Investors eager for Kraft public offering

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As if to prove IPOs are not all DOA in this economy, Philip Morris Cos. will push out the third-largest initial public offering in the New York Stock Exchange's records, a spinoff of its Kraft Foods unit.

Analysts expect the IPO to create a food-manufacturing powerhouse, a bellwether for all other stocks in that sector. Kraft alone creates a $63 billion company and will still be one of the biggest advertising spenders in the U.S. With quality IPOs very rare so far this year, investors are eager for this offering, expected in June. The only qualms raised are related to the possibility that Kraft could end up paying for its parent's tobacco lawsuits. A Kraft spokeswoman declined to comment, citing government regulations.

"They are in a very enviable position of selling top-drawer goods," said Ken Harris, partner, Cannondale Associates. He foresees a successful IPO since it's a quality company producing consumer staples at a time when investors are looking for blue-chip, old-economy stocks.

Philip Morris filed papers in April to offer 308 million shares of Class A stock, slightly less than 20% of Kraft, at $26 to $31 per share, a total of $8 billion to $9.6 billion. Earlier this month, after informal meetings with institutional investors, it revised its target price to $27 to $30 per share, still a healthy $8.3 billion to $9.2 billion payday. All the money will go to Philip Morris to pay back part of an $11 billion note related to the December 2000 acquisition of Nabisco.

Raising the big bucks

The IPO effectively will put a total valuation on Kraft of some $41.5 billion to $46 billion at an IPO price of $27 to $30.

Philip Morris pushed into the food business in the `80s with its $5.75 billion purchase of General Foods and $12.9 billion purchase of Kraft. It paid $19.2 billion for Nabisco.

Together, Kraft and Nabisco spent $1.01 billion in U.S. measured media in 2000, according to Taylor Nelson Sofres' CMR. That sum would have put the merged company in seventh place in CMR's totals; without Kraft's spending, Philip Morris drops off to just below the list of top 10 spenders.

After the spinoff, Philip Morris still will control 97.7% of the voting power over the new company, a relationship that raises questions about how insulated Kraft's holdings will be from the ongoing tobacco-liability cases Philip Morris has been fighting since the 1980s.

The filing admits the control issue could leave Kraft open to liability, but management argues it can prove in court that Kraft's assets should not be held liable for any tobacco-related judgments, based on the two companies' separate manufacturing operations.

Philip Morris is not bound to hold the rest of the stock, but according to the filing, it has agreed not to sell any of its holdings for six months after the IPO. Kraft's management statement speculates investors' fears that Philip Morris will need to sell Kraft stock to cover its tobacco-lawsuit judgments may depress Kraft's share price.

Goldman Sachs analyst Romitha Mally translated that tobacco-related risk to a 5% to 10% discount on the stock's price, a problem shared by Nabisco during its years with R.J. Reynolds Tobacco Co. within RJR Nabisco. Because of the tobacco litigation, Philip Morris can't simply spin off the company to its shareholders without facing charges of "fraudulent conveyance"-sheltering assets from liability.

While Kraft is a powerhouse in the U.S., its international unit is far behind Nestle in the international markets. It will need to make an international acquisition overseas, possibly funded with its new stock, according to Ms. Mally's analysis. But the Philip Morris control could be a hurdle, she added.

Committed to Growth

"Some potential targets are likely to prefer cash rather than the opportunity to be a large shareholder in a company that will be controlled by Philip Morris through supervoting stock," Ms. Mally wrote. Philip Morris will retain 100% of the Class B stock, which has 10 votes per share, while Class A has only one vote per share.

Management's discussion notes Kraft's 15 largest customers account for 40% of its sales revenue, and the continuing grocery consolidation will require lower pricing and more spending on trade promotion. Still, the company has committed to 3% to 4% annual volume growth and 18% to 22% in earnings growth over the next three years.

Kraft anticipates that synergies from the Nabisco merger will help it reduce marketing costs by 5% to 7% annually. According to IPO filings, Kraft and Nabisco spent a combined $1.4 billion globally on advertising last year. The marketing reduction could mean some $70 million to $98 million in spending cuts.

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