M&A Report

Cadbury SA Value
53-256-02

Team Assignment #2
To: Professor Alix Mandron From: Tamara Rozansky 11123133

Jean-Francois Saine 11032592 Nikola Vukov 11154913

Date: May 30th 2012

Instructions In principle, you should estimate the intrinsic values of both the acquirer and the target as standalone. Applying the VAP, you would then add the value of the synergy effects and go on to compute the share-exchange ratio. However, because your time is limited, you will only do the following : Compute Cadburys intrinsic value as a stand-alone and compare it with the pre-rumors stock market price (justify the date you select in this regard). (about 3 or 4 pages plus tables and appendices if appropriate). Important remarks Note that you will find it very difficult to put a value on the target if you do not understand the industrial/economic context in which the company operates. You will also need to understand how the target has performed so far. Otherwise, you will not be able to justify your forecasts. I expect justifications and explanations. This is not a pure number crunching exercise. You will have to write an analytical report, and a convincing one, at that. I must also understand what computations you have performed and how; give the required technical explanations under your tables or in appendices. You must work as if we were still in February 2010. Avoid presenting posterior results as perfect forecasts; rather try to imagine what would have seemed reasonable/logical in February 2010. The Gordon model is not an acceptable model, except for the estimation of a horizon value.

The Project Weve dissected this assignment in a step-by-step process to facilitate the understanding of the material and results we found. Step 1: Forecasting EBITDA & Obtaining FCFE In order to find the residual cash flow from equity, we need to start with cash flow from operations; we will assume that clean EBITDA is a fair proxy for CFO, and we will work from there. Next, Several things will be considered when forecasting the EBITDA into the future. For one, the confectionary industry is said to have grown over the past five years at 5% per year in developed economies and 12% in emerging markets, which together represent 40% of the global confectionary revenues. Currently, Cadbury holds approximately 10% of the global confectionary market, with 11% in emerging markets. While certain markets may be expected to grow into the future, others may not. Thus, when forecasting revenues, each geographical segment will be taken into account separately. Additionally, several scenarios will need to be forecasted due to the risk of uncertainty with several market metrics. While the confectionary market is rather steady, with little volatility, certain factors could affect Cadburys sales. For one, the economic and financial climate has changed in 2010, and it is unknown when the market will recover. Furthermore, Cadbury is currently restructuring, and major costs will be involved in this in the future, which can materially affect cash flows. We will begin by forecasting revenues based on past data and future growth forecasts in each area. While the industry has been growing at a rate of 5% per year in developed markets and 12% in emerging markets, we can notice that this is not necessarily the case for Cadbury, who has in the past year grown its revenues by as much as 14.58%1. In publications released prior to February 2010, it is stated that revenues grew by 5% in 20092. Given this public information, we opted to forecast 2009 revenues globally, whereas every year thereafter, we forecasted revenue increase by geographic segment in all 3 sensitivity scenarios. As a result of this, within all of our sensitivity scenarios, the 2009 revenues will have grown by 5% from 2008. We have chosen to forecast 10 years into the future, until 2018. This is because we feel that the market should continue to grow throughout these 10 years, before eventually leveling off. Thus, after 2018, we will assume a steady-state, at which point we will calculate the normalized terminal value of Cadbury and discount it back to time 0.
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From 2007 to 2008 http://www.confectionerynews.com/Markets/Cadbury-worth-more-than-Kraft-bid-analysts

Research has shown that there has been little negative impact on sales in certain regions due to the recession; consumers have tended to turn to confectionary treats in tough financial times in search for comfort. Thus, we will continue to forecast growing sales3 for Cadbury. While sales in Europe and North America are said to have decreased as a result of the recession, Cadbury has compensated for this shortfall through their improved operating margins due to efficient cost saving measures in other areas. Our base case forecast of Cadburys revenues will be made using a growth rate of 5% over the next few years, then continuing with this growth rate into perpetuity in developed markets, and using a higher rate of 7%, which is still very conservative compared to the 12% stated, for emerging markets (Middle East and Africa, Asia and South America (said to include Brazil, Argentina, Venezuela and Colombia)4. Our optimistic view will have this market growing at the same rates as seen in the past, at 5% for emerged markets and 12% for emerging. Our pessimistic view will remain low, as we are uncertain when the recession will end, and are concerned by increased competition in the markets. Additionally, the recent rising costs of raw materials (namely cocoa) are of great concern. Bearing this risk in mind, we recognize how volatile the price of the ingredients could be; we have built in the volatility of the fluctuations in input prices in our pessimistic model. Thus, we will slow growth to 4% for developed markets, and 6% for emerging markets, and adjust the operating margin accordingly. Cadbury has reported that they will be spending 650 million on their Value In Action restructuring plan over four years, as announced in 20065. Thus far, Cadbury has spent 492 million in 3 years; there is 158 million in expenses remaining, which will be deducted as an expense in 2009. We will assume that the cost of sales, along with distribution costs, marketing and selling costs, and administration expenses will all increase somewhat proportionally to the increase in revenue each year. The cost of sales will be affected so as to give the desired operating margin. The other costs will be calculated in keeping the proportion from 2008 in relation to revenue. We will also deduct any depreciation and amortization from previous costs (cost of sales and administrative expenses) before forecasting, as we wish to calculate clean EBITDA, which we consider to be a decent proxy for CFO. This will allow us to compute FCFE. Given the investment in the Value in Action plan, we can assume that the operating margin will improve in the next few years. To remain conservative, we will forecast our base case model
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http://articles.economictimes.indiatimes.com/2009-05-03/news/28384215_1_todd-stitzer-cadbury-chiefexecutive-chocolate 4 Cadbury 2008 Annual Report, http://www.scribd.com/doc/22681262/Cadbury-2008-Annual-Report, p. 28. 5 Cadbury 2008 Annual Report, http://www.scribd.com/doc/22681262/Cadbury-2008-Annual-Report, p. 12.

