Hershey-Mondelez $107 Takeover Bid: Five Thoughts

Five thoughts on the news of a possible Hershey takeover beyond what the mainstream news has already reported:

#1. Rationally, Nestle should the highest bidder for Hershey stock. Due to an old agreement with Rowntree (a confectionary business now owned by Nestle), Hershey gets licensing rights to sell Kit-Kat in the United States. Those licensing rights terminate, and revert to Nestle, if a transfer of control occurs at Hershey. About $600 million worth of Kit Kats get sold in the United States every year, which flows through as $120 million worth of profits to Hershey shareholders. Assuming, in a takeover scenario, that those rights are worth 25x earnings, then Nestle ought to be willing to pay $3 billion more to acquire Nestle than any other competitor.

Being taken over by Nestle, and then getting those funds into Nestle stock, is an attractive investment strategy to keep in mind as you go through life. If you owned shares of Ralston Purina in 2001, and took the $33.50 cash offer and put it all into Nestle, you’d have 15.6% annual returns from the start of 2001 through today. Not bad for the supposedly stodgy industries of pet food, milk, and chocolate candies.

That doesn’t mean this will happen, as antitrust considerations may keep Nestle out of the bidding altogether. They may be content to regain their Kit Kat rights in the United States and just go from there.

#2. Speaking of Kit-Kat, we need to talk about the real powerhouse engine at Hershey. A lot of people think it is Hershey’s eponymous brand that earns the most lucrative profits for shareholders. It’s not. It’s the H.B. Reese Candy subsidiary that pumps out those Kit Kats and Reese’s Candies. The profits from Reese’s and Kit Kats are almost 30%. Reese’s sales growth is in the high single digits, despite perpetual price raises in the candy.

If I could only own one brand in the world, and you assumed everything was fairly valued and you manually adjusted to make the sizes equal, I’d choose Reese’s. It’s profit engine, and perpetual sales growth in response to price hikes, is incredible. Hershey’s chocolate, in personal, earns about 17% profit margins and has low single digit sales growth. That is fantastic, but ultimately, Reese’s has been a sweeter contributor to shareholder returns.

#3. But don’t cry for the Reese family. In 1963, six members of the Reese’s family signed off on the original sale of H.B. Reese’s to Hershey. In fact, it was on this day 53 years ago (July 1, 1963). Robert Reese got 20,000 shares of Hershey; John Reese got 20,000 shares of Hershey; Edward Reese got 15,000 shares of Hershey; Ralph Reese got 15,000 shares of Hershey; Harry Reese got 15,000 shares of Hershey; and and C. Richard Reese got 15,000 shares of Hershey.

Having sold their cash cow, they chose the next most intelligent thing: they never sold a share of Hershey stock. All of those shares remain in the family to this day. Collectively, they receive cash dividend payouts of $37.2 million annualized. That’s a family that wakes up with $102,000 in additional chocolate wealth every morning. If it took you a minute to read this paragraph, the Reese family just made another $70 in Hershey stock dividends. Large chunks of ownership + very long periods of time = Extremely large chunks of passively generated wealth.

#4. The buyout story is just beginning. Given that Mondelez offered $107 per share for shares of stock in Hershey, you may wonder why the stock price trades above that in the $110 range. That’s because the story is just getting started. Hershey was trading at $98 before public disclosure of the bid, and the offer price was only a 9% premium.

The typical takeover premium of a publicly traded American company over the past fifteen years is 37%. For the typical takeover, that would suggest a final price of $134 per share. However, given the exceptional characters and stability of earnings power at Hershey, I would think that a 50% premium would be necessary. That suggests a takeover price of $147 per share. If the final bid price crossed into the $150s, I think it would be difficult to vote no on the transaction. At the very least, something other than fair investment returns on this particular stock would have to be your basis for voting at that point (not that it matters, as the Hershey Trust gets over 80% of the voting power despite having an economic interest in only 8% of the shares).

#5. Everything is relative. In some respects, the Hershey Trust has not been the best controlling voter of the stock. There has been a lot of factory outsourcing to Mexico, there has been some dilution of the chocolate brand in recent years (heck, some products don’t even contain outright chocolate anymore and has to describe itself under the FDA term chocolate candy). Many people in Hershey have complained of getting bullied by the actions of the Hershey, and it is has been accused of miserly distributions to its charities. And from a business perspective, the desire to build up the brand name “Hershey” while not giving adequate resources to market the Reese’s brand is frustrating. Reese’s gets some air time around Easter and March Madness, and then disappears the rest of the year. It deserves far more advertising heft and overall priority.

However, Mondelez is noticeably worse. Irene Rosenfeld has not kept her non-binding promises to Cadbury after the acquisition of the British chocolatier, and all of its community assurances have received minimal compliance at best. The milk has been replaced in the famous Cadbury Eggs with some substitute, and the portion size reduced from 6 to 5 (again, Hershey Trust has advocated and got its managers to do the same with Reese’s candies over recent years). The promise of continued headquarters in Hershey, as well as the continuity of the Hershey name, mean very little.

Just as no British citizen is satisfied that Mondelez has complied with the spirit of taking care of the Cadbury brand and original community after the transaction, a similar will refrain will soon be echoed in Hershey, PA if it gains control over Hershey. And likewise, changing the name is inevitable because Mondelez is an albatross of corporate-speak that stirs no positive emotions. However, if the Hershey name lives on, while the spirit of what made it great does not, then the reputation will endure for a generation or two while the brand equity built up over past generations is gradually depleted until eventually the new reality is fully recognized.