Business & Finance essay
Harvard Business School 9-289-045 Philip Morris Companies and Kraft, Inc. John M. Richman, the chairman and chief executive officer of Kraft, Inc., concluded his October 23, 1988, letter to shareholders as follows: We deeply regret the dislocation and hardships that the [restructuring] plan we contemplate will cause, and we will seek to ameliorate these hardships as much as possible. We know that our shareholders, employees, customers, suppliers and communities recognize that today’s situation is not of our making. Rather it is the product of current era investment policies and financial attitudes that favor shortterm financial gratification over steady, long-term growth and the need to provide a sound economy for future generations. It will take several years, but with the history and traditions of Kraft and the dedication of Kraft people, we are confident that we will rebuild Kraft to the position it occupies today. The letter announced a radical restructuring of Kraft in response to a hostile tender offer by Philip Morris Companies: $90 per share in cash for all of Kraft’s outstanding common stock. The offer had been announced just five days earlier, on October 18, 1988. Kraft, Inc. In 1987, Kraft was known for such brand names as Miracle Whip, Seven Seas, and Kraft salad dressings; Kraft mayonnaise; Velveeta cheese; Parkay and Chiffon margarines; Lender’s Bagels, and Breyers ice cream. Net sales from continuing operations were $9.9 billion in 1987, an increase of 27% over 1986. Net income from continuing operations rose 11%, to $435 million. Exhibit 1 presents operating and stockholder information for Kraft from 1982 through 1987. Exhibit 2 presents balance sheet information for 1986 and 1987. Kraft’s strategy was focused on food. Its 1987 annual report stated: The food industry offers such diverse and rewarding opportunities that we see no purpose in running the risk of diluting our efforts or our focus with other lines of business. This all-food strategy was in sharp contrast to its earlier diversification program. Most of the diversification occurred when Mr. Richman engineered the September 1980 merger between Kraft This case was prepared by Professor Richard S. Ruback as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1989 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http:/ / www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1 and Dart Industries, a $2.4 billion consumer products manufacturer. Mr. Richman, who had been promoted to chairman and CEO less than 1 year before the merger, noted that the merger brought “diversification in one fell swoop to Kraft.” Dart’s products included Tupperware containers, Duracell batteries, and West Bend appliances. The merger was accomplished by exchanging one share of the merged company, Dart & Kraft, for each outstanding share of the two preexisting companies. Dart & Kraft was the twenty-seventh-largest company in the United States at the time of the merger. Six months later, in March 1981, Dart & Kraft acquired for $460 million Hobart Corporation, the manufacturer of KitchenAid and other food-related equipment. Richman reversed direction and began pursuing the all-food strategy in 1986. Kraft spun off most of its nonfood businesses acquired in the Dart & Kraft merger into Premark International, Inc., on October 31, 1986. Each shareholder of Dart & Kraft received one share of Kraft common stock and a quarter share of Premark. Kraft, with sales of about $9.9 billion after the spin-off, retained its food businesses and Duracell batteries. Premark’s share of Dart & Kraft included Tupperware and Hobart food service equipment, with combined sales of $1.8 billion. Kraft sold its last nonfood asset, Duracell, to Kohlberg, Kravis, Roberts & Co., a leveraged buyout firm, for $1.8 billion in June 1988. According to Kraft’s 1987 annual report, the proceeds of the sale were to be used to repurchase shares and to repay debt obligations. In October of 1987, Kraft authorized the repurchase of 10 million shares, and 6 million were repurchased under the authorization by year’s end. In 