SAN FRANCISCO (MarketWatch) — Kraft Foods Inc. is selling off its red-hot pizza business to raise more cash for its hostile pursuit of Cadbury PLC, making a long-term bet instead on chocolate.
On Tuesday, Kraft /quotes/comstock/13*! kft/quotes/nls/kft (KFT 28.55, -0.22, -0.77%) sold its frozen-pizza business to Nestle SA /quotes/comstock/06p!nesn-otc (CH:NESN 49.16, -0.54, -1.09%) for $3.7 billion in cash, a move to increase its war chest to acquire U.K. chocolate maker Cadbury /quotes/comstock/23s!a:cbry (UK:CBRY 770.00, -11.00, -1.41%) /quotes/comstock/13*!cby/quotes/nls/cby (CBY 49.13, -0.60, -1.21%) .
Kraft’s pizza business includes DiGiorno, Tombstone and Jack’s in the United States and the Delissio brand in Canada. The deal also includes rights to the California Pizza Kitchen trademark license. It is expected to generate $1.6 billion in 2009 sales.
Analysts were a bit taken aback. Kraft’s frozen-pizza business has been a star performer during the so-called Great Recession — a period in which the company has lost U.S. market share and struggled to grow sales and volume shipments.
Pizza sales at Kraft have risen by the “double-digits” for eight straight quarters as budget-minded consumers have found frozen pizzas a cheaper alternative to eating out.
“The sale is somewhat surprising considering Kraft touted its success in frozen pizza, and it has been a strong growth contributor to the company,” said Craig Hutson, senior analyst at Gimme Credit, an independent-research service on corporate bonds.
For instance, DiGiorno sales have jumped 20% in each of the past two quarters.
“The pizza franchise has been a good business,” said Edward Jones analyst Matt Arnold, who rates Kraft shares a hold. “The fact that they are willingly to give up that business shows they are very serious about pursuing Cadbury. ”
Nestle said Kraft’s pizza business had a 2009 operating profit of $297 million and an operating margin of 14.2%. The deal is valued at 1.8 times estimated 2009 sales.
Morningstar analyst Erin Swanson said Kraft is getting a “fair price” for the pizza unit. “We believe this move signals management’s belief that the high-growth confectionary business is a far more attractive space,” she wrote in a research brief.
Profit margins in the chocolate business are fatter than most other products in Kraft’s $42 billion food portfolio. But swapping pizza for chocolate may prove to be a gamble. Whether or not Kraft succeeds in acquiring Cadbury is in question.
Its bid hit a roadblock Tuesday after Warren Buffett’s Berkshire Hathaway Inc. /quotes/comstock/13*!brk.a/quotes/nls/brk.a (BRK.A 99,621, -89.00, -0.09%) voted against a proposal to fund the deal by issuing millions of new shares. Berkshire controls 9.4% of Kraft’s shares. The deadline for Cadbury shareholders to accept Kraft’s offer is Feb. 2. Read more on Buffett criticizing Kraft deal for Cadbury.
Jeff Auxier, portfolio manager of the Auxier Focus Fund /quotes/comstock/10r!auxfx (AUXFX 14.25, +0.02, +0.14%) , has been worried that Kraft will overpay for Cadbury, which has rebuffed Kraft’s overtures more than once. He surmises that Kraft shares will lag the stock market for five years if the food giant makes a higher bid.
“We were frustrated and were wondering how to stop this thing getting out of control,” Auxier said. “Finally [Buffett is] stepping up and saying that these prices make no sense. The board isn’t stepping up, but thankfully he is.” Read story on Buffett’s unusual activism with regard to Kraft.
In trading Tuesday, Kraft shares jumped almost 5% to $28.77.