Cadbury Schweppes has not made a popular decision, but it has made the right one. Shares in the UK confectioner dropped 5 per cent on Tuesday, following the announcement that shareholders would not receive a cash payment when the US beverages business is demerged.
The Dr Pepper Snapple Group is shortly to be spun out from Cadbury’s confectionery arm via a listing in New York. Some investors, most vocally the activist Nelson Peltz, whose Trian Fund Management owns 4.5 per cent of Cadbury, had hoped that more debt would be taken on. In his December letter to the company he advocated a hefty ratio of net debt to earnings before interest, tax, depreciation and amortisation of 4.5 times for beverages, and 2.5 for confectionery.
Cadbury’s management has opted instead to maintain investment-grade credit ratings for both units, and run with current debt levels – once split, net debt to ebitda for beverages and confectionery should be about three and two times respectively. This is both pragmatic – the junk debt market is effectively closed, making any financing expensive – and sensible. A higher level of gearing would simply be reflected in a lower equity value for the demerged unit, while competitors Coke and Pepsi are run with far less debt.
The decision is also not greatly surprising. Activism works best when there is a lack of direction operationally, and management are distant from shareholders. Mr Peltz found success with Heinz, where his arrival helped to clarify management’s ideas for improving the business. At Cadbury his agitation for a break-up was well timed last year, but there was already a clear plan in place for confectionery. Even if there is still a reluctance to provide precise targets for margins, its aims are well understood. Concentrating on delivering them without unnecessary financial engineering seems right.