1987, Kraft was organized into three business segments: U.S. Consumer Food, U.S. Commercial Food, and International Food. In 1987, U.S. Consumer Food had sales of $4.5 billion and an operating profit of $593 million. U.S. Commercial Food, which included Kraft Foodservice, the second-largest U.S. food service distributor, had sales of $3 billion and an operating profit of $86.4 million. International Food had sales of $2.3 billion and an operating profit of $229.8 million. Exhibit 3 presents a financial summary of Kraft by business segments. The Philip Morris $90-a-Share Tender Offer On the evening of October 18, 1988, Philip Morris offered to purchase all Kraft common stock at $90 per share in cash. The offer represented a 50% premium over the $60.125 closing price on October 18. At $11 billion in total value the bid, if successful, would have been the second-largest acquisition ever completed, exceeded only by Chevron Corporation’s $13.3 billion acquisition of Gulf Oil Corporation in 1984. Most Philip Morris sales and profits came from its Marlboro, Benson & Hedges, and Virginia Slims cigarettes. The company’s tobacco sales increased by 15%, to $14.6 billion in 1987. Philip Morris increased its domestic share of the cigarette market to 38% in 1987, from 37% in 1986, and 1987 operating profits were $3.3 billion. Nevertheless, consumption of cigarettes in the United States had been declining from its 1981 peak of 640 billion cigarettes. Estimated U.S. consumption for 1988 was 563 billion cigarettes. Increases in exports offset the decline in U.S. consumption, as new markets were entered, especially Japan and Taiwan. Overall, cigarette exports were predicted to increase by 15%, to 115 billion cigarettes in 1988. Philip Morris had been pursuing a strategy of diversifying out of the tobacco business since 1969, when it acquired 53% of the Miller Brewing Company’s common shares, the remainder of which it acquired in 1970. With brands like Miller, Lite, and Matilda Bay Wine Coolers, the brewing 2 division generated sales of $3.1 billion in 1987. Philip Morris also purchased Seven-Up in May 1978 for $520 million. Its largest food acquisition by far was General Foods which Philip Morris purchased in 1985 for $5.6 billion. Like Kraft, General Foods was based on brand-name products such as Maxwell House coffee, Birds Eye frozen foods, Jell-O, Oscar Mayer meats, Ronzoni pasta, and Post cereals. It had 1987 sales of $10 billion. Philip Morris’s acquisitions had mixed results. See Exhibit 4 for operating and stockholder information from 1982 through 1987. Exhibit 5 presents balance sheet information for 1986 and 1987. Exhibit 6 presents the consolidated changes in financial position, and Exhibit 7 reports line-ofbusiness information. Philip Morris sold its Seven-Up operations in 1986 for about book value after a $50 million write-off in 1985. General Food’s operating profit declined from $624 million in 1986 to $605 million in 1987. The 1987 operating profit represented a 9.3% return on Philip Morris’s $6.5 billion investment in the food industry, including additional postacquisition investments of $868 million. Speculation was that Philip Morris might use Kraft’s management team to revitalize General Foods, which had been without a chief executive officer since July 1988, when Philip L. Smith left to become chairman of Pillsbury. Smith, a 22-year veteran of General Foods, had been president and chief operating officer before its merger with Philip Morris. The acquisition of Kraft would have made Philip Morris the world’s largest food company, and it would have been a major step in the firms’s strategy of reducing its dependence on tobacco and moving into the food business. As Hamish Maxwell, the chairman and CEO of Philip Morris, said in his October 21, 1988, letter to John Richman, Our goal is to have Kraft combine with Philip Morris to create the leading international food company. . . . Our intention is to keep Kraft’s present businesses intact and for the company to be managed by Kraft executives, using your present headquarters and facilities. Exhibit 8 contains