Philip Morris Companies and Kraft, Inc

Case #1 - Philip Morris Companies and Kraft, Inc

Submitted by Ishita Thukral

1. Why is Kraft a takeover target?

The stock price index for Kraft was at 397.3 which was above Food index of 387.4. Moreover, the return on equity for Kraft was 23%, which was almost double the Food index ROE of 12%. It is clear through this data that Kraft was performing well in the food industry and was way above the S&P 500 index average. It had re-established itself as a food industry company and had $9.9B in sales and $ 0.4B in profits in 1987, which was a significant increase from 1986.  Pre- bid sales and profit forecasts of Kraft showed that the company was going to increase its sales from $9.9B to $11.2B, and its net income from $0.4B to $1.2B from year 1987 to 1988. Its price-earnings ratio was at 13 in 1987.Kraft was successfully operating in 3 business segments now.

2. Should Philip Morris buy Kraft?

Philip Morris was strategizing to diversify out of tobacco business since 1969. It had acquired Miller Brewing company in 1969, seven up in 1978 and General Foods in 1985.General Foods was the largest acquisition for $5.6B. However, there was a decline in General Foods profit from $624M in 1986 to $605M in 1987 and Philip Morris could garner 9.3% ROI though operating profit in food industry.

With the acquisition of Kraft, Philip Morris would become the world’s largest food company. This step would enable to it to diversify, not limit itself to tobacco industry and reduce its dependence on tobacco. Through this consolidation, Philip Morris will be able to be competitive in the food industry in US.  Further, Philip Morris would use Kraft’s management team to revive General Foods whose CEO had left office for Pillsbury. Other benefits of the acquisition would be increase in tax shield and transference of wealth from bond to shareholders. Kraft’s acquisition will help Philip Morris to access products such as Seven Seas, Miracle Whip, margarines. Moreover, as per data it would also help Philip Morris reduce chance of wealth expropriation. Although Philip Morris would be paying a premium, it should acquire Kraft.(firm is doing fine still why restructuring)

3. Does the market think this offer is good for Philip-Morris?

The market doesn’t really respond well to Philip Morris’s announcement of Kraft acquisition, since on the day of the announcement, the share price for Philip Morris plunges by $4.5 per share. Also, it is to be noted that the market must have analysed previous acquisitions by Philip Morris which posed mixed results. Philip had to sell its Seven up operations in 1986 after a write off of $50M in 1985.Moreover, the product lines of the two companies- General Foods and Kraft - are different so the market may have been sceptical of synergies.

4. Does the market think this offer is good for Kraft shareholders? Why?

The market did not think that this is a good offer for Kraft since Kraft’s share price was trading above $90 bid and the investors though that the bid was low. On the other hand, the market responded to Kraft’s restructuring plan announcement wherein the share price increases by $10 to $ 102, which was lower than Kraft’s evaluation of share price of $110. Hence the market believed that restructuring was not worth $110.Clearly Kraft was in a better position as a profitable company to negotiate terms with Philip Morris. So, Kraft management was right in announcing plans of restructuring. At the same time, it was open to negotiations if Philip Morris offered a better price. The market analysts thought that the restructuring plan would provide greater shareholder value at $102 per share than Philip Morris bid of $90 per share. This entire scenario also increased chances of another potential buyer entering the space for acquisition.(the tobacco industry is in danger from federal regulators,congress wants to ttake away wealth from tobacco comp and use it for health and medical care.so the tobacco companies devised this strategy of buying consumer product companies. So its harder for federal  to take away wealth if its in the form ofoperating assets. Also you gain political power if you spreadacross US through diversifying.you can then influence congressmen.