In September, we speculated that Warren Buffett might be less than thrilled with the terms of Kraft’s bid for Cadbury. In particular, his comments at the time indicated that he was hesitant to use Kraft’s “undervalued” stock as currency for the transaction. It appears that Mr. Buffett is growing increasingly concerned about the judgment of Kraft’s management as the “animal spirits” so often associated with expensive acquisitions intensify ahead of the January 19 deadline for Kraft to finalize the terms of the Cadbury bid.
In a press release issued by Berkshire Hathaway this morning, Kraft management is criticized for seeking a “blank check” which will allow the company to issue up to 370 million shares in order to facilitate an offer for Cadbury. The press release refers to Kraft’s proxy statement for a special meeting set for February 1 seeking approval for issuance of up to 370 million shares.
It is unusual for Warren Buffett to publicly criticize the management of companies in which Berkshire holds minority positions. Let’s look at a couple of excerpts from the press release:
The share-issuance proposal, if enacted, will give Kraft a blank check allowing it to change its offer to Cadbury – in any way it wishes – from the transaction presented to shareholders in the proxy statement. And we worry very much that, indeed, there will be an additional change from the revision announced this morning. To state the matter simply, a shareholder voting “yes” today is authorizing a huge transaction without knowing its cost or the means of payment.
The tone of the statement is revealing in that is reveals a lack of confidence in management to protect shareholder interests and profound dissatisfaction with the slightly sweetened terms of Kraft’s offer for Cadbury which were announced this morning (click on this link for coverage in the Wall Street Journal).
The press release goes on to criticize Kraft management for being so willing to issue shares at $27 (or lower) when the company repurchased shares at a higher price in 2007:
What we know with certainty, however, is that Kraft stock, at its current price of $27, is a very expensive “currency” to be used in an acquisition. In 2007, in fact, Kraft spent $3.6 billion to repurchase shares at about $33 per share, presumably because the directors and management thought the shares to be worth more.
Does the board now believe those purchases were a mistake and that Kraft’s true value is only the current price of $27 per share – and that it is therefore fine to structure a major acquisition based upon that price? Would the directors use stock as merger currency if the price were, say, $20 per share? Surely the true business value of what is given is as important as the true business value of what is received when an acquisition is being evaluated. We hope all shareholders will use this yardstick in deciding how to vote.
Here we see the familiar standard that Mr. Buffett has long used to measure whether using stock in an acquisition makes sense for the acquirer: As much business value must be received as the company is giving up in the share issue. This does not mean that Kraft cannot use “undervalued” shares to purchase another company, but the target company must be at least as “undervalued” as Kraft if stock is employed in the transaction.
While the press release keeps open the possibility that Berkshire may change its vote to “yes” if the terms of Kraft’s final offer for Cadbury (due by January 19) are acceptable, today’s press release clearly is intended to send a message to Kraft’s management and board. Perhaps the most amazing aspect of today’s drama is that Kraft CEO Irene Rosenfeld either did not consult with her biggest shareholder in advance or knew of Mr. Buffett’s opposition and went ahead regardless. In either case, Mr. Buffett’s reason to criticize management in a very public way seems very justified.
The author owns shares of Berkshire Hathaway.