Cheesy conglomerate catches Cadbury's - Commentary no. 370

Something needs to be done to prevent predators from buying up British companies by issuing debt. The problem this creates is that the victim of this kind of operation ends up having to pay back this unwanted leverage. This is what has happened to the latest case, Cadbury’s. This example has been particularly painful because the victim is every inch a British company. It is like a stick of Brighton rock, where the name goes right through the whole stick. Break it where you like and there is the iconic name, Brighton rock, or in this case Cadbury’s Milk Tray.

Now we’ve had Lord Mandelson pleading with institutional shareholders to take the long view not just sell out because of what seems at the moment to be an attractive cash and share offer. We can sympathise with that. We can even go further and fully agree with him but we all know that this isn’t how the markets work. Fund managers are rewarded by their success. This can be measured annually or even quarterly. How can they resist an offer of nearly 850p a share when, pre-bid they were standing at 550p or thereabouts? It’s just not possible. There’s a level when even the Board, who’ve done their best to resist it, have to give in and recommend it. It’s all part of our belonging to the capitalist club.

But this doesn’t mean that we should acquiesce in every bit of the capitalist system. Not every part of it is really healthy. Take for instance the use of debt to finance major takeovers. In the case of Cadbury’s it could be pernicious. What happened was that a major shareholder in Kraft, namely the much admired and hugely successful Warren Buffet whose funds are a major shareholder in the cheesy conglomerate, publicly told the Board not to pay too much for Cadbury’s. What he implied by this advice was that they shouldn’t pay too much of the offer in Kraft shares. Why did he do this? Because in his professional view Kraft shares were too low to be used as currency in the offer. He would prefer Kraft to pay more in cash and less in stock. And so it has turned out. The offer which has finally won the Cadbury’s Board approval totals 850p per share made up of 500p in cash and the rest in stock. The 500p has of course got to be borrowed. The original offer only contained 300p in cash. So the cash element has nearly been doubled. Thanks in part to Mr. Buffet.

Well, we all admire Mr. Buffet, nobody more than the shareholders in his funds. But frankly his advice is not welcome particularly to the employees of Cadbury’s. It means that when the bid has gone through and Cadbury’s is absorbed into the Kraft enterprise, it is bound to be put through the ringer to squeeze out repayment of the debt incurred in its takeover. Cadbury’s is a very successful company. This success is not only financial, it’s social. Over the last hundred years or more it has made its name partly by looking after its employees. Now it will have to look after its creditors. Who comes first? There’s little doubt about that issue. It will be the repayment of debt that matters the most.

All is fair in love and war. But some things about markets need to be watched and if necessary dealt with. So what about a new regulation? One that says that any bid for a company cannot proportionately increase the victim’s leverage. Debt for debt would be alright but not debt for equity. Such a ruling would fit with today’s widespread attitude to the problems created by the issuing of too much debt. We are, we are told, overborrowed as a nation. The public sector has got much too much debt and is going to issue a lot more. The private sector is also overborrowed. We’ve all got to pull in our belt and manage on less. But here we’ve got a major takeover bid for an iconic British company being heavily financed by bank borrowing. Whose got to pay this debt off? Why the company that has been bid for. It’s doubly the victim. It’s just not on. Thank you Mr. Buffet but “no thanks”.

The imposition of this new regulation would not be popular with the private equity fraternity. Their business has been founded on debt for equity. They sweat what they buy to service the debt or the borrowings they make. Then finally they sell on the equity at a fat profit. They’re like the players at the roulette table. The rules they play by mean that they are practically always the winners not the croupier. What we suggest is that it’s about time the croupier woke up.

Tony Rudd

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