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The fate of Kraft Foods (KFT, news, msgs), the world's premier maker of cookies, crackers and cheese, hangs in the balance now that its majority owner has decided to sell its 89% of Kraft to the public in the form of a corporate spinoff.
At stake is not just who gets to market Oreos, Velveeta, Lunchables and Jell-O to a snack-craving public, but the very nature of what it means to be a junk-food king in the age of an increasing focus on nutrition and health. The spinoff, Kraft-parent Altria (MO, news, msgs) said Wednesday, will happen on March 30 and give Altria shareholders 7/10ths of a Kraft share for each Altria share they own.
Wall Street has so far appeared lukewarm to the prospect of the transaction because Kraft has done a lousy job in recent years of streamlining its product lines for maximum profitability. During the 20 years it has been a reluctant part of Altria, best known for its Marlboro cigarettes, Kraft has fallen badly behind competitors such as Kellogg (K, news, msgs) in the quest to turn flour, milk and sugar into gold.
Just to give you an idea, Kraft's gross profit margins are just 36%, compared with 44% at Kellogg and 42% at Campbell Soup (CPB, news, msgs). That means its competitors spend much less on expenses like wheat, labor and marketing, or find ways to charge much more at the register, or both. On the surface, in other words, it may seem as if Kraft has built a brilliant shelf lineup that includes perennial kid favorites like Oscar Mayer Wieners, Crystal Light and American Cheese Singles, but its executives actually deserve a big fat frowny face on their report card for the way those brands have been managed.
Free the Oreo!
The depth of Kraft's misfortune can be viewed better in the stock market than the supermarket. In the past five years, shares of Kraft, which have traded separately from Altria since 2002, are basically flat, while shares of Kellogg are up 85%, Campbell Soup is up 50%, and the broad market is up 30%. Yecch! No wonder Altria wants to give this biz the old heave-ho.Should you be a buyer? Well, when the fundamental results of a famous business become so bad that its parent decides to kick it out of the house, the contrarian in you should smell opportunity. And in this case, you should pay heed, because when those new Kraft shares come on the market in the spring, they're almost certainly going to start life by crumbling like a stale biscuit. But be ready to pounce, perhaps a few weeks later around the $31 level, because they should then recover and begin a binge of appreciation.
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The reason: Liberty has its advantages. The slogan "Free the Oreo!" might not have the same ring to it as "Free Tibet!" but the concept is the same. A company like Kraft should do much better as an independent entity than as a cog in a giant machine.
To understand why, let's rewind a moment. Twenty years ago, investors applauded diversity in companies. When the cigarette maker then known as Philip Morris purchased Kraft for $12.9 billion in what was then the largest transaction in history, the market gave the deal a big thumbs up. It seemed like a good idea to become less reliant on making products that killed your customers, and the processed food business was considered a star performer.
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Video: Kraft cut looseAltria's proposed spinoff of Kraft should boost shareholder value, says Charles Norton, Vice Fund's co-portfolio manager.
Now a different theory has swept Wall Street. Investors currently prefer companies that do one or two things really well, and urge them to shed operations that divert top managers' attention from core strengths. This is one reason that you are seeing so much merger and acquisition activity, as business units are being swapped around left and right, and then repackaged and resold to investors as shiny, new, refocused entities.
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