Wednesday, January 6, 2010

Schroeder on Buffett's note to Kraft

For awhile I have been nail-biting over Kraft's proposed deal to buy Cadbury. Irene Rosenfeld, CEO of Kraft, is much-admired, but Kraft has problems. Middle-market brands have lost their edge, and consumers are increasingly disinclined to pay a premium for them in the middle of the Great Recession. Cadbury increasingly has positioned itself, or has been flattered in the media, as the unique, best, most important confectioner of all time -- the great white whale of chocolate. Buffett warned Rosenfeld not to overpay, and she said she would not let "animal spirits" take over. Then Kraft proposed a deal that would let it tweak the terms to issue an unspecified amount of stock. Cadbury responded to the higher price by saying "Despite this tinkering, the Kraft offer remains unchanged and derisory with less than half the consideration in cash." Buffett put his foot down this morning and said that Berkshire would vote its 9.4% of Cadbury shares against the deal unless the terms were changed. As a shareholder of both companies, I am REALLY grateful. Thanks, Warren. Okay, a few thoughts.

> Perhaps Cadbury's old slogan, "everyone's a fruit and nut case," explains why it thinks Kraft would fall for its demands for a higher price. To say the least, recent events have fanned Cadbury's high opinion of its business.With Nestle pulled out, and Hershey hovering in the background apparently as only a mirage, the lack of other suitors should signal that Kraft's bid is hardly "derisory."

> it is well-known that Buffett simply hates auctions. He often cites the winner's curse. He also has a penchant for secrecy and exclusivity, so this stance fits his personality. Still, as far as I know he's never participated in a banker-led auction unless you count something unconventional such as the race to save Long-Term Capital.

> Based on my fifteen years on Wall Street, the only winners in an auction are the bankers and the sellers (in that order). If it works out any other way, that is because the bankers screwed up. Their job, and this is explicit, is to raise the price more than enough to justify their own fat fees. Bankers flatter their clients by telling them that they are only getting the fair value for their oh-so-precious businesses, but the bankers' real job is to whip up a frenzy to psychologically manipulate the buyer into overpaying for what in fact may be a piece of junk.

> There are no soulmates in business. This is not like dating. Capital is fungible, and sooner or later, another opportunity will come along at a better price. The price you pay determines your return, period. Buffett made a lot of money by understanding that. There is never any need to do any particular deal. Yeah, yeah, you guys know this already but it bears repeating.

> Is Cadbury really that special? (After all, it recently tried to pass off products made with palm oil instead of cocoa butter as chocolate until forced to stop by complaints from consumers. Cadbury apologized.)

> Buffett left himself open to a different bid with more reasonable terms. I think he fundamentally trusts Irene Rosenfeld and likes Cadbury. He just doesn't like the price and is frustrated that is remarks in private weren't listened to. It's certainly unusual for him to take a public position like this, but it's not as shocking as it seems. He's been criticized in the past for being too passive, and he doesn't like criticism. (Always keep in mind that everything Buffett does -- everything -- contains an element of reputation management.)

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