Merger Bids by Kraft and Changes in Price on Key Dates

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Table of Contents

General Overview of the Problem
Analysis of Stock Returns to Bidding
Analysis of Target Company during a Merger Bid
Explaining Possible Reasons for Changes in Prices
Conclusion
Bibliography
Footnotes

General Overview of the Problem

In February, 2010, the world witnessed a significant merger of two leading confectionary companies – Kraft Foods in the United States and Cadbury, a famous British company. The merger perceived a mixed reaction and disapproval from the British government. Nevertheless, Cadbury and Kraft Food has gained much more beneficial positions in the world due to the takeover. Having accepted a £ 11.9 from Kraft Foods, the company has gained a great competitive advantage at the international market¹.

The point is that the bid is about 9 % higher than the previously established by Kraft, which is considered as a kind of a victory of Cadbury shareholders so that Kraft investors appeared to be the most advantageous variant for the British confectionary company. The increase in bid can be considered as a reaction to completion on the part of other well-known and respectable companies that were just about to prepare a rival bid. Arising from these financial and business operations, the change in prices during a merger bid can be explained by several reasons. On the one hand, Kraft’s offer could be triggered either decline in stock returns².

On the other hand, Kraft investors selected a specific corporate approach while offering a lower price. In order to find out the actual reasons, it is necessary to analyze the basic theoretical frameworks and corporate finance strategies implemented by the bidding company and the target company.

Analysis of Stock Returns to Bidding

Theoretical viewing the problem, it should be stressed that corporate performance of large companies largely depends on their sustainability as well as stock returns. In this respect, Stern and Chew believe that “…the market value of corporate stock – like the value of a bond or any other investment – is the present value of a company future expected after-tax cash flows…”³. Interpreting this, reported earning can be considered a measurement tool for evaluating the main concepts of finance marketing. Relying on the importance of value and profitability, the stock return of Kraft Food has been significantly increased after the takeover and, therefore, it can be regard as on of the main reasons for carrying out this operation.

While analyzing the connection between stock returns and bidding process in more detail, particularly the decision of Kraft managers to lower the bid price after the initial offer, one should discuss the concept of aftermarket strategies and phenomenon of underpricing⁴. The fact is that the mean underpricing often exceeds 15 % in most cases and this decline is often explain by the investors’ attempt to receive more returns. However, if investors offer a market-clearing price, their returns are, apparently, below the normal level. So, in case the initial order is rejected, the next bid will be much lower because investors strive to compensate their losses.

Stock price fluctuations also depend on the speculative demand where “momentum induces a myopic but active strategy of buying winners/selling losers, in which the momentum parameter of the stock price dynamic nearly appears”⁵. The demand is also significantly influenced by performance return rates that can be either above or below the expected return. In this respect, the momentum makes the demand negative through the boost of the distant-future stock prices volatility.

Regarding the Kraft Food and Cadbury merger, the target company has much more benefits in terms of increasing momentum that will further help the company to foster and ameliorate the ability to deliver much more attractive returns. Kraft position is quite beneficial as well, because the merger transaction will help the company to conquer the premium positions in emerging markets.

Long-term and short-term performance studies differ significantly in terms of stock returns connected to merger announcement dates. In particular, empirical studies conducted by Clayman, Fridson, and Troughton suggest that the target company can significantly prosper from the merger transaction because they create value, though in the short run⁶. They believe that about 30 5 premiums over the share’s pre-announcement price, and about 2 % percents are marked by the acquirer’s stock price falls⁷.

What is more interesting is that both the target company and the bidding one are more likely to experience higher stock returns. In general, returns gained by the target shareholders are traditionally measured by the control premium that is identical to the price paid for the target firm in excess of it actual value. In its return, the acquirer returns are identical to the value of any interactions initiated by the merger transaction minus the premium paid to target firm.

Analysis of Target Company during a Merger Bid

While analyzing the position taken by Cadbury, the target company, a particular emphasis should be placed on the merger bid process, a hostile takeover bid, and takeover defense strategies chosen. On the one hand, Cadbury’s position is quite effective and rational, but a bit risky. In particular, the company’s fear to be underestimated explains the initial bid rejection, but such risky decision and desire to receive higher price can be really a disastrous combination

According to Bender and Ward, “successful corporate raiders do not often get involved in changing the business strategies of the companies they buy, buy they do alter their financial strategies; normally or dramatically increasing the financial risk profile by raising the debt to equity ratio”⁸. It is understandable that financial risk directly relates to the maturity of the company that is also less influenced by the external factors. Consequently, shareholding companies should adhere to a low-risk business strategy to avoid the risk of a hostile bid and a hostile takeover.

In addition, due to the fact that company is often owned by shareholders, there is often a conflict between shareholders and an executive power preventing the achievement of company’s specific goals. In this respect, the shareholder value can be perceived as the company’s target⁹. In addition, even if the possibility of a takeover is insignificant, risk managers should be ready to react when a hostile takeover bid will be presented.

