The Faber Report

What Warren Buffett Didn't Say About Kraft

In a great interview with the "Squawk" crew today Warren Buffett left no doubt where he stands on Kraft’s pending purchase of Cadbury for more than $19 billion in cash and stock.

Warren Buffett

He vehemently dislikes the deal. While I am not one to quibble with the smartest investor in the land, it is worth briefly reviewing one of his fundamental objections to the deal.

Buffett’s contention is that Kraft is paying too high a price and he noted with particular disdain that Kraft is selling its frozen pizza business to Nestle for what he says is nine times earnings, while buying Cadbury at 13 times EBITDA, not a good trade in his opinion.

Buffett: They are using their own stock (260 million shares) that they're own directors say are significantly undervalued and when they calculate that 13 they're calculating kraft at market price, not at what their own directors think their stock is worth. so the actually multiple -- if you look at the value of kraft stock -- is more like 16, 17 and they sold earnings at 9x. so its hard to get rich doing that and I've got lot of doubts about the deal.

Kraft and its advisers are not looking to provoke the company’s largest shareholder, but they are chafing a bit from this comment. The fact is that while the pizza business will generate about $290 million in annual earnings for its new owner Nestle, it was not doing anywhere near that amount of profit for Kraft. Nestle’s distribution system for frozen pizza had a lot more efficiency than Kraft’s and Nestle is not buying the overhead that comes along with the pizza business.

It seems that Kraft’s distribution of frozen pizza suffered because it required a unique distribution mechanism that other Kraft products did not benefit from. Hence, Kraft would say that the multiple on the deal was far higher even after the $1.2 billion in taxes it is paying as a result of the sale. (Sale was for $3.7 billion)

And to be fair, while Buffett may not like issuing stock for any deal, the stock price is the stock price, not some mystical number its directors think it’s worth.

Warren may well end up being right (most deals are not worth doing) and there’s no doubt that Kraft CEO Irene Rosenfeld’s future rides on making the Cadbury acquisition a good one.

But don’t forget that even Buffett makes his mistakes when it comes to deals. As a board member of Coke he voted down its attempt to acquire Quaker Oats, letting rival Pepsi  make what has been a very beneficial acquisition.



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