With the aim to answer the questions outlined by the Advanced Financial Management lecturer from The University of West of Scotland, this report will look at the news-breaking story of Kraft taking over Cadbury at the end of January 2009. The history of both companies will be explored and also the rationale of the takeover from both companies points of view. The main body of the report will focus on facts regarding mergers and acquisitions and the affects they have on the shareholders wealth of each company. From these facts, a conclusion will be drawn on whether Kraft will be successful or unsuccessful in the takeover in terms of increasing shareholders' wealth.
The objectives this report plans to meet are, to show the background of both companies involved in the takeover, Kraft and Cadbury. Along with the profiles of the companies, the report aims to show the business rational from each companies point of view and information regarding what may happen to the shareholder wealth of both Cadbury and Kraft. Finally, the report will show a conclusion concerning the success or failure of Kraft increasing shareholder wealth.
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"Cadbury is one of the world's largest confectionery businesses with number one or number two positions in over 20 of the world's 50 biggest confectionery markets"(Cadburys).This description of worldwide company, Cadburys, emphasises how well known and successful the chocolate company is. After over a century of business, British company, Cadburys was taken over by the American company Kraft on 19th January 2010 for £11.5 billion(the economist). The company was listed in the FTSE 100.
Kraft, is listed in the Dow Jones Sustainability Index and the Ethibel Sustainability Index(Kraft). The company is the second largest food company in the world and sells their products in 150 countries.
This report will set out the prevailing views about the business rationale for the takeover and discuss the pro's and con's of the Kraft takeover of Cadbury and offer conclusions.
There has been a wide range of resources used to provide information for the report. Websites of both companies have been used, accounting websites have also been used, along with newspaper articles found on the internet. Journals and books were also used to find information on acquisitions.
In 1824, John Cadbury, founder of Cadburys opened a shop which sold liquid beverages such as tea, coffee and coca. It was not until 1874, when John went into business with his brother Benjamin, did the company Cadbury Brothers become known. With sales of £5,384 million, and a profit before tax of £400 million in 2008, the chocolate firm saw a 7% growth in their sales from 2007(Cadbury). Although Cadburys is specifically known for their chocolate, they also produce sweets and chewing gum (See Figure 1).
Kraft, was founded by James L Kraft, and initially introduced as a cheese business. By 1914, Kraft was producing his own cheese in Chicago. By 1924, Kraft had spread his business overseas to London. Kraft is now well known for cheese, coffee and chocolate. Before investing in Cadbury, Kraft had experience in chocolate, as it produced Terry's chocolate orange and all gold chocolates. Along with these, they also produce Toblerone, Daime bars and also Cote D'Or chocolate. In 2008, Kraft had recorded sales of $42,201 billion however this dropped dramatically in December 2009 to $40,386 billion (Yahoo finance).
Business Rationale (Prevailing Views)
The takeover of Cadbury has received controversial views to whether it was the ideal situation for Cadbury. The takeover also raises a level of uncertainty about the future of Cadbury. It has also left Britain with one less company which established and developed for many years in Britain. Although there is no guarantee that this takeover will be successful, the British companies may learn different techniques from the way in which Kraft will run Cadburys.
The main rationale of Kraft taking over a very successful company, is the possibility of increasing their profits and also paying a reasonable dividend to its investors, this is been made public with Kraft's chief executive, Irene Rosenfeld stating they will give: "outstanding returns to our shareholders". The value of sales when both companies are joined together are estimated at a remarkable $50 million(Reuters), with the chance of an increase in turnover, Kraft would see this as an opportunity for a reasonable deal as they would make over five times the value paid to buy Cadbury. Kraft will also have the expertise from managers who previously worked with Cadbury before the takeover, meaning Kraft will already have workers with previous knowledge of the chocolate company. Kraft believe the takeover will leave them as a:"global powerhouse in snacks"(Kraft foods), this is also more likely as Trevor Bond, who dealt with selling Cadbury products in Britain and Ireland, is now working for Kraft, promoting chocolates across various countries in Europe(Kraft foods). If Trevor Bond is successful in achieving this, Kraft will also increase the profits which are already being made in Europe. The chocolate sales in India alone are also anticipated to increase to 14.8% (food and drink insight). However, although Kraft are expecting to increase their turnover and expand their growth after the takeover, they now have £7 billion worth of debt to repay, which was used to takeover Cadbury (bbc news).
