November 18, 2009 4:33 pm

Hershey, Ferrero bid faces significant hurdles in rivaling Kraft’s Cadbury bid

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A consortium between The Hershey Company (NYSE: HSY) and Italy’s privately held Ferrero would face many obstacles in the fight for Cadbury, though its presence could force Kraft (NYSE: KFT, A-/Baa2) to flex its financial muscle, sources told dealReporter.

Both Hershey and Ferrero operate under family-owned structures that would place severe constraints on the amount of equity they could raise to finance a bid, according to a source close to Cadbury and a source familiar with the situation.

“They would need to lever up significantly,” the source familiar said, noting that he was “extremely skeptical” that both controlling families would agree to that structure.

Hershey, the US chocolate company based in the eponymous Pennsylvania town, is controlled by a trust whose charter mandates that it retains a majority stake in the company’s equity. Using any equity to fund a Cadbury deal would require completely deconstructing the family trust and voting on a new charter, according to the source close and the source familiar.

The initiative to entertain an idea is coming from “senior executives and bankers... rather than the family,” said the source close to Cadbury, noting that he does not “really see a united front from the family to change the charter. ”

Yet another question is how the two parties would split the assets. Perhaps Hershey could use Cadbury’s sought-after gum assets to complement its Ice Breakers brand; if not, Hershey would likely face heightened antitrust scrutiny from US regulators in trying to further scale its chocolate operations.

Ferrero, too, could see several obstacles ahead of trying to make a bid, even with a partner.

Ferrero’s annual revenues were pegged to be around USD 9bn; the second source close, using this number and information available, estimated its EBITDA to be USD 1.5bn annually, which could likely mean that the family could only borrow up to USD 5bn to fund the bid. Such a number would hardly be enough, even with a Hershey contribution, to top Kraft’s unchanged bid of USD 16bn.

“It’s not going to be that easy to agree on the split, and then the valuation of the split,” the source familiar said. “Then [the parties will] have to get the financing. ”

Together, the chocolatiers would likely find willing financiers led by JPMorgan, long observed to be advising Hershey, the source familiar said. JPMorgan, he continued, has shown that it can assume a sizeable underwrite if it wanted to – and if the companies wanted to pile on enough leverage to do that.

Private equity could be the situation’s wildcard, the source familiar said, noting that “five or six” private equity firms had looked previously into buying the whole of Cadbury themselves. The source familiar had yet to see that option being seriously discussed but said it remained a possibility, since shareholders continued to demand more cash.

The takeover defense advisers have an obligation to “earn their defense fee,” and the board has an additional obligation to make sure the company gleans the best price, the source familiar said. The source close to Cadbury went further to note that UK-based Rothschild, reportedly advising Ferrero, would “love to do this deal.” There has been no confirmation that Rothschild has been officially mandated to prepare a counterbid and the source close to Cadbury believed the investment bank is still pitching this deal.

The source close to Cadbury noted that the UK confectioner has yet to be approached by either Hershey or Ferrero. At this juncture, the consortium appears to remain in the drafting stage, the first source close said, even though Hershey is said to have been attempting to cook up ideas as early as September, following Kraft’s initial offer.

The mere presence of a competitor would be likely to light a fire under Kraft to increase its bid, which the source close to Cadbury believes could see an injection of another USD 1bn to USD 1.2bn. Kraft ended 3Q 2009 with USD 2.7bn in discretionary cash flow—a USD 1bn increase from the previous year—which CEO Irene Rosenfeld said was due to the prospect of a Cadbury bid and requirements from ratings agencies.

The source familiar said that his doubts about the success of a Hershey-Ferrero combination goes back to the Cadbury shareholders, expressing disinterest in holding Kraft shares. With this in mind, the source continued to doubt why shareholders would want to hold minority shares in Hershey, with a family-controlled company like Ferrero holding a stake on the side.

“It’s another way to go about [pursuing Cadbury],” the source familiar said, “but at this point, it’s not an alternative bid.”

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