using the operating margin of 53.4%, the 2006 pre-recession value. For our optimistic scenario, this value will be 55%, above any operating margin in the past 3 years. For our pessimistic forecast, it will remain low at 48%, considering the lowest past margin of 50.3% in 2008 and keeping in mind that our margins will be squeezed even more due to rising cocoa prices. Now that we have determined an optimistic, base, and pessimistic forecast for Cadburys EBITDA, we must determine what weight to assign to each scenario based on their likelihood. Given industry forecasts and research, the confectionery sector is said to continue growing and remaining profitable6. Cadbury has a history of growing and adapting with the times and customer demands, as proven by Cadbury New Zealand pledging to receive Fairtrade Certification 7. Public relations acts like these keep customers interested in the products, and ensure that Cadbury continues growing and staying strong in the market. While these are positive developments for Cadburys profitability in the future, certain other factors such as the rising raw material costs make the pessimistic model seem appealing8. Therefore, we will give the base case scenario a 50% weight, and each of the optimistic and pessimistic scenarios a 25% weight. Step 2: Parameters for Discounting Residual Cash Flow from Equity Tax Rate: The statutory tax rate has been changing, so we opted to choose an average of the previous 3 years before 2008 to smooth out any future fluctuations. The information we obtained is located on page 176 of the 20F report, and yields a result of 30%. Risk free: The proxy we used for the risk free rate is the 30-yr UK GILT; the current rate (December 2008) is approximately 3.74%9. Market Risk Premium: We assume this to be 6%, based on historical returns of the MSCI UK All Cap. Index versus the 30-yr UK GILT yields, for the past 5 years. Interest Rate on debt: 70% of debt is a fixed rate, while the remainder is floating. Page 168 of Cadburys 2008 20F report indicates all the borrowings, their interest rate, and their weights. For the fixed portion, the weighted interest rate is found to be 5.255%. Because it is impossible to associate an interest rate for floating payments, we will have to assume a rate. We will assume a slightly higher rate for the floating rate payments than for the fixed payments simply because of
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http://www.candyusa.com/IndustryResources/PRdetail.cfm?ItemNumber=1456 http://www.cadbury.co.nz/about-cadbury/news.aspx?newsID=271 8 http://www.ft.com/intl/cms/s/0/1f48a1b8-d129-11dd-8cc3-000077b07658.html#axzz1w5vspm2z 9 www.bankofengland.com

the variability risk, and uncertainty of the future market conditions. As such, we will assume that the floating rate average will be 5.74%.
Interest Type Interest Rate Fixed Interest - 70% 7.25% Sterling Notes due 2018 7.25% 4.25% Euro Notes due 2009 4.25% 4.875% Sterling Notes due 2010 4.88% 5.125% US Dollar Notes due 2013 5.13% Total Interest Type Interest Rate Floating Interest Commercial Paper Libor + X Bank Loans in Foreign Currencies Libor + Y Bank Overdrafts Libor + Z Total BV 347 571 77 683 1678 BV 373 165 152 690 Cost of Debt 1.499% 1.446% 0.224% 2.086% 5.255% Cost of Debt ? ? ? 5.740%

Therefore, the total cost of interest for Cadbury, as of December 31st 2008 is (0.70 x 0.05255) + (0.30 x 0.0574) = 5.40%. Step 3: Calculating PV of the FCFE

Step 1 Compute FCFE in 2007, 2008, 2009: this will allow us to estimte a growth in FCFE that we would be able to apply in the future. CFO changes using blablba. Based on that, we have to compute notional debt. If first five years are positive, then we can assume perpetuity.

Step 2 Compute Notional D/E; this can be done by following the notes and looking tat the excel file. Go to Step 3 Apply multiple scenarios to the analysis, using weighted average to come up with ONE value

Step 4 Compute different scenarios, with british