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There is concern for Britain loosing another British company, however, fifty percent of Cadburys was owned by a firm based in America(Rodger Carr, Financial Times)and by the second quarter in 2009 Cadbury, had been reporting an increase in sales by 4%(Cadbury). If the sales were increasing whilst there is a poor money climate, Cadbury must have had a specific reason for selling. Investors of Cadbury believe that whilst the management excelled at introducing new products and negotiating takeovers with other companies, they were not as skilled when it came to managing the everyday routine of the factories used in production (Jenny Wiggins, Financial Time). If the investors believe that the management of Cadburys has major faults, Kraft may resolve this problem and bring good management procedures to the company.
Watson and Head(2007, P.312)define a takeover as:"the acquisition of the one company's ordinary share capital by another company, financed by a cash payment, an issue of securities or a combination of both." When this happens, there is the chance of great success for the company but there is also the chance that the company will not succeed.
Accounting Treatment for Acquisition
Under IAS 22 section 19, the date in which the company was acquired, should be the date that the company acquiring the firm enters the money value outcome of the acquisition into their income statement. Any goodwill, including negative goodwill, received as a result of the acquisition, should be entered into the acquiring company's' balance sheet. Along with this, under IAS 22, companies are required to enter any assets and liabilities obtained from the company they are taking over.
The Failure of Acquisitions
One specific cause of mergers and acquisitions failing is the variety of workers in the companies involved(Geoff Gravil, ACCA). In the case of Kraft taking over Cadbury, the floor staff and management staff will be a mixture of American and British. Takeovers can also stumble into trouble when the company has paid more than what they can afford for the company they desire. When this is the case, the company needs to ensure they will generate an income high enough to repay the shareholders the contracted price. In this takeover of Cadbury, Kraft borrowed seven billion pound to buy Cadbury. With this level of borrowing and the promise of an additional bonus dividend after the takeover, there is now added pressure for Kraft to excel in their sale to recoup the money owed to the bank and also pay the expected dividends. There is also the concern for repaying other incidental costs relating to the takeover: "Companies involved...incur other costs too...public relations...advertisements." (Meeks and Meeks, 2001). Therefore Kraft will have to find a positive method which will increase their sales to make a profit large enough to repay all the additional costs before the debt increases, whilst still paying money to their own shareholders, Cadburys shareholders and the money owed to the bank.
When two companies become one and still aim to increase the investors value, greater than when both companies were separate, then the company is using a method known as synergy. There is Operating synergy and financial synergy, and financial syneregy. Operating synergy is where the company improves the way in which they manage and run the business to increase the capability of the company. Financial synergy is where the expected dividend for the shareholders is affected by the acquisition. This may be the reduction in capital and less risk of the company failing to repay their shareholders.
Affect on Shareholders
The shareholders must be paid their dividend from the company after acquisition, however the value of the dividend can vary due to the costs which have impacted from the takeover. If the takeover of Cadbury by Kraft is successful, there is a large chance of the shareholders wealth increasing, Meeks and Meeks state: "Target company shareholders typically experience large gains in wealth...(20-30 percent)" , however the shareholders could see a dramatic drop in their share values if it is not successful. This is not always the case with acquisitions, in a study based on UK acquisitions, carried out by Cooke, Gregory and Pearson, 1994(cited in Gregory, (1997), P. 974), eleven companies from a group of thirty-one did not increase their shareholder value, but instead reduced it, thus emphasising that not all acquisitions of UK companies are triumphant.
