September 25, 2009 / 7:13 PM / in 8 years

Arbs: Cadbury price hopes may be overblown

NEW YORK/PHILADELPHIA, Sept 25 (Reuters) - U.S. arbitrage investors have bet that a white knight will not materialize in Kraft Foods Inc’s KFT.N unsolicited bid for British confectioner Cadbury CBRY.L, with some warning about too much optimism over a higher deal price.

Kraft unveiled its bid, currently valued at around 10 billion pounds ($15.9 billion), earlier this month and was quickly rebuffed by Cadbury.

Shares of the British company surged more than 40 percent after Kraft’s offer and have settled above the implied value of the bid, currently around 730 pence in cash and stock.

Cadbury shares are trading at about 804 pence, about 10 percent higher than the Kraft bid, and some analysts believe it could take an offer of up to 900 pence to swallow the chocolate maker.

But one arbitrage investor suggested that Cadbury’s stock was already “pricing in a lot of optimism,” and could limit profits if the company accepts a deal below investor expectations.

That investor said Kraft might attempt to “push the timeline out and convince the market that they are the only game in town. Then negotiate.”

That would also allow arbitrageurs, who are more likely to be concerned with a short-term payday than a company’s long-term prospects, to snap up a bigger share of Cadbury.

Large Cadbury investors are already expressing concern that Chief Executive Todd Stitzer may overplay his hand in trying to secure a higher price [ID:nLP429502].

On Friday, Stitzer clarified remarks made earlier this week that were construed as being more open to the deal after coming under scrutiny from Britain’s Takeover Panel [ID:nLP537188], and also said the Kraft offer made no strategic sense.


Kraft investors say they also don’t believe the company has much leeway to raise its bid.

Kraft CEO Irene Rosenfeld “will have to go a little higher, but the question is, what’s my threshold of pain?” said one fund manager who owns more than 60,000 shares of Kraft. “Maybe it is 10 or 20 percent more. Any higher than that and I probably won’t be a shareholder anymore.”

More than 280 million of Cadbury’s shares have traded since the deal was announced on Sept. 7. While many of those trades likely involved the same shares changing hands several times, that volume accounts for roughly a fifth of the British company’s outstanding shares.

The company has American depositary shares CBY.N that have also been trading above their normal volumes.

One arbitrageur said there was money to be made from the Kraft-Cadbury dance, but no major excitement as it plays out.

“This is lining up as a typical M&A play: unsolicited bidder lobs a reasonable, but not yet full price. Target balks. Bidder will likely tweak the price or the mix of securities being paid enough to trigger a negotiation. Deal happens. Pretty cut and dry,” the arbitrage investor said.

Some arbitrageurs, who speculate on companies involved in ongoing deals, said they were long Cadbury and short Kraft in a typical arbitrage play.

Others had not shorted Kraft’s stock as much as they normally would in order to account for the possibility of a counterbidder. Some had doubled their risk by going long on both stocks -- known in the industry as a “Texas hedge.”

One London-based merger arbitrageur said the deal was being closely followed by hedge funds overseas, which had endured a barren 2009 without any European deals where stock could be bought or borrowed in sufficient quantities to place big bets.

“It’s really the only liquid M&A deal that we’ve had all year in Europe,” he said. But funds were split over whether the deal would drag out for months or Kraft would move to complete a takeover quickly, he added.

Reporting by Michael Erman and Jessica Hall; Additional reporting by Ross Kerber and Quentin Webb; Editing by Richard Chang

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