Evaluating the takeover market in the UK, it should be pointed out that the merger waves have acquired a much more intense nature. Approximately 25 % of all takeovers were hostiles in the 80s of the past century. Interestingly, the cases show that hostile character has been more typical of takeovers that were rejected initially¹⁰. Stern and Chew has also found that a number of financial variable including dividends, stock returns, and cash flow rates, the performance of the target companies of hostile bides prior to a bid was not significantly differed from that of examples of either non-merging companies or accepted ones. In this respect, share performance, but not hostility of bids significantly influences the overall company’s reputations and revenues. In contrast, companies with a low level of performance significantly reduced their dividends prior to a bid.

Explaining Possible Reasons for Changes in Prices

It is obvious that cash bidding, but not stock bidding, was chosen by Kraft to avoid stock undervaluation that followed a tender offer. It also partially explains why the second offer was relatively lower that the initial proposition. Another explanation of cash flow lied in greater efficiency and higher probability of success in tenders¹¹. Nevertheless, the above-presented assumptions do not fully disclose the reason for price fluctuations, but just create pre-conditions for developing hypotheses concerning possible underpinning for changes in prices on the merger announcement days. A possible reason for price shifts can be connected with Kraft’s desire to make Cadbury’s shares rise in value and create a great competitive advantage. Leaving the rivals behind, Kraft has considerably contributed to the value of its shares.

Price changes can be clearly explained in terms of Kraft desire to receive higher stock returns, but there are no rational explanations for the last increase in a bid price. One the one hand, the rise indicates that Kraft was in extreme need of receiving a lager segment at the stock market. One the other hand, the company just had to raise the bid rate to compete with other bidding companies. More importantly, the merger was beneficial for Craft with regard to cost saving policies. Kraft planned to lift share values with the help of the merger transaction and generate cost savings. The deal is also to increase the long-term earnings.

Cadbury financial strategies can also be the cause of bid price change on the announcement dates. During the first bidding, Cadbury managers rejected the offer to raise the price and increased the share value. A hostile bid was also successfully withdrawn due to the appearance of a competitive environment. Consequently, despite of the risk accepted by the target company, Cadbury can be considered as a winner in this business transaction because to manage to stand a hostile takeover and increase the stock returns. What is more important is that the company is now considered to be one of the leading world producers of confectionary. In general both parties have considerably benefited of the merger transaction in spite of existing frictions and business risks.

Conclusion

The merger of two great companies – Kraft Foods and Cadbury has been a significant event in a financial world that has perceived a mixed reaction. Despite the controversies and hostile reaction on the announcement dates, both companies have considerably prospered from the merger transaction. In particular, Cadbury has received the world recognition, becoming the leading company at the international market. In its turn, Kraft has also been honored by a number of benefits, despite disapproval expressed by the British government. First of all, the company has increased the values of shares and stock returns and has reduced the costs.

However, closer consideration deserves the bidding process that received much more attention. Many questions were raised concerning the price fluctuations as well as the reasons for those shifts. In this respect, one of the reasons was Cadbury’s fear of being underestimated and Kraft concerns with risk management. One way of another, both Kraft and Cadbury have chosen beneficial corporate finance strategies to overcome the problems.

Bibliography

Bender, R & K Ward, Corporate Financial Strategy. Butterworth-Heinemann, New York, 2008.

Buxton, T & P G Chapman, Britain’s Economic Performance. Routledge, New York. 1998.

Clayman, M R, M S Fridson & G H Troughton. Corporate Finance: A Practical Approach, John Wiley and Sons, Ney Jersey, 2008.

Rodriguez, J C & A Sbuelz, ‘Understanding and Exploiting Momentum in Stock Returns’ in Advances in Corporate Finance and Asset Pricing. Emerald Group Publishing, US, 2006.

Stern, J M & D H Chew, The Revolution in Corporate Finance, Willey-Blackwell, New York, 2003.

Wearden, G, ‘Timeline: Cadbury’s fight against Kraft’, Guardian. 2010. Web.

Footnotes

G Wearden, ‘Timeline: Cadbury’s fight against Kraft’, Guardian.co.uk. 2010, n. p.
Wearden, n. p.
J M Stern & D H Chew, The Revolution in Corporate Finance, Willey-Blackwell, New York, 2003. p. 254.
J M Stern & D H Chew, The Revolution in Corporate Finance, p. 255.
Rodriguez, J C & A Sbuelz, ‘Understanding and Exploiting Momentum in Stock Returns’ in Advances in Corporate Finance and Asset Pricing. Emerald Group Publishing, US, 2006.
M R Clayman, M S Fridson & G H Troughton. Corporate Finance: A Practical Approach, John Wiley and Sons, Ney Jersey, 2008. n. p.
Clayman, Fridson &. Corporate Finance: A Practical Approach n. p.
R Bender & K Ward, Corporate Financial Strategy. Butterworth-Heinemann, New York, 2008. p. 60.
R Bender & K Ward, Corporate Financial Strategy. p. 61.
J M Stern & D H Chew, The Revolution in Corporate Finance, Willey-Blackwell, New York, 2003, p 545.
T Buxton & P G Chapman, Britain’s Economic Performance. Routledge, New York. 1998, p. 220.

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