The company expects to create these companies through a tax-free spin-off of the North American grocery business to Kraft Foods shareholders. Global snacks will consist of the current Kraft Foods Europe and Developing Markets units as well as the North American snacks and confectionery businesses. The North American grocery business would consist of the current U.S. Beverages, Cheese, Convenient Meals and Grocery segments and the non-snack categories in Canada and Food Service. The spin-off to be completed in 12 months with new companies to be launched before year-end 2012.
Kraft feels that the spin-off will offer investors the best of both worlds. Kraft can now take advantage of Cadbury’s excellent marketing and distribution networks in emerging markets like India, China and Brazil to help propel the growth of new products it plans to launch in these economies. Already, emerging markets are a significant growth driver for Kraft, and the company feels that the growth of the Global Snacks Division is somewhat nullified by the stagnant nature of the North American Grocery Division. Thus spinning them off will help it realize high value for both the companies to provide higher returns to its shareholders.
Rewind back to March of year 2008, when Altria spun off its tobacco division into two separate companies, Phillip Morris International (PM) and Altria Group (MO). Since the spin-off, both companies have outperformed the S&P 500 performance by a wide margin. Phillip Morris international stock is up 63% (17% CAGR) while Altria stock is up 44% (13% CAGR) vs. 6.5% decline in S&P 500 in the same time period. This sets an excellent precedent for what we can expect from the spin-offs coming out of Kraft (Kraft was also a spin off from Altria back in 2007) in terms of their stock performance.
There are some parallels to note here. Altria spun off its tobacco division into two companies with Phillip Morris International focusing on high-growth international markets, whereas Altria focused on the more mature U.S. market. Kraft also is spinning into Company A, focusing on higher growth international/emerging market business, whereas Company B will be focused on a more mature U.S.-based grocery business.
Similar to Phillip Morris, Kraft products are also staple and mass market sold to millions of consumers, and the company has a solid brand and a durable competitive advantage generating loads of cash year after year.
Recently, Kraft came out with further details on its spin-off plans. Kraft announced that Irene Rosenfeld, who is the current CEO of Kraft Foods, will head the Global Snacks division whereas Anthony Vernon, executive vice president and president of Kraft North America, will head the North American Grocery Division.
Mary Buffet in her book "Warren Buffett and the Art of Stock Arbitrage" talks about how investor should keep a keen eye on insiders and where their loyalties lie in order to decide which of the two companies spun off will provide better opportunity for higher returns. Joel highlights that top management mostly associates with the company which offers higher return and higher financial benefits to them.
From Kraft’s recent announcement that its current CEO will head its Global Snacks division provides us enough hints that Kraft Global will be a clear winner. That is where the growth lies and that’s where the returns will come from. So it is a highly probable that after the spin-off, Kraft Global will outperform the parent company which will focus on the more mature North American Grocery business.
But Joel Greenblatt’s book " You Can Be a Stock Market Genius" highlights that paying attention to the parent company can also pay off handsomely (read my previous article Seasons of Spin-offs to understand key principles and rules to consider while analyzing a spin-off).
Surely the global business will outperform the more mature North America business, but there is good probability that the North America business will also provide excellent returns versus the S&P and the broader market. The North America business will be slow growing but will be high margin and will generate loads of free cash which will drive its stock price higher.
Kraft will provide further details of its two businesses when it files its Form 10 right before the spin-off of two companies in August 2012. Additional details will provide further insights into the earning power of the two separate companies as well as details on their business strategy and business plans, providing key data points to estimate their intrinsic values.
Investing in the Kraft spin-off will pay off handsomely in the long term. Kraft management has taken an excellent step to unlock value for its shareholders.
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