Catching the KitKat

Related tags Hershey Chocolate Hershey foods

Nestle believes it will walk away with lucrative US rights to its
KitKat brand whether or not it wins a takeover battle for American
chocolate icon Hershey because of a deal dating back to 1970,
reports Reuters on Thursday.

Nestle believes it will walk away with lucrative US rights to its KitKat brand whether or not it wins a takeover battle for American chocolate icon Hershey because of a deal dating back to 1970, reports Reuters on Thursday.

KitKat, made in the United States under licence by Hershey, is seen as a crown jewel in a potential merger deal that analysts say could fetch a total of $12 billion (€12.2m).

Industry sources say Nestle, the world's largest food group, has a relatively weak third position in the US chocolate market and is keen to gobble up market leader Hershey, which was put up for sale last month.

The same sources suggest that US food group Kraft Foods is also keen and the Hershey sale could turn into a bidding war. However a Kraft purchase may come without KitKat, the fifth-biggest selling chocolate confection in the United States and a top global brand.

Any change in voting control of the famed maker of Hershey's Kisses is expected to trigger a clause that lets the Swiss-based food group regain KitKat sales estimated at some $300 million.

"On our side (there is) a conviction that any change of control -and I do believe that a management buyout qualifies as such -triggers the clause,"​ Nestle spokesman Francois Perroud told Reuters.

He said it was "a key consideration" that the US KitKat brand reverts back to Nestle, but declined to reveal any financial terms.

"Since KitKat is one of Hershey Foods' five most important brands contributing some $300 million or seven per cent to Hershey's sales, Nestle is clearly out front of Kraft,"​said Bank Vontobel analyst Rene Weber in a note.

Nestle inherited both KitKat and the licensing deal with Hershey when it bought British confectioner Rowntree in 1988. Rowntree gave Hershey US Kit Kat distribution rights in 1970 and similar rights in 1971 for its Rolo brand, which also would revert to Nestle in the event of a Hershey sale.

KitKat, the UK's top-selling chocolate bar, was launched in 1935 as Rowntree's Chocolate Crisp. It was renamed KitKat in 1937 after an 18th century literary club.

Jaine Mehring, analyst with Salomon Smith Barney, estimates KitKat contributes six to seven per cent of Hershey's operating (EBIT) income, which was $118 million in the second quarter.

"As we understand the agreement, Nestle pays nothing to take the business back,"​ Mehring said in a recent note, although Nestle was unlikely to be able to start producing KitKat instantly in its own US facilities.

But other analysts are not so sure. Goldman Sachs analyst Romitha Mally said in a recent research note that a loophole in the licensing agreement could allow Hershey's business to change hands without a transfer of voting rights.

"We believe there are ways to structure a deal without technically triggering a change of control such as a direct merger, reverse merger or possible joint venture structure with the Hershey Trust,"​ Mally wrote.

Goldman's investment banking arm is advising Britain's Cadbury Schweppes in the Hershey bidding, sources close to the situation said.

A Hershey spokesman declined to discuss the KitKat licensing agreement.

Nestle has long expressed an interest in acquiring Hershey, which analysts say has better profit margins than its own chocolate business, although Nestle will not comment officially.

"It is fantasy to say they are not seriously interested,"​ said BNP Paribas analyst John Keele, saying Nestle would gain potential synergy savings and a boost to its margins.

"In the short term, the market fears that Nestle will pay too much but from a long-term perspective, the world's largest food company is not going to allow that to get in the way of a business they have wanted for many, many years,"​ he added.

The battle for control of Hershey has also moved from the boardroom to the courtroom as the decision by the Milton Hershey School Trust, which owns 77 per cent of Hershey's voting rights, to sell the firm has aroused local political opposition.

A Pennsylvania judge on September 3 will hear arguments on a proposed restraining order to bar a Hershey sale. There are fears that a new owner would close plants and lay off workers in the town that derives its name and identity from the company.

But analysts say Nestle, given its weak US position, may integrate its operations into Hershey's rather than the other way around, which would actually strengthen Hershey's role.

Nestle's shares have lost around 10 per cent of their value in a little over a week on fears that the firm will overpay and on concerns that any deal would be drawn out because of political opposition and anti-trust issues.

Buying Hershey would vault Nestle to the top US market position over M&Ms maker Mars, but the combined entity would have more than half of the US chocolate confectionery market, raising regulatory concerns, according to Vontobel's Weber.

Credit rating agencies Moody's and Standard and Poor's said on Wednesday that Nestle would lose its top debt rating in the event of another big debt-financed acquisition. The firm has been swallowing companies in the fast consolidating food sector.

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