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Cadbury (CBRY)

Chocolate Heaven Could Be As Much As 979p

Ever since Cadbury demerged the drinks business, it has looked increasingly vulnerable to an offer.
That has now occurred with Kraft’s opening £10.2bn offer that Cadbury summarily rejected.

At the end of the day, it will only be a full and fair offer, appropriately discounting the future potential that
will result in Cadbury losing its independence. However, Kraft and its advisers mis-judged the situation
– the bear market is over as is the recession and Cadbury, shod of it drinks business, is starting to
demonstrate its growth potential. Consequently, any opportunistic offer needed to be pitched high
enough to look serious as well as discourage other potential predators. This offer does not!

This is basic and Kraft should be kicking their advisors across the City, if they had not strenuously made
those points. Kraft should not expect help from shareholders because they want the highest possible
price that fully discounts Cadbury’s future earnings potential. Now all Cadbury shareholders have to do
is, sit back and enjoy the prospect of a bidding war.

In any takeover situation, there are a limited number of options:

• Negotiate a price for agreement;
• Go hostile;
• A bidding war breaks out;
• Walk away.

Kraft needs to reacquire the initiative whether it goes hostile or not.

Kraft Negotiates
By negotiating, Kraft will pay a higher price but in the process keep the key personnel to successfully
merge the enlarged group’s operations and leverage opportunities. In the long term, probably a small
price to pay for securing the business.

Kraft Goes Hostile

Kraft, by going hostile, opens the doors to a bidding war because Cadbury know that it will only be the
offer value that prevents the group falling into their unwanted suitor’s arms. Therefore, in this situation,
Cadbury will seek out their preferred ‘white knight’, which could be Hershey because the groups have
co-operated in the past.

A Bidding War Breaks Out

This is the advisor’s ‘fee fest’ and all involved investment banks love it because during an auction
rational behaviour flies out the door. There are basically 3 phases to the irrational behaviour of an
auction:
1. Entrapment (i.e., Cadbury’s current value);
2. Win at all costs (or raising the Cadbury value closer to its discounted future value); and finally
3. Not to lose (or staying the course, no matter the eventual cost).
Cadbury may have already started this latter phase! The problem for the losers is that they expose
their weaknesses and as a result stimulate the next round of consolidation within their market segment.

Walk Away
This is the hardest option for any predator because it opens the business up to unintended deeper
scrutiny and leaves their group vulnerable to an unsolicited offer. It also makes management appear
weak.

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Already many hundreds of column inches have been written on the Kraft/Cadbury bid and the obvious
names have bubbled to the surface, such as Nestle, Hershey, etc but there are undoubtedly more.
Furthermore, like other commentators, we believe that it is now inevitable that Cadbury will lose its
independence unless the potential bidders are unwilling to offer a full and fair price. We have dusted
down a well tried and tested model and applied it to Cadbury. In arriving at our implied exit price, we
have assumed that any bidder will have the full support of their financial stakeholders, which suggests
an exit price of 979p or £13.3bn.

For now Cadbury shareholders should sit back, enjoy the battle develop but remain be ready to respond
to developments.

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