010617 Investors Expected to Feast on Kraft IPO

Chicago - Investors are betting that Kraft Foods Inc.'s initial public offering next week, like its Maxwell House coffee, will be good to the last drop.

“Very seldom do you get a quality name like this that everybody knows and can understand,” said George Wild, director of research at Indianapolis-based Heartland Capital Management, which oversees nearly $2 billion in funds. “It's probably the best food company in the world.”

Kraft, the largest U.S. food maker and a unit of Philip Morris Cos. Inc., is offering 280 million shares at an expected price of $27 to $30. The offering of a 16% stake in the company could raise as much as $8.4 billion, making it the second-biggest U.S. IPO ever after AT&T Wireless Group Inc's offering last year.

At the high end, Kraft's IPO values the whole company at about $52 billion, making it the world's second-largest food maker by market value after Switzerland's Nestle SA. Kraft will use the money to pay down debt to its tobacco parent Philip Morris for Kraft's $19.2 billion acquisition of cookie maker Nabisco Group Holdings Corp.

Kraft holds the leading position in several food categories, with brands ranging from Oscar Mayer meats to Jell-O gelatin, Kool-Aid drinks, Philadelphia cream cheese and DiGiorno pizza.

But the offering is not without drawbacks. The U.S. food industry is a slow- growing business with low profit margins. Kraft is lagging rivals in their faster growing sales overseas. The IPO is also richly priced: it values Kraft at 32 times last year's net income, well above the industry's average of 18.

Still, investors see the Kraft IPO as a hot prospect. The IPO market still is in a slump -- this year's deal volume is about a quarter of last year's -- and investors mostly are betting on energy companies and blue-chip companies with predictable earnings like Kraft.

“There is a great level of anticipation for this offering,” said David Menlow, president of IPO financial.com., a Millburn, New Jersey-based firm that conducts independent IPO research. While Menlow said he expects Kraft's IPO to be oversubscribed, he doesn't predict big spikes in early trading. “We're not looking at a runaway at the opening,” he said.

Kraft, based in the Chicago suburb of Northfield, Illinois, will become the largest publicly traded U.S. food stock, with 2000 pro forma revenue of $34.7 billion and operating income of $5.7 billion, including Nabisco. Its sales already eclipse other U.S. food makers such as Kellogg Co., General Mills Inc. and Hershey Foods Corp.

“It's going to have excellent prospects. It's not like one of those dot-com wish-and-promise companies,” said Ken Harris, whose firm, Cannondale Associates, provides strategic consulting to large U.S. food companies. “I think most people will be doing this for the long term.”

Long Shelf Life but Not Without Risk

Despite its sterling reputation, Kraft suffers from the overall slowing of food industry growth that has helped pull down its sales more than 16% since 1994. Like its North American rivals, it has been pressured by increasingly bigger supermarket chains to keep prices low.

Recent data from Information Resources Inc., which tracks sales of products in retail stores, shows that consumption trends in the United States for Kraft's 25 leading products are down slightly in the most recent 12-week period, said one industry source.

“At the end of the day, when all the hype is gone, the stock is going to trade like a food stock,” the source said.

Abroad, Kraft lags its big European competitors Nestle and Unilever Plc (quote from Yahoo! UK & Ireland: ULVR.L) in market share. The company gets only 27% of its total revenues overseas and has not made a strong effort in emerging markets such as Asia, analysts said.

That, according to Goldman Sachs analyst Romitha Mally, is one reason why its stock should not price for more than $28 a share. While she likes Kraft's prospects for North American growth, she told her clients in a recent report she believes its sales growth projections of 3% to 4% annually are high. Kraft's recent sales growth of about 2.5% still tops the industry average of about 1% yearly.

Donald Yacktman of Chicago-based Yacktman Asset Management also thinks the price looks steep.

“Realistically it is too expensive for what we're looking for,” Yacktman said. He said he wants eventually to add Kraft to his portfolio alongside Philip Morris, but initially he thinks he'll stay on the sidelines with other value investors.

There's also fear of so-called “tobacco taint” from big lawsuits that have hit Philip Morris and other big tobacco companies hard in recent years. Should Philip Morris ever need money to settle a big case, it could be forced to sell its Kraft stock.

And some worry about Philip Morris's continued role as Kraft's parent. It will control nearly 50% of Kraft's Class A shares, which will trade on the New York Stock Exchange under the ticker KFT. It also holds all of Kraft's Class B stock, which have 10 times the voting clout of the public stock, a situation that might make its stock less attractive as currency for future acquisitions.

Most market watchers, such as IPO financial.com's Menlow, said Kraft's stature and stability outweigh those concerns. “The muscle of Kraft Foods can pretty much set the terms with any bank in the world,” he said.

Kraft has been helping Americans stock their pantries for about 100 years, with long-time products such as its name-brand cheeses and Miracle Whip salad dressing. James Kraft began delivering cheese to Chicago grocers in 1903, and by 1914 he and his brothers operated a cheese factory that was selling product nationwide.

The company went public in 1924 and became part of National Dairy -- later Kraftco -- in 1930. It merged with Dart Industries in 1980, but the companies separated six years later. In 1988, Philip Morris bought Kraft for nearly $13 billion. The next year it combined Kraft with another of its well-known holdings, General Foods, creating Kraft General Foods. The two companies, which maintained separate operations, merged in 1995.

Many see Kraft's pending IPO as Philip Morris's first step toward a full spinoff that analysts wager could happen within two years.

“People want the pure play,” Menlow said.

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