Big Changes in Food Industry Turn Activists Upside Down
Push to reunite Kraft Foods, which activists split apart just three years ago, shows seismic shift in the food industry
Activist investor William Ackman’s Pershing Square Capital Management has built a $5.5 billion stake in Mondelez, whose brands include Nabisco. PHOTO: BLOOMBERG NEWS
Three years after the old Kraft Foods split in half with the backing of activist investors, one of the activists is suggesting those businesses ought to reunite. The move is a testament to the seismic changes that have turned the food industry upside down in that short time.
The notion of a reunion is partly behind William Ackman’s investment in Mondelez International Inc., the global snacks giant that Kraft became after spinning off its North American groceries business in 2012. Mr. Ackman’s Pershing Square Capital Management LP revealed late Wednesday it has built a $5.5 billion stake in Mondelez, 7.5% of the company.
Mr. Ackman believes Mondelez must cut costs significantly or sell itself to a rival, according to people familiar with the matter. They identified as one potential buyer Kraft Heinz Co., the company formed last month when H.J. Heinz merged with the old Kraftgrocery-brand business.
The wild card is 3G Capital Partners LP, the Brazilian private-equity firm that acquired control of Heinz in 2013 and engineered the Kraft-Heinz merger.
3G is unlikely to explore a merger of Mondelez and Kraft Heinz immediately, said people familiar with the matter, given that Kraft and Heinz closed their merger in July. Kraft Heinz has just begun its integration process, which is expected to involve huge changes to the former Kraft operations that had revenue last year of $18.2 billion. Even given 3G’s ambitious bent, it could be some time before it would be ready to digest the far larger Mondelez, whose sales last year topped $34 billion, they said. One person said there was no pressure for 3G to rush to weigh Mr. Ackman’s thesis.
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The recent run-up in Mondelez’s shares could make it too pricey for the investors, some of the people added. On Thursday, Mondelez’s trailing 12-month price-to-earnings ratio was 37, compared with Heinz’s valuation of 19 the day before its takeover was announced, and Kraft’s respective multiple of 35.
Shares of Mondelez edged up 1.1% Thursday, indicating investors had a measured reaction to Mr. Ackman’s idea.
Nevertheless, the activist’s move is part of the new reality facing big packaged-food companies, which are under pressure to trim spending amid broad weakness in sales of traditional products. Even companies like Mondelez that have already emphasized efforts to enhance efficiency are being pressed to do more.
Mondelez has one major activist on its board, Nelson Peltz, who joined in January 2014and has advocated aggressive cost cuts to expand profit margins. The company has made headway, improving its adjusted operating profit margin by 2.1 percentage points this year through June. Its shares are up about 29% this year and more than 67% since the Kraft split.
But while Mondelez has made more progress than many peers in streamlining its business, it hasn’t lived up to expectations, said Erik Gordon, a professor at the University of Michigan’s Ross School of Business.
“Peltz now has an ally who will push even harder for deeper cuts and a merger,” he said, which would create “the biggest opportunity to reduce costs.”
Mr. Peltz on Wednesday said Mr. Ackman is bright and “recognizes value when he sees it.”
A Mondelez spokeswoman said late Wednesday it welcomed Pershing Square as an investor. “We’ll continue to focus on executing our strategy and on delivering value for all our shareholders.”
A Kraft Heinz spokesman declined to comment on the potential for a merger.
Mondelez and its Big Food rivals are battling a panoply of troubles, including a major shift in U.S. consumer tastes away from traditional heavily processed foods. On top of that, they’re saddled with bloated cost structures—including inefficient manufacturing and distribution systems—built up during years of steadier growth.
Mr. Ackman was among the investors in the old Kraft Foods Inc. who favored splitting it, as were Mr. Peltz and Warren Buffett, whose Berkshire Hathaway Inc. was a top Kraft shareholder.
The argument then was that Kraft couldn’t realize the potential of its faster-growing brands, such as the Cadbury chocolates and Oreo cookies now owned by Mondelez, when it was bogged down with U.S.-focused staples like macaroni and cheese and Jell-O dessert. Those grocery mainstays, meanwhile, were said to suffer from all the company’s attention on the higher-growth brands.
At Heinz, 3G famously slashed costs and has said it expects to cut $1.5 billion from the combined company’s annual budget. Other food companies haven’t been able to cut spending to that extent, analysts said.
Mondelez’s goal to expand its profit margin by three percentage points was impressive when first announced in 2013, said Bernstein Research analyst Alexia Howard, who suggested in a note last week that Kraft Heinz might buy Mondelez and other food companies over the next years.
But, “this now seems paltry,” she said, given that Heinz boosted its margin by seven percentage points in half that time under 3G’s leadership. “Although many in private equity do purchase companies to cut costs, the extent of the cost-cutting by 3G seems rather unique.”
Christopher Geier, partner-in-charge at Sikich Investment Banking, said cutting costs behind the scenes and uniting multiple billion-dollar brands into one empire would benefit Mondelez and Kraft Heinz. “It’s no surprise to me to see more activity in this space; further consolidation is around the corner.”
While a combined company could get some savings on purchasing and distribution, it wouldn’t gain much strength with grocery chains because Kraft Heinz and Mondelez don’t have many overlapping food categories and Kraft Heinz doesn’t offer much to further Mondelez’s international expansion, analysts said.
Some analysts said a more global company like Nestlé SA would be a better fit for Mondelez or it could expand into the fresher-food segments by acquiring smaller, faster-growing companies like WhiteWave Foods Co., which owns the Horizon organic-dairy brand and Earthbound Farm salads.
Mondelez and its rivals have been using acquisitions and other tactics to try to keep up with changing U.S. eating habits. Still, the companies are struggling to provide the sales growth that they once did and that their much smaller counterparts like Chobani Inc. yogurt and Kind LLC granola bars are clocking.
“When are we going to get activist investors in these food giants whose agenda is to accelerate the trend towards healthier eating?” said Greg Wank, a partner who works on the food industry at advisory firm Anchin Block & Anchin LP.
“They’d be better off bringing their economies of scale to acquired natural brands,” Mr. Wank said, “to really ignite growth.”
