Read this transcript to learn why Warren Buffett opposes the dealS.
On selling the pizza business:
1. Kraft sold the (frozen) pizza business at $3.7 bn, but net of tax will receive only $2.5 bn.
2. The pizza business earns 280 Million pre-tax income on $2.1 bn in sales which has been growing over the years.
3. He thinks that giving up $ 280 million in earnings in exchange for $ 2.5 bn is a bad deal for the seller. We can infer that paying $2.5 bn for $280 million is a GOOD deal for the buyer (ie PE of around 8.9x).
On buying the chocolate business:
1. Kraft stated that they are paying 13x EBITDA
2. Buffett told the interviewer that DEPRECIATION IS A VERY REAL EXPENSE. (i believe he meant capital expenditure to keep the business in place)
3. There will be about 1.3 bn in restructuring charges.
4. Part of the ''currency" used for this transaction is Kraft's undervalued stock. Thus they are acquiring Cadbury at more than 13x EBITDA based on intrinsic value of stock.
(the above two paragraph of numbered points were extracted from the transcript, the following is my analysis... ...proceed with care, cuz this author is famously careless)
"So, the actual multiple, if you look at the value of the Kraft stock, is more like 16 or 17 and they sold earnings at nine times. So, it's hard to get rich doing that. And I've got a lot of doubts about the deal."
From the above statement, we can reverse engineer what may approximate Kraft's intrinsic value per share.
Let us just convert all the deal details available at Kraft's website into USD.
840 pence per Cadbury share for 500 pence in cash and 0.1874 New Kraft Foods Shares
at the exchange rate of 1.63 USD/GBP
840 pence = 13.69 USD ----(1)
500 pence = 8.15 USD ---- (2)
0.1874 Kraft shares at $29.58 = 5.54 USD ----(3)
Check: (1) = (2) + (3) , therefore balance
Since Kraft's statement states that at the current deal price, it is acquiring at 13 x EBITDA, then
13.69 / EBITDA = 13
EBITDA = 1.0533
Mr Buffett said that Kraft is paying at least 16 x EBITDA based on kraft's intrinsic value, thus value of deal at
16 x EBITDA = 16 x 1.0533 = 16.853 USD ----(4)
0.1874 Kraft shares = (4) Less Cash component (2) = 16.853 - 8.15 = 8.703
Intrinsic value of 1 Kraft share = 8.703/0.1874 = 46.44
Compare this to the closing price of 29.58, no wonder Buffett is against the deal as (I think) he believes that the company is selling at 35% discount to intrinsic value!
However, I would like to add that Kraft is expected to earn around $2 per share. Is Kraft worth 23x PE based on share price of 46.44? Of course PE is a super shorthand to estimate value. However, i find this an interesting exercise as this is one of the few times in recent years that Buffett 'reveals' his estimation of intrinsic value.
Also note that for 2008, on 3 bn in net profit, almost 4bn of operating cashflow is generated and CAPEX (with growth) is about 1.3 bn. So maintenance CAPEX maybe way less than 1.3 bn, with free cashflow exceeding net income, which means that EPS multiple maybe a lousy way to estimate value to the long term owner.
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Actually I don't quite know who I wrote the above post for, cuz most friends who read this blog will probably stop at the first line. haha. So I wrote it mostly for myself, to remind me that Price does NOT equal Value, and that smart people may do things that are not too smart things, and that I must not fall prey to over-enthusiastic promoters (however well intended they might be).
Also any readers who find errors in my reasonings or calculations, please tag or comment to set me right.
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