After months of wrangling between Kraft and Cadbury's, it looks almost certain now that another iconic British brand will fall into the hands of foreign buyers.
After months of wrangling over price, thinly veiled political intervention and the continued enrichment of investment bankers, it looks almost certain now that the ownership of another iconic British brand will fall into the hands of foreign buyers.
Kraft and Cadbury have agreed on a value of £11.5bn – or 840p a share – for the British company, a number that is likely to please most shareholders given that only four months ago Cadbury’s shares were trading at 568p.
On the one hand, this is no different from the hundreds of mergers and acquisitions that take place around the world every year. Some turn out well, but many do not – and in the latter case the management and shareholders of the merging companies usually suffer.
The outlook for Kraft and Cadbury is an uncertain one, with trends to consolidation in the industry alongside complimentary market positions potentially offset by high integration costs and a clash of business and operational cultures (and our chocolate may start to taste of cheap cheese!).
But these are all matters for shareholders. So should the progressive Left even have a view on deals like this, and does policy have a role to play? The answer is unequivocally yes. The financial crisis has demonstrated that in the event of a significant corporate failure, governments – and ultimately taxpayers – find themselves under pressure to provide financial support potentially running into tens of billions of pounds; and the resulting unemployment, often concentrated in particular towns and cities, places enormous strain on social security and public services.
The crucial point is that transactions in the private sector do not occur in a vacuum, and it is usually when things take a turn for the worse that the broader societal impact becomes clear, but as we operate in what is primarily a market economy, it is difficult, and perhaps even undesirable, for a government to intervene on purely commercial grounds.
Further bluntly “protecting” jobs by seeking guarantees from a buyer is not a particularly progressive policy – it ignores the forces of competition and globalisation that all companies, UK owned or otherwise, face. Indeed, Cadbury itself has a record of aggressive cost-cutting.
The biggest risk to Cadbury workers is not that Kraft is an American company that will seek out profits at the expense of British jobs, it is that Kraft is funding the acquisition with £7bn of debt, taking the group’s debt to EBITDA (Earnings before interest, taxes, depreciation and amortization – a measure of earnings) ratio to nearly four times.
The cost of financing the massive mountain of leverage means that much of the cash generated by the business will be spent not on investment and training, but on interest payments. And if rates rise or sales drop, the group will be forced to cut jobs – and at worst may even fail.
Therefore the right approach is to enact public policy that demands financial prudence as part of any deal, domestic or cross-border. This could simply be a cap on the amount of leverage a buyer of a British business can apply. Just as we should probably have stopped Northern Rock lending 125 per cent of the value of someone’s home, we should stop companies picking up British businesses when there is a risk that the terms of the acquisition could lead to job losses.
This is not the government trying to second guess what best represents shareholder value. It is the government protecting its, and our, interests.
12 Responses to “Cadbury and Kraft – public policy should focus on debt, not nationality”
Mark
Varun, some good points. But credit risk isn’t the problem here. Many UK deals from London private equity houses are far more leveraged. But capping is clumsy since the cash flow can vary a lot, as can future performance.
The progressive idea would be to ensure a takeover shows due concern for employment and ensured pensions are protected.
Varun
Thanks Mark. A final comment from me: UK corporate pensions in takeover scenarios are perhaps the most secure in the world, with the powers of The Pensions Regulator beefed up considerably in the last few years. It can even act retrospectively to hold a company to account. And I’m not sure how a takeover could show ‘due concern’ regarding jobs in any meaningful fashion without risking court action for discrimination. And these aren’t progressive or innovative policy positions in my view – they are already the status quo.
Of course private equity transactions are highly leveraged – their business is borrow lots, cut costs, use cash to pay down debt then sell quickly to make lots of money. And in the last few months many of these businesses have found themselves struggling to stay above water – precisely due to their debt burdens and the difficulty of refinancing in stressed market conditions (I wouldn’t merely call this ‘credit risk’ – it is a genuine operational consideration). When the negative externalities of failure are as significant as could be with Cadbury, leverage caps (applied on a case by case basis, using deal specific metrics that take into account cash flow variance) could be a valuable, and practical, intervention.
Mark
Cap leverage and firms would quickly find a way around it, whether just issuing equity, resorting to convertible instruments or other more structured items. You could oblige acquirors to state the number of job losses up front, so staff know what’s happening. But we can only ponder, after all the PM is closely linked to a private equity house so nothing is going to change in the wake of this bid.
stevie b
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Politics Summary: Wednesday, January 20th | Left Foot Forward
[…] to allow ministers to intervene in high-profile deals where the national interest is at stake. Left Foot Forward said yesterday: “we should stop companies picking up British businesses when there is a risk […]