Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Hey Mondelez, how does $125 a share look now?

It was just two months ago that Mondelez International Inc., the $70 billion international snacks business formerly part of Kraft Foods, dropped a poorly executed attempt to acquire chocolate behemoth Hershey Co. Mondelez had made a low-ball bid of $107 a share in cash and stock, which was difficult to take seriously when Hershey -- a trust-controlled entity with deep ties to its hometown, long considered an unwilling seller -- already traded in the high $90s. It was reported at the time that Hershey would only discuss a sale to Mondelez if the price started at $125 a share. The talks never did begin.

Stale?
Hershey's stock nearly tripled from 2009 through 2013. But as growth has slowed, so have its returns:
Source: Bloomberg

On Friday, Hershey shares surged about 6 percent to $101 and change after it reported better-than-expected third-quarter profit on sales that were in line with estimates. The $22 billion company is trying to show investors how it can hold up as not just candy makers, but the entire packaged-food industry faces slow-to-no growth and many consumers turn toward healthier-ish options. Hershey has cut costs including advertising spending and is ramping up innovation by introducing new versions of old favorites, such as the Reese's Pieces peanut butter cups mashup -- yet another iteration of a more than 80-year-old product.

Hershey's recent performance could warrant another more thoughtful look from Mondelez, which is the second-biggest seller of chocolate globally thanks to its Cadbury brand but is trying to make a push into the U.S. chocolate market. (The Oreo-branded candy bars you may have noticed on your store shelves aren't just a one-off thing.) Buying Hershey, the industry leader, would be much easier.

Chocolate, Bar None
They say there's no wrong way to eat a Reese's
Source: Euromonitor International, Bloomberg Intelligence
North American chocolate confectionery market *Hershey has the rights to sell Kit Kat in the U.S.

Mondelez, which was intended to have more of an international focus, is now realizing that because of sugar-addicted Americans, the U.S. is still probably the best place to be. That's especially true when the strong U.S. dollar is eating profit earned overseas. Hershey is still North America-centric. 

United States of Sugar
Hershey generates almost all of its revenue in the U.S., while more than a third of Mondelez's sales come from Europe and an additional 30% is split between Asia and Latin America
Source: Bloomberg
Trailing 12-month revenue

Those points aside, the longer-term outlook for Hershey isn't so rosy that the company is above selling itself should it receive a fair offer. Aside from the boost it got when Mondelez proposed a merger, Hershey's stock has been flat for two years and only one of 21 analysts tracked by Bloomberg recommend buying the shares at these levels.

Sugar Crash
These past few months, Hershey has gotten the least love from analysts since the U.S. recession in 2009
Source: Bloomberg

Hershey is working to drive down costs, the same strategy that helped Mondelez post profit this week nearly 20 percent above analysts' average forecast. But you can't cut costs forever to make up for a lack of growth, especially as competition intensifies. Aside from Mondelez getting into the U.S. chocolate game, earlier this month Mars Inc., the maker of M&Ms, said it was buying out Warren Buffett's $2.1 billion preferred stake in its Wrigley chewing-gum business, making it easier for Mars to combine its chocolate and gum units. 

There are also questions about the sustainability of Hershey's gross margin and whether it's reached a peak. The company has been making bolt-on acquisitions of faster-growing brands, such as Krave jerky and BarkThins, but the catch is that these diversification efforts may run counter to its margin-expansion goals, given that snacks generally carry lower margins than its U.S. chocolate products. So Hershey may face an internal tug of war between growth and profitability, which could be easier to balance out within a broader entity.

King-Size Margin
After incurring costs of goods sold, Hershey has a lot left over -- but this may be as high as its gross margin can go as it adds snacks to the mix. In addition, its operating margin has room for improvement.
Source: Bloomberg

Let's also not forget that Hershey CEO J.P. Bilbrey is on his way out. Bilbrey, who has been at the company for more than a decade and at the helm since May 2011, plans to step down by next summer. The board has tasked a special committee with searching for his replacement, which always brings a certain degree of uncertainty as far as future strategy.

The timing of this, alongside a shakeup of the scandal-laden trust that controls Hershey, potentially makes a merger more feasible next year. Because the trust is legally obligated to finance the Milton Hershey School for underprivileged children, though, any acquirer would need to continue providing that support. A deal also hinges on the Pennsylvania attorney general not opposing a transaction. So there are still hurdles, but perhaps they're lessening.

Mondelez is no doubt keeping an eye on these developments, plus it has Bill Ackman's Pershing Square Capital Management and Nelson Peltz's Trian Fund Management among its shareholder ranks and they're waiting for the company to do something -- eat or be eaten. Should Mondelez relent and come back with a bid proposal in the neighborhood of what Hershey's looking for, that may be good and plenty to bring the chocolate maker to the negotiating table and give investors their pay day.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net