Is Parting Sweet for Cadbury?
By Janet Morrissey
Cadbury Schweppes' two-pronged portfolio of candy and soft drinks wasn't too far off strategically from the soft-drink and snack-food approach that has served PepsiCo so well. The difference is that Pepsi has Pepsi, not Dr Pepper, as a top brand and an organization that can execute to the last bottle cap. For Cadbury, growing two separate businesses proved an insurmountable task, undone by bad execution, bad luck and the weird actors who dominate candyland--the secretive, privately held Mars Inc. and the stumbling, publicly held Hershey Co., which is controlled, ineptly, by the Hershey Trust Co.
Under relentless pressure from shareholders like agitator Nelson Peltz to sell its beverage business--yet unable to find a buyer given the collapse of the credit markets--Cadbury spun off its soft-drinks unit as the Dr Pepper Snapple Group earlier this year, leaving it once again a stand-alone candy company. And a relatively diminished one. Cadbury was dethroned as the king of candy by the surprise buyout of Wrigley by Mars, giving Mars-Wrigley a 14.4% share of the global confectionery market, compared with Cadbury's 10.1%, according to Wachovia Capital Markets.
But the spin-off also leaves a pure-play candy outfit that might be able to find chocolatey growth again. "We're focused on delivering," says CEO Todd Stitzer, the veteran Cadbury executive who is only the second person outside the Cadbury family to run the shop. Stitzer is predicting that yet another restructuring--the company plans to close 15% of its factories and ax 15% of its workers in the next four years--will allow Cadbury's chocolate, candy and chewing-gum business to deliver annual sales increases of 4% to 6% and profit margins in the midteens by 2011 from its current level of around 10%.
Wall Street thinks Stitzer can do it. In the first half of 2008, sales (unadjusted for currency) rose 14%, to $5.27 billion. Cadbury's clever drumming-gorilla ads helped too. Morgan Stanley said in a recent report that "unlike with many other consumer stocks, we expect Cadbury's earnings growth to accelerate." Says David Morris, food and beverage research director at Mintel International Group, a market-research company: "The spin-off is a smart move. Investors had felt these businesses weren't getting their appropriate valuations when they were combined." As stand-alones, they can also grow by attracting merger partners, he says.
Over the years (the company dates to 1824, when John Cadbury, a Quaker in Birmingham, England, opened a shop selling tea, coffee and chocolate), Cadbury has snapped up some impressive brands, including such names as Dr Pepper, 7Up, A&W, Canada Dry, Sunkist and Snapple, which came as part of its merger with Schweppes in 1969. On the candy side, it was Stitzer's 2003 acquisition of Adams, which included the Halls, Dentyne and Trident brands, that transformed Cadbury into the world's largest confectionery company.
Despite its scale, Cadbury has been hobbled by decisions made years, even decades ago that have hampered its ability to compete globally. For instance, Cadbury doesn't control its own chocolate brand in the U.S., having sold those rights to Hershey in 1988 under a 25-year agreement that only Hershey can terminate. The idea at the time was that Hershey had the distribution power Cadbury was lacking to compete with Mars and Nestle. But losing control of your own brand's destiny in a major market doesn't look smart today.
Logically, it made Cadbury and Hershey potential merger partners. Indeed, Cadbury has had on-and-off merger talks with Hershey for more than a decade and even teamed with Nestle in a failed $10.5 billion bid for Hershey in 2002. The latest talks occurred in 2007 between Stitzer and then Hershey CEO Richard Lenny. But Lenny was ousted from Hershey in an ugly shake-up later in the year. Hershey continues to stumble--most recently when it raised prices 10% in response to rising costs, a move that hit its stock hard.
Stitzer has also engineered a series of restructurings. Beginning in 2003, he sold off low-margin businesses, closed about a quarter of the company's factories and cut 10% of its workforce. But a series of missteps hindered the company's turnaround. Although Stitzer had projected annual margin growth of 50 to 75 basis points for four consecutive years, it came in at less than half that.
On the beverage side, Cadbury was equally handicapped. The company sold its rights to Dr Pepper outside North America to rival Coke and Lion Blackstone in 1999, which made it difficult to compete head to head with international powerhouses like Pepsi--and Coke. "We really can't go back on the deal," says Larry Young, a 30-year Pepsi veteran who was coaxed out of retirement to head the beverage business. "I don't think you'd ever get Coke to sell it back. If I were them, I wouldn't."
Dr Pepper also has old distribution deals with Coke and Pepsi bottlers, which Goldman Sachs analyst Judy Hong describes as a "potential Achilles' heel." According to Hong, "there is an inherent conflict of interest because Pepper's distribution platforms are also its largest competitors'," and as an example, she cites Pepsi's Sierra Mist displacing 7Up as the No. 2 lemon-lime brand, behind Sprite, in part because Pepsi Bottling stopped distributing 7Up.
That makes the newly spun-off Dr Pepper Snapple Group a bit of a soft-drink Frankenstein, cobbled together from odd parts. Dr Pepper has acquired about $1.2 billion in bottling assets over the past two years, and that will likely continue, which bodes well for its longer-term outlook, says Wachovia analyst Brian Scudieri. Young is predicting that the Dr Pepper Snapple Group will deliver annual revenue growth of 3% to 5% and earnings-per-share increases in the high single digits over the next few years.
Now that the two companies are separated, Wall Street buzz naturally revolves around their merging with or buying other companies or being sold themselves, especially in the wake of the Mars-Wrigley deal. "We believe [the spin-off] makes Cadbury a more attractive potential acquisition target, especially for Kraft," says Andrew Wood, a Sanford C. Bernstein & Co. analyst.
Stitzer says he's under no pressure to do a deal. When Nestle acquired Rowntree in 1988, there were similar predictions of industry consolidation that never materialized, he says. "I don't think I'd be a proponent of the domino theory of consolidation." He insists he's committed to achieving revenue and margin growth targets to restore investor confidence and sees Cadbury as more of an acquirer than an acquiree. "We're always looking for the right bolt-on acquisition," he says.
Cadbury's operating margins expanded 190 basis points in the first half of 2008, and Stitzer expects this to continue despite the economic downturn. "We don't sell automobiles," he says. "We sell small moments of pleasure--small treats that are affordable in most circumstances." The question is, Can Cadbury sell enough of them?