Kraft Deal Has Investors Saying Cheese
Investor enthusiasm for the upcoming Kraft IPO shows a clean conscience -- or at least a clean record - and that's worth a lot these days.
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The Kraft IPO looks as if it will be the second-largest in U.S. history, behind last year's spinoff of
AT&T Wireless
(AWE)
. Tobacco giant
Philip Morris
(MO) - Get Report
will let go of a 16% stake of the big foodmaker in the IPO, which is expected Wednesday. If Kraft prices at the top of its $27 to $30 range Tuesday night, it will take in $8.4 billion, giving the company an implied
market capitalization of $52 billion.
Velveeta Gold
That's the market cap if the shares remain flat on the first day of trading -- an unlikely scenario given demand for the offering. This is the most widely anticipated deal of the year, and investors are clamoring for their piece. Big as this deal is, however, it doesn't seem as if there are going to be enough shares available to sate initial demand.
"I know we're not going to get enough to make a position," says one hedge fund trader, who reckons she'll end up flipping any stock she gets and then taking a look at the company again later on, when things have settled down.
Puff, Puff |
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Even if it hangs near its offering price, Kraft will by no means be cheap. At $30, its
price-to-earnings ratio would be about 30 -- fairly rich for a company whose earnings have been growing at an annualized rate of about 10% over the past couple of years. With similar earnings growth,
General Mills
(GIS) - Get Report
has a P/E of about 20.
"It's not cheap," says
PNC Advisors
food and tobacco analyst Ruairi O'Neill of the Kraft IPO. "But it's reasonable. It's a strong company, great brands, great track record. I don't see it going through the roof, but I think it will be OK. There's a lot of money on the sidelines looking for a quality IPO. I think this fits the description."
Whether O'Neill is right on the appropriateness of Kraft's valuation, one thing is certain -- it's going to be a heckuva lot more richly valued than its parent.
Tar Stains
At the close on Friday, Philip Morris had a total market capitalization of $106 billion -- almost exactly twice the capitalization of Kraft, if it prices at the top of its range. Yet Philip Morris' earnings last year were about four times Kraft's, and historically it has grown earnings at about the same rate as its subsidiary.
The obvious difference between the two companies is that Philip Morris still carries the stink of tobacco lawsuits -- something investors were reminded of Wednesday when a Los Angeles jury awarded $3 billion to a smoker in a suit against the company. Kraft is basically free of such worries. The most extreme thing that could happen to it is that Philip Morris would have to hand over its Kraft shares to tobacco plaintiffs -- but that would happen only if the company was forced into bankruptcy, in all likelihood.
In turn, that would probably happen only if Philip Morris hasn't distributed its stock in Kraft to its shareholders -- something O'Neill thinks the company will do at some point. After Kraft goes public, Philip Morris will still hold 84% of the company. If Kraft goes out at the top of its range, a big chunk of Philip Morris essentially becomes tobacco-free. If Kraft is the kind of IPO it's cracked up to be, and ends up going even higher on the first day of trading, that chunk gets bigger. By spinning off Kraft, Philip Morris has essentially put its tobacco-suit exposure into a box. It has made its stock a less risky investment.
And when the risk associated with an investment goes down, its price usually goes up.