excerpts from the letters between the two companies throughout the takeover contest. Philip Morris proposed to finance the acquisition with $1.5 billion in excess cash and its available bank credit lines of up to $12 billion. Kraft’s Response On October 23, 1988, Kraft’s board of directors rejected the Philip Morris bid: We strongly believe the $90 bid . . . undervalues Kraft, for these important reasons: first, after careful analysis, our investment banker, Goldman Sachs & Co., has advised us that the bid is inadequate; and second, our stock has been trading above the $90 offer, a clear signal that investors see the bid as low. Kraft’s response occurred when the food industry was undergoing a major restructuring and revaluation. Grand Metropolitan PLC began a hostile tender offer for Pillsbury on October 4, 1988. Grand Met was a diversified British company that brewed and distributed beer, ale, and lager; produced and distributed alcoholic beverages; and owned and operated pubs and restaurants. Pillsbury was a diversified food and restaurant company, with popular brands such as Pillsbury 3 Doughboy bakery items, Green Giant vegetables, and Häagen-Dazs ice cream in its food business and Burger King in its restaurant group. Like Kraft, Pillsbury had just completed a major restructuring that focused the company on the food business. The $5.2 billion Grand Met bid was a 53% premium over the previous market price—about 25 times Pillsbury’s net earnings and about four times the book value of common equity. Pillsbury opposed the bid, and its outcome was uncertain. The developments at RJR Nabisco were more startling. Management, in partnership with the investment banking firm of Shearson Lehman Hutton, had proposed a $17 billion leveraged buyout of RJR Nabisco on October 20, 1988. Like Philip Morris, RJR Nabisco was a tobacco and food company with brand names such as Winston and Salem cigarettes, Oreo cookies, Ritz crackers, Planters nuts, Life Savers candy, Royal gelatin, and Del Monte fruit and vegetables. At $75 a share, the buyout offer was at a 34% premium over the previous market price of RJR Nabisco, $56.875. The $75 offer was about 16 times RJR Nabisco’s 1987 earnings per share of $4.70 and about three times the book value of common equity. Analysts speculated that a higher offer for RJR Nabisco was likely: its stock closed above the offer price. Taken together, the Philip Morris bid for Kraft, Grand Metropolitan’s bid for Pillsbury, and the RJR Nabisco leveraged buyout attempt by its management involved about $34 billion—an amount unprecedented in the history of the industry. Exhibit 9 examines this history, with statistics on mergers and acquisitions for food and beverage firms, as well as a listing of transactions of more than $1 billion. Exhibit 10 contains historical stock prices and return-on-equity information for the food and tobacco industries. Kraft proposed a restructuring plan as an alternative to the Philip Morris tender offer. For each share of common stock, shareholders would receive a cash dividend of $84 and a high-yield debt valued at $14, and they would retain their now highly leveraged equity interest. Kraft valued the postrestructuring stock at $12 per share and the total restructuring package at $110 per share. Under the plan Kraft would sell some businesses for cash proceeds of about $2.1 billion after taxes. The businesses to be sold represented 45% of estimated 1988 revenues and 19% of estimated 1988 operating profits. Kraft would also reduce operating expenses. It would finance the $10.2 billion in dividend payments to shareholders with $6.8 billion in bank borrowings at a 12% annual interest rate and the $3 billion in debt with rates ranging from 12.5% to 14.75%. The $2.1 billion from asset sales would be used to pay down the bank debt. The company planned to retain $904 million of existing debt at an average annual interest rate of 8.65%. The debt received by shareholders would accrue interest at a 15.25% annual rate (paid semiannually), with no cash payments in the first 5 years. Interest would be paid in cash at the 15.25% semiannual