Nestle waits for market pressures to soften Hershey

Nestle, the world's largest food group is set to drop to No. 3 in the chocolate world behind Mars-Wrigley and Kraft-Cadbury, an unfamiliar role for a company that holds No. 1 or No. 2 positions in all its key segments.

Buying Hershey would solve that problem to put it at No. 1, and while the charitable Hershey Trust controls 80 percent of voting shares at the maker of Hershey Kisses, effectively blocking any takeover, analysts believe hurdles preventing a takeover or even a joint venture will now start to ease.

They argue that after Kraft and Cadbury join together, Hershey's main U.S. market will become more competitive and that Hershey as a pure confectionery player is more exposed to commodity costs like cocoa and sugar than wider ranging groups.

We believe a deal for Hershey could be secured at around $10-11 billion plus a $2 billion debt take-out, said analyst Deborah Aitken at brokers Bryan Garnier.

This would put Hershey's price on a multiple of 14 times its underlying operating profit, or earnings before interest, tax, depreciation and amortization, compared to the Kraft-Cadbury deal agreed at 13 times EBITDA, Aitken added.

Kraft is expected to seal its recommended 11.6 billion pound ($18.7 billion) deal for Cadbury, with shareholders of the British group due to vote by February 2.

The fact that Hershey had been actively trying to fund a bid for Cadbury, even if it ultimately failed, has also raised speculation about its future, as has the fact that 85 percent of its sales come from the U.S. market, where Kraft is likely to attack it with Cadbury products.

We wonder whether investors begin to view Hershey as a potential seller at some point, rather than a buyer, said analyst Andrew Lazar at Barclays Capital.

BULCKE'S WARCHEST

Nestle has plenty of firepower with $28 billion from the sale of its remaining stake in eyecare group Alcon and although it favors share buy backs and small bolt-on deals, for a group with market capitalization $176 billion, Hershey might be seen as no more than a large bolt-on.

Nestle's CEO Paul Bulcke said in September that the group planned no major acquisitions in 2010, but then saw an opportunity to snap up Kraft's U.S. pizza business for $3.7 billion and may look to his next move to strike a deal with Hershey's CEO David West.

Belgium-born Bulcke took over as CEO in April 2008 after turning Nestle Americas into its biggest and most profitable region, so he will know all about Hershey's big lead over Nestle in the U.S. chocolate market.

When Nestle confirmed it would not bid for Cadbury earlier this month it said it did not intend to make or participate in a formal offer sparking talk that the word participate meant it had been planning a joint bid with Hershey for Cadbury.

Nestle's confectionery unit has annual sales of 12.4 billion Swiss francs ($11.88 billion), accounting for 11 percent of group sales. Its underlying sales in the first nine-month of 2009 rose 4 percent -- not growing as fast as coffee and pet food but well ahead of bottled water, milk products and prepared meals.

SUPERB FIT

In the chocolate world, Hershey is one deal Nestle could do without big anti-trust issues, and would have the advantage of getting back rights to some of its brands in the U.S. market.

For Nestle, Hershey is the deal it would like to do. It would have no major anti-trust problems, address its weakness in U.S. confectionery and get back its license to KitKat, said an industry insider with knowledge of the situation.

When Nestle bought Rowntree in 1988, the British chocolate maker had already given up its U.S. rights to KitKat and Rolo to Hershey in the early 1970s, so the return of these brands would give a big boost to Nestle's U.S. confectionery business.

We see Hershey as a superb fit into Nestle's portfolio, being able to boost Nestle U.S. chocolate market share to competitive levels, Aitken said. She put Hershey's share at 30 percent, similar to Mars and both ahead of Nestle on 6 percent.

RBS analyst Julian Hardwick said there were big impediments to a number of rumored deals for Nestle: a purchase of baby food group Mead Johnson would bring anti-trust issues, while closer ties with General Mills, its partner in a breakfast cereal venture, are hampered by a standstill pact that extends to 2040.

Nestle has 30 percent of the world's biggest cosmetics group L'Oreal but cannot raise its stake until six months after the death of Liliane Bettencourt, the daughter of the firm's founder and owner of a 31 percent stake, who is 87 years old.

Hershey's West is currently focused on turning around the underperforming group, increasing marketing and help stabilize its U.S. market share, pushing through price rises to counter commodity inflation and cutting back on costs.

(Additional reporting by Emma Thomasson)

(Reporting by David Jones; Editing by Sitaraman Shankar)