PEC (Bitterly) Calls “Leverage” On Kraft

Even though some are calling Kraft’s deal for Cadbury a sweet one, to private equity firms, it tastes like sour grapes.

In light of Kraft’s generous use of leverage, the Private Equity Council, a PE advocacy group, released an analysis that can best be described as a vindictive “toldja so.” And they’re right, and they did tell us so, but still.

The PEC’s research that shows Kraft, a strategic buyer, will use more leverage (gasp!) on its deal for Cadbury than private equity did in the boom-era. For shame! According to the PEC, Kraft’s leverage ratio is 24% higher than the average debt-to-cash flow ratio for large buyout deals between 2005 and 2008. The Counsel said:

Many market commentators subscribe to a certain narrative about the supposed excesses* of the largest private equity acquisitions agreed to in the years immediately preceding the onset of the credit crunch.

I am amused because the Private Equity Counsel represents the 14 largest buyout firms in the countries, or the mega firms, yet the data they use for boom-era PE leverage is on “large” deals, defined as companies with Ebitda over $50 million. During private equity’s heyday, I believe a $50 million Ebitda company would be considered middle market, an area that decidedly uses less leverage than the mega-deals. To put that in perspective, the largest buyout target of all time, TXU, had an Ebitda of roughly 3.7 billion. Cadbury’s Ebitda is $1.67 billion.

But regardless of whether mega-buyout leverage is padded by more-conservative middle market deals, I was skeptical of the data because there is a huge difference in leverage and deal multiples by sector. Comparing one consumer products deal to buyout deals across sectors isn’t fair, because branded consumer products companies like Cadbury, with higher margins, usually garner a higher premium. But the PEC disproved that theory, pointing me to S&P data that shows Kraft is paying 23% more for Cadbury than the average 2007 private equity acquisition of retailers, and using 14% more debt.

So it seems, the PEC is right. Kraft’s deal for Cadbury is using a ton of leverage and, on average, buyout firms were not this wildly risky. But really how is that fact helping private equity? Kraft-Cadbury is a mega-deal, and unlike mega-buyouts, there will (hopefully) be cost savings once the companies combine. (Truth be told, I’m cynical about large corporate mergers, both from market observations and my own experience at two merging employers…) Either way, its just a lot of sour grapes, and who wants to eat that when there’s all this candy around?

*I really love the use of the word “supposed” here. Are we really to believe that these supposed excesses which may or may not have allowed nine of the ten largest deals of all time are actually a conspiracy created by market commentators?