tender offer by Philip Morris Companies: $90 per share in cash forall of Kraft’ outstanding common stock. The olfer had been announced jus five days erie, on Octobe 18,198, Kraft, ne. In 1987, Kraft vas known for such brand names ax Miracle Whip, Seven Seas, and Kraft salad dressings: Kraft mayonnaise; Velveeta cheese; Parkay and Chiffon margarines; Lenders Bagels, and [Breyers ie cream. Net sales from continuing operations were $8. bili in 187, an increase of 27% ‘ver 1986, Net income from continuing operations rose 1%, ¢o $435 milion. Exhibit 1 presents ‘operating and stockholder information for Kraft from 1982 though 1987. Exhibit presents balance ‘Sheet information for 1986 and 187 Kraft’ strategy was focused on food, ts 1997 annual report state: ‘The food industy offers such diverse and rewarding opportunites that we ‘see no purpose in running te risk of élluting our efforts or our focus with other lines of busines. ‘This afood strategy was in sharp contrast to is earlier diversification program. Most of the diversification occurred when Me. Rican engineered the September 1980" merger between Kraft “Thess war prpard by Profer Ricard 5. Roach rte Basso ass dcusion rate han ate ar cient andi of a edna susan, Copyright © 989 bythe President and Fellows of icv Calley. To ards copies or rut persion to ‘epodce material all 00545-1695, write Harvard Busnes Schaal Publishing, Boron, MA DES, or got Intp//wore hsp harvaredu No pat of ths publaion may be reproduce, stored in a erieva syste ‘sed in'a spreadsheet. © tansmited in any form oF by any meang-elecrnic, mechanical Photocopying, ‘cording or oerse —wlhau! he persion of Harvard Busia Schoolm0 Pop orn Companies na Kee and Deft Industrls, a $2.4 bilion consumer products manufacturer. Me. Richman, who had been ‘Promoted to chairman and CEO less than 1 year before the merger, noted that the merger brought versifleation in one fell swoop to Kraft" Dart's products Included Tupperware containers Dur ates, acd Wes Berd appliances. The merger was acomplia by exchanging one shave of Ue sumsyed conan, Dat & Keaf, for each outstanding stave of the two preniting ompanies. Dart & Kraft was the twenty-seven largest company in de United Sates atthe ime of the merger. Six months Tater, in March 1881, Dare & Katt acquired for $460 milion Hobart Corporation, the manufacturer of KitchenAid and other food-related equipment Richman reversed direction and began pursuing the all-fod strategy in 1988. Keat spun off most of te nonfocd businesses acquired inthe Dart & Kraft merger ito Premark Intemational, Ine. ‘on October 3, 1986 Each shareholder of Dare & Kraft recived one share of Kraft common stock and fa quarter share of Premark. Kraft, with sales of about $09 billion after the spin-off, retained food businesses and Duracell bateses. Premark’s share of Dart & Kraft included Tupperware and Hobart, {ood service equipment with combined sles of $1.8 billion * Keaft sold it lst nonfood asset, Duracell to Kohlberg, Kravis, Roberts & Co, a leveraged buyout firm, fr $1.8 blion in une 1988 According to Krafts 1987 annual repor, the proceeds ofthe sale were to be used to repurchase shares and to repay debt obligations. In October of 1987, Kraft Suthorizad the repurchase of 10 milion shares, and 6 milion were repurchased under the authorization by years end In 1987, Kraft was organized into three business segments: US, Consumer Food, US. Commercial Food, and international Food. In 1987, U.S. Consumer Food had sales of $5 billion and {an operating profit of $388 milion, US. Commercial Food, which included Krat Foodservice, the Stcond largest US. food service distributor, had sales of $2 bill and an operating profit of $86.4 mln, International Food had sale of $2.3 billion and an operating profit of $228.8 milion, Exhibit ‘presents ainanchal summary of Kraft by Business segmens ‘The Philip Morris $90-a-Share Tender Offer (On the evening of October 18,198, Philp Mores fered to purchase all Kraft common stock ‘at $90 per share In cash. The offer represented’ 80% premium over the $60.15 closing price on (October 18. At $11 bilion in total value the bi, If successful, would have been the Second largest, acquisition ever completed, exceeded only by Chevron Corporation's $123 bilionacquistion of Cul (il Corporation in 1984 ‘Mes Philip Morris sles and profits came from its Marlboro, Benson & Hedges, and Virginia Sims cigarettes. The company’s tobacco sles Increased by 15%, t0 $14.8 bilon in 1987, Philip Morris increased its domestic share ofthe cigarette market o 385 in 1887, rom 37% in 1986, and 1967 operating profs were $3: billon. Neverteles, consumption of cigarettes in the United States had ben decinng from it 1981 peak of 640 billion eigaretes, Estimated US. consumption for 1988 was 583 billion cigarettes, Increases in expors offset the decline in US, consumption, as new markets, ‘were entered, especially Japan and Talwan. Overall cigarette exports were predicted Io increase by 159%, (015 billion eigaretes in 1988, Pit Moris had been pursuing a strategy of diversifying out ofthe tobaceo business since 1969, when it acquired 59% of the Miler Brewing Company's common sheres, the remainder of ‘which acquired in 1970, With brands ike Miller, Lite, and Matilde Bay Wine Coolers, the brewing "wind ad been sold ebruary 198 for $150 mon 2st had 119,285,188 shares oustanding and ousanaing employee stock optons on 2:36.58 shares. The total numer of Kraft shares pureed under te offer ra therefore 121,68 983.Phu Mota Companis and Kat me mooes ‘ivision generated sales of $3. ilion in 1987, Philip Moris also purchased Seven-Up in May 1878, for $520 milion. It largest fod arquistion by far was General Foods which Philip Morris purchased fn 1985 for $56 billion. Like Kraft. General Foods was based on brand-name products such as “Masovell House coffe, Birds Eye frozen foods, JllO, Oscar Mayer meats, Ronzoni pasta, and Past, cereals It had 1987 sales of $10 blion. Philp Mori's aequisiors had mixed results. See Exhibi 4 for operating and stockholder {information from 1962 though 1917. Exhibie 5 presets balance shet information fr 1986 and 1987 Exhibie 6 presents the coneolidned changes in financial positon, and EXC T reports neo. busines informatio, Philip Morris sold its Seven-Up operations In 198 for about book value after $50 milion \wrte-of in 1985. General Fod's operating profit declined from $624 millon in 1886 ¢o $605 malion in 1987, ‘The 1987 operating proMt represented 9.9% return on Philip Morris's $65 ‘lion Investment in the food industry, incuding adcitone) postacqulston investments of $888 malion Speculation was that Philip Morris might use Krafts management eam to revitalize General Foods, which had been without a chief execative officer since July 1988, when Philip L. Smith lef to become chairman of Pillsbury Smith, a 22-year veteran of General Foods, had Been president and chief ‘operating oMicer before ts merger with Philp Moris. ‘The sequiston of Kraft would have made Philp Morris the world's largest food company. and it would have been a major tp inthe Rirms's strategy ofrecing i's dependence on tobacco and ‘moving into the food business As Hamish Maxwell, the chaman and CEO of Philip Mori, said in his October 21 1988, eter o Join Richman. Our goal Is to have Kaft combine with Philip Moris to create the leading {international food company... Out intention i to Keep Kraf's present businesses {ntact and forthe compary tbe managed by Kraft executive, using your present headquarters and facies [Exhibit 8 contains excerpts from the Iter between the two companies droughout the takeover Philp Moris proposed ta finance the acquisition with $1.5 bllon In excess cash and its available bank credit Une of up to$12 bien, Kraft's Response (On October 2, 1988, Krafts board of eectore rejected the Philip Morris bi ‘We strongly believe the $90 bid. undervalues Kraft, for these important reasons fst, afer careful analysis, our investment banker, Goldman Sachs & Co. has advised us thatthe bid is inadequate, and second, our stock has been trading above ‘he S00 offer a lea signal that investors ce th Bd a ow Kraft's response occurred when the fod industry was undergoing a major restructuring and ‘evaluation. Grand Metropolitan PLC began a hostile tender offer for Pillsbury on October 4, 1988. Grand Met was a diversified Briish company that brewed and distributed becr. ae, and lager produced and dlstrbuted alechalc beverages; and ovned and operated pubs and restaurants Pillsbury vas a diversified food and restaurant company, with popular brands such as PUlsbury the combination azo would have ineeaad leverage with gracery stores and advertisers In 1987 Philp Morris pent $15 bili and Kal St lion on averting 3