rate after the fifth year. Exhibit 11 presents prebid sales and profit forecasts for Kraft through 1989. Exhibit 12 presents earnings and cash flow forecasts for the restructuring plan proposed by Kraft’s management. The Stockmarket Response The price of Kraft common stock rose $10 per share, to $102, in response to the restructuring announcement. Philip Morris criticized the restructuring plan and reiterated its offer to negotiate with Kraft, which responded that “if Philip Morris or another company truly wishes to negotiate with 4 Kraft, a simple phone call proposing a price of more than $110 is all that is necessary.” Philip Morris did not increase its bid. Uncertainty about the market value of food assets grew as Kohlberg, Kravis, and Roberts entered the bidding for RJR Nabisco, with a $20.6 billion offer on October 24, 1988. On Thursday, October 27, Kraft’s common stock closed at $94.50. On Friday, October 28, Kraft’s stock rose $2, closing at $96.50. Exhibit 13 contains the closing stock prices for Kraft and Philip Morris throughout the takeover contest. Exhibit 1 Condensed Operating and Stockholder Information for Kraft, 1982-1987 (millions of dollars except per share data) 1982 1983 1984 1985 1986 1987 Revenues $7,041 $6,660 $6,831 $7,065 $7,780 $9,876 Cost of goods solda 5,350 4,928 4,969 4,963 5,393 6,912 Depreciation 103 80 74 74 79 103 Delivery, sales, and administrative expenses 1,183 1,157 1,238 1,391 1,620 2,068 Interest, net 24 (8) 22 26 31 91 Other income (expense)b (38) 23 43 37 37 86 Income from continuing operations before taxes 343 526 571 648 694 788 Income taxes 164 225 252 286 300 353 Income from continuing operations 179 301 319 362 394 435 Income from discontinued operationsc 171 134 137 104 19 54 Net income $ 350 $ 435 $ 456 $ 466 $ 413 $ 489 Earnings per share $ 2.13 $ 2.65 $ 3.17 $ 3.24 $ 3.06 $ 3.73 Dividends per share 1.20 1.28 1.38 1.52 1.68 1.84 Closing stock priced,e 22.83 22.21 28.04 43.38 49.38 48.25 Price-earnings ratioe 11 8 9 13 16 13 Number of shares (millions)e 164 164 144 144 135 131 Betaf .72 .55 .69 1.12 1.18 .74 Sources: Company reports and casewriter’s estimates. aCost of goods sold does not include annual depreciation. bIncludes the cumulative effect of a change in method of accounting for income taxes of $45 million in 1987 and a nonoperating item of -$91 million in 1982. cDiscontinued operations include Duracell, whose sale was announced in 1987, and the business of Premark International, which was spun off on October 31, 1986. Also included in discontinued operations is a $41 million gain on the sale of KitchenAid in 1986. dAdjusted for a 3-for-1 stock split in 1985. eYear-end. fCalculated by ordinary least-square regression using daily stock price data. Exhibit 2 Consolidated Balance Sheets for Kraft, 1986-1987 (millions of dollars) 1986 1987 Cash $ 321.5 $ 189.0 Accounts Receivable 637.6 763.6 Inventories 1,061.1 1,283.4 Investments and long-term receivables 236.2 178.3 Prepaid and deferred items 127.5 161.5 Property, plant, equipment, net 1,087.7 1,424.2 Intangibles 419.0 888.3 Net assets of discontinued operations 600.7 598.4 Total Assets $4,491.3 $5,486.7 Accounts payable $ 492.1 $ 544.8 Short-term borrowings 596.4 645.9 Accrued compensation 148.9 151.2 Accrued advertising and promotions 113.7 132.8 Other accrued liabilities 188.4 245.4 Accrued income taxes 335.3 399.3 Current portion of long-term debt 108.5 37.2 Current liabilities 1,983.3 2,156.6 Long-term debt 237.7 895.3 Deferred income taxes 286.4 282.7 Other liabilities 185.9 253.7 Total Liabilities 2,693.3 3,588.3 Shareholders’ equity 1,798.0 1,898.4 Total Liabilities and Net Worth $4,491.3 $5,486.7 Source: Company reports. Exhibit 3 Financial Summary for Kraft by Business Segment, 1983-1987 (millions of dollars) 1983 1984 1985 1986 1987 U.S. Consumer Fooda Sales $3,718.0 $3,781.2 $3,911.3 $4,016.1 $4,518.9 Operating profit 388.1 446.0 527.3 545.9 593.3 Identifiable assets 1,450.9 1,615.4 1,309.1 1,807.6 2,509.3 Depreciation 54.0 50.0 37.6 36.6 47.4 Capital expenditures 58.0 71.7 63.1 93.7 151.2 Operating profits/Identifiable assets 26.75% 