U.S. food giant Kraft could raise its bid 20 percent up to 12.3 billion pounds ($20.1 billion) to seal a takeover deal for Britain's Cadbury without losing a key investment grade rating on its debt.
Cadbury immediately rejected Kraft's bid, launched on September 7, which then valued Cadbury at 745 pence a share, but analysts believe the world's second largest food group could, if needed, bid 850-900p to swallow the Dairy Milk chocolate and Trident gum group.
With a counterbid seen as unlikely, the phony war between Kraft and Cadbury could go on for weeks, with Kraft leaving time to put pressure on Cadbury's board to talk, and Cadbury reluctant to engage without a better formal offer on the table.
Comments by Kraft's biggest shareholder, billionaire investor Warren Buffett, have led to speculation that U.S. chocolate maker Hershey may join Kraft to help fund the Cadbury bid and break up the spoils between them.
We believe at a price of 860p Kraft can increase the cash component of the transaction to at least 65 percent, and maintain an investment grade rating, said analyst David Tovar at Bank of America/Merrill Lynch.
Credit Suisse's Robert Moskow says Kraft has communicated with the debt rating agencies, and it sounds as if they are comfortable with what it has presented so far.
We believe Kraft has a lot of leeway with the agencies to increase its bid, said Moskow, who believes Kraft will need to pay 850-875p to win the battle for the confectionery group.
Sanford Bernstein suggests Kraft might have the flexibility to raise its bid up to 900p, Analyst Andrew Wood said: We consider that Kraft will need to increase its offer up to 900p in order to stand a good chance of getting the deal done.
Kraft's bid of 40 percent cash and the rest in new Kraft shares initially valued Cadbury at 10.2 billion pounds, but a fall in Kraft shares puts the current value at 720p or 9.9 billion pounds, compared with the current share price of 786-1/2p.
Rating agency Fitch puts Kraft's debt on a BBB rating, two notches above junk status, where raising money becomes very expensive, while S&P has Kraft on BBB+, and both placed Kraft on a negative rating watch after the bid was announced.
However, Buffett, whose Berkshire Hathaway owns 10 percent of Kraft, doubts Kraft has the shareholder support to raise its bid significantly, and said it has the disadvantage of using its undervalued stock.
Help for Kraft might be on hand, though, after Buffett's favorite banker, Byron Trott, was reported to have been hired by the charitable trust which controls smaller rival Hershey to weigh up a possible move for Cadbury.
While Trott's appointment may be unrelated to Buffett, it did set analysts speculating a Kraft-Hershey combination may be able to bid a higher price for Cadbury, and Buffett's help was a major factor in bringing Mars and Wrigley together last year.
A further boost to Kraft's bid could come from a reassessment of its potential annual cost savings target of $625 million, as the savings equate to just 6.5 percent of Cadbury's annual sales, compared with deals in the food sector of between 6 and 10 percent.
We believe a savings target of $750 million - 7.8 percent of Cadbury sales - is not unrealistic to use, said Tovar.
If no counterbidder emerges and Kraft drags its feet on coming up with a formal offer, Cadbury could request the UK Takeover Panel to use a Put up/Shut up notice to Kraft, requiring Kraft to announce a firm formal offer or withdraw.
These delays could see a firm offer only made by the end of November and a deal closing by end-March 2010, Tovar said.
(Reporting by David Jones; editing by Simon Jessop)