Last week Mondelez (MDLZ) launched a bid of $107 a share for chocolate maker Hershey (HSY). Hersey rejected the offer, but the stock traded higher anyway, as investors are anticipating a sweeter deal to come. Hershey shares rose almost 16% on the news. I believe HSY investors should take profits off the bounce. This deal would be a disaster.
Mondelez made the nonbinding bid to acquire the chocolate maker, and was quietly rebuffed by Hershey. The snack maker is desperately trying to fill a hole in its strategy, a strategy that I believe needs serious reworking. Currently, North America represents just 27% of MDLZ sales, whereas North America accounts for 90% of Hershey sales.
With 85% of its revenues from snacks, Mondelez is having a hard time growing, as it has been hit with a double whammy -- a global economic slowdown and a snacking slowdown. Emerging markets GDP has fallen from 5.2% in 2012 to 4% in 2015. Likewise, according to A.C. Nielsen, the global snack category has slowed dramatically. Global snacks grew 5.9% in 2012 and just 4.1% in 2015. Meanwhile, currencies, like the strong U.S. dollar, and volatile input commodities, like cocoa, are playing havoc with margins.
At the analysts meeting back in February, MDLZ gave guidance of organic revenue growth of 2% and double-digit earnings growth for 2016, but it is unlikely the company will be able to make those forecasts.
Most analysts forecast a 2016 sales decline of 11% for MDLZ, reflecting an accounting change in its Venezuelan operations, unfavorable currency exchange rates and a drop in shipment volumes.
In fact, falling revenue is not new to MDLZ, having fallen 16% in 2014 and 9.8% in 2015. While revenue is expected to decline, gross profit is forecast to increase 3% as a result of cost cutting and a lower tax rate.
I have been skeptical of this story since the company was spun out of Kraft (KHC).
I think Hershey shareholders should take profits on the 16% pop in the stock. It is unlikely this $23 billion deal will get done. First, Hershey is controlled by the Hershey Trust Company, which has 81% of the company's voting power and 8.4% of the common stock. The trust was set up in 1905 by Milton Hershey, and one of its founding missions was to make decisions based on the impact to the Milton Hershey School (also set up by Hershey, in 1909) and the community of Hershey, Pennsylvania.
The Trust unanimously voted against the Mondelez offer last week. I think the Trust takes its responsibility to the children of the school and the community very seriously, and any deal would be very difficult to achieve.
Second, as a result of a 2002 state law, any deal would need the approval of the Pennsylvania attorney general. Third, any deal could face legal challenges in Pennsylvania Orphans' Court, which overseas the school and could hold up any deal.
Some investors argue it would be prudent for the Trust to diversify its portfolio and stop holding just one stock. But, shares of Hershey have outperformed the S&P 500 for 30 years. They've done a lot better than MDLZ holders.
To me, this takeover bid is a desperate attempt by MDLZ management to cover up its lousy top-line performance. Mondelez is probably running out of expenses to cut, so adding another company to the fold allows management to push its cost cutting and EPS growth agenda for another few years. Run up debt and force all the free cash flow into stock buybacks. It sounds good, but doesn't usually work too well.
Of course, hedge funds love this deal because they all fell for the Mondelez story to begin with. But they would have been better off buying an Index fund. The S&P 500 has outperformed MDLZ by 30 points since it went public.
I believe a deal between Mondelez and Hershey would leave a bad taste in your mouth. It is not a sweet deal.