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Whilst this is the case for the shareholders of the acquired business, the shareholders of the company, in which is purchasing the company up for sale, find that there may not be any change in their return. This may lead to shareholders losing faith in the company and no longer wanting to invest, this could be a downfall for Kraft as increasing the investors rate of return would be as valuable as being the most common company in their particular FTSE, Donald DePamphillis(2005) states:"recent research suggests that gains in aggregate shareholder value are attributable more to the improved operating efficiency...than to increased market power". This would suggest that Kraft should look after their shareholders before they try and commandeer the market, however Dr Mike Hicks(ACCA, 2007)believes that both mergers and acquisitions:"destroy shareholder value". This would suggest that the acquisition of Cadbury may fail, as investment value is crucial when running a company.
Financial Times columnist Kate Burgess (2004, cited in Pike and Neale, 2009, P. 587), when American takeovers of UK companies are described as a:"graveyard for acquisitive UK companies, losing shareholders vast sums of money". Thus giving the impression that American companies struggle to repay dividends to their shareholders in Britain, this may be due to the different methods used in evaluating the financial growth of a company whilst considering investing in it. American investors tend to look at the way in which the company have already performed and use this information to decide whether to invest or not. This is not the case in the UK, as investors do not wholly rely on this information when they decide whether a company would be worth investing in. However, both companies do look at the way the company has performed after the acquisition has taken place. When looking at the method in which a company would use to purchase another company, Sudarsanam and Mahate(2003) state that there is:"significant value destruction in UK acquisitions." With negative attitudes to an American takeover of a British firm, begs the question that the British public have the faith needed for an American firm to run a British firm.
A successful takeover from America on a UK firm
In 1988, the British firm Rowntree was taken over by American firm, Nestle with a bid of £2.55 billion(management today). This takeover had a vast amount of criticism, from the British public, workers of Rowntree and politicians. There was the fear of job losses, Britain losing a company, and also investors not getting the correct return on their money. Twenty two years on, and Nestle are still producing the older Rowntree products and have also added new products to their market.
There is a mixed view as to whether acquisitions are successful, more specifically, there is a large view that American takeovers of British companies do not succeed and cause many losses to the shareholders. Many of these views range from the different workers and different management styles being introduced, to the level of money spent on the acquisition itself. The Kraft takeover is the prime example of a famous American company taking over a well loved British company. There have been many criticisms of the takeover, which almost mirrors the criticisms which were shown for Nestle takeover of Rowntree. If Cadbury do receive the increase of 20% in their wealth, Kraft have started on the right path, however the Kraft shareholders may not see the difference. There is just under a 50% chance that Kraft will fail, however, they need to ensure they have the correct strategy in place to ensure the increase in shareholder wealth. However, they do owe the bank £7billion and have the costs to repay which were incurred during the acquisition period. Kraft has moved a highly experienced Cadbury worker, from promoting the chocolate in Ireland, to promoting it in Britain and Europe. Also, with an increase in India of chocolate sales of 14.8%, Kraft could a see a rise in their profits. If the profits of Kraft increase, the shareholder value will increase and with the high profits of Kraft alone, the additional profit from Cadbury products, should cover the costs incurred in the acquisition. In light of this, like the Nestle and Cadbury takeover, Kraft should successful in increasing their shareholder wealth.
ACCA (2007) the people side of mergers and acquisitions [online]. Available: http://www.accaglobal.com/pubs/members/publications/sector_magazines/corporate_sector_review/archive/2007/62/people_side [22 March 2010]
ACCA (2010) Mergers and Acquisition - A Problem of Culture [online]. Available: http://www.accaglobal.com/students/student_accountant/archive/2000/4/32487 [8 March 2010]
BBC (2010) Kraft takeover of Cadbury: the terms [online]. Available: http://www.bbc.co.uk/blogs/thereporters/robertpeston/2010/01/kraft_takeover_of_cadbury_the.html [14 March 2010]