Investors Often Evaluate a Firm’s Performance in Terms of How

question 47

Essay

Investors often evaluate a firm’s performance in terms of how well it does as compared to its peers.
Activist investors can force an underperforming firm to change its strategy radically.
The Kraft decision to split its businesses is yet another example of the recent trend by highly diversified businesses to increase their product focus.
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Following a successful career as CEO of PepsiCo’s Frito-Lay, Irene Rosenfeld became the CEO of Kraft Foods in 2006. As the world’s second-largest packaged foods manufacturer, behind Nestlé, Kraft had stumbled in its efforts to increase its global reach by growing in emerging markets. Its brands tended to be old, and the firm was having difficulty developing new, trendy products. Rosenfeld was tasked by its board of directors with turning the firm around. She reasoned that it would take a complete overhaul of Kraft, including organization, culture, operations, marketing, branding, and the product portfolio, to transform the firm.

In 2010, the firm made what at the time was viewed by top management as its most transformational move by acquiring British confectionery company Cadbury for $19 billion. While the firm became the world’s largest snack company with the completion of the transaction, it was still entrenched in its traditional business, groceries. The company now owned two very different product portfolios.

Between January 2010 and mid-2011, Kraft’s earnings steadily improved, powered by stronger sales. Kraft shares rose almost 25%, more than twice the increase in the S&P 500 stock index. However, it continued to trade throughout this period at a lower price-to-earnings multiple than such competitors as Nestlé and Groupe Danone. Some investors were concerned that Kraft was not realizing the promised synergies from the Cadbury deal. Activist investors (Nelson Peltz’s Trian Fund and Bill Ackman’s Pershing Square Capital Management) had discussions with Kraft’s management about splitting the firm. This plan had the support of Warren Buffett, whose conglomerate, Berkshire Hathaway, was Kraft’s largest investor at that time, with a 6% ownership interest.

To avert a proxy fight, Kraft’s board and management announced on August 4, 2011, its intention to restructure the firm radically by separating it into two distinct businesses. Coming just 18 months after the Cadbury deal, investors were initially stunned by the announcement but appeared to avidly support the proposal avidly by driving up the firm’s share price by the end of the day. The proposal entailed separating its faster-growing global snack food business from its slower-growing, more United States–centered grocery business. The separation was completed through a tax-free spin-off to Kraft Food shareholders of the grocery business on October 1, 2012. The global snack food business will be named Mondelez International, while the North American grocery business will retain the Kraft name.

Management justified the proposed split-up of the firm as a means of increasing focus, providing greater opportunities, and giving investors a choice between the faster-growing snack business and the slower-growing but more predictable grocery operation. Management also argued that the Cadbury acquisition gave the snack business scale to compete against such competitors as Nestlé and PepsiCo.
-How might a spin-off create shareholder value for Kraft Foods shareholders?

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Definitions:

Cost Conditions

The specific factors affecting the cost of production or service delivery, including material costs, labor expenses, and overheads.

Output

The total amount of goods or services produced by a company, industry, or economy.

Increasing Cost Industry

An industry in which production costs rise as output increases, often due to factors like limited resources or higher prices for inputs.

Constant Cost Industry

An industry in which the costs of production do not change as the industry's output changes, maintaining the same unit cost for production regardless of scale.