27.61% 40.28% 30.20% 23.64% U.S. Commercial Food Sales $1,172.7 $1,349.3 $1,421.0 $1,755.8 $3,022.0 Operating profit na na 61.7 79.5 86.4 Identifiable assets na na 291.4 558.9 914.6 Depreciation na na 7.6 8.0 15.3 Capital expenditures na na 5.2 17.6 33.7 Operating profits/Identifiable assets na na 21.17% 14.22% 9.45% International Food Sales $1,769.7 $1707.2 $1,733.0 $2,007.7 $2,334.8 Operating profit 165.4 169.4 145.9 182.8 229.8 Identifiable assets 680.9 701.1 793.7 861.1 1,000.5 Depreciation 19.2 18.9 20.6 27.5 34.0 Capital expenditures 37.3 36.2 39.2 41.7 48.3 Operating profits/Identifiable assets 24.29% 24.16% 18.38% 21.23% 22.97% Direct Sellingb Sales $ 825.1 $ 776.9 – – – Operating profit 189.3 138.8 – – – Identifiable assets 462.7 488.0 – – – Depreciation 36.0 28.9 – – – Capital expenditures 40.7 62.8 – – – Operating profits/Identifiable assets 40.91% 28.44% – – – Consumer Productsc Sales $1,181.0 $1,244.8 $ 962.5 – – Operating profit 104.7 118.4 66.9 – – Identifiable assets 828.0 958.8 849.6 – – Depreciation 26.9 42.9 34.2 – – Capital expenditures 43.0 67.9 47.4 – – Operating profits/Identifiable assets 12.64% 12.35% 7.87% – – Commercial Productsd Sales $1,047.5 $ 899.3 – – – Operating profit 104.8 101.0 – – – Identifiable assets 727.6 556.9 – – – Depreciation 30.4 23.9 – – – Capital expenditures 25.4 28.1 – – – Operating profits/Identifiable assets 14.40% 18.14% – – – Source: Company reports. na = not available. aFigures for 1983 and 1984 include both U.S. consumer foods and U.S. commercial foods. bIncludes Tupperware, which was spun off to Premark International in 1988. cIncludes Duracell, West Bend, Health Care, and KitchenAid. All assets except Duracell were sold or spun off to Premark International in 1986. dIncludes Hobart, which was spun off to Premark International in 1986. Exhibit 4 Condensed Operating and Stockholder Information for Philip Morris, 1982-1987 (millions of dollars except per share data) 1982 1983 1984 1985c 1986 1987 Revenues $11,586 $12,976 $13,814 $15,964 $25,409 $27,695 Cost of goods solda 5,046 5,028 5,170 5,926 10,495 10,664 Excise taxes 2,615 3,510 3,676 3,815 4,728 5,416 Depreciation and amortization 281 327 375 424 655 704 Selling, administrative, and research expensesb 2,125 2,377 2,467 3,244 6,061 7,004 Equity in net earnings of unconsolidated subsidiaries 71 83 54 82 111 126 Interest 246 230 273 308 770 685 Other expense 44 – 300 – – – Income before taxes 1,300 1,587 1,607 2,329 2,811 3,348 Income taxes 518 681 718 1,074 1,333 1,506 Net income $ 782 $ 906 $ 889 $ 1,255 $ 1,478 $ 1,842 Earnings per share $ 3.11 $ 3.58 $ 3.62 $ 5.24 $ 6.20 $ 7.75 Dividends per share 1.20 1.45 1.70 2.00 2.48 3.15 Closing stock priced 30 35.875 40.375 44.125 71.875 85.375 Price-earnings ratiod 9 10 11 8 11 11 Number of shares (millions)d 252 250 243 239 238 237 Betae 1.04 .77 .94 .88 1.24 .88 Sources: Company reports and casewriter’s estimates. aCost of goods sold does not include annual depreciation. bSelling, administrative, and research cost includes corporate expenses. cGeneral Foods was acquired on November 1, 1985. dYear-end. eCalculated by ordinary least-squares regression using daily stock price data. Exhibit 5 Consolidated Balance Sheets for Philip Morris, 1986-1987 (millions of dollars) 1986 1987 Cash $ 73 $ 189 Receivables 1,878 2,083 Inventories 3,836 4,154 Other current assets 127 146 Property, plant, equipment, net 6,237 6,582 Investments in unconsolidated subsidiaries and affiliates 1,067 1,244 Goodwill and other intangibles 3,988 4,052 Other assets 436 695 Total Assets $17,642 $19,145 Notes payable $ 864 $ 691 Accounts payable 813 803 Current portion of long-term debt 103 465 Accrued liabilities 1,967 2,277 Income taxes payable 557 727 Dividends payable 178 213 Current liabilities 4,482 5,176 Long-term debt 5,945 5,222 Deferred income taxes 994 1,288 Other liabilities 566 636 Total Liabilities 11,987 12,322 Stockholders’ equity 5,655 6,823 Total Liabilities and Net Worth $17,642 $19,145 Source: Company reports. Exhibit 6 Consolidated Statements of Changes in Financial Position for Philip Morris, 1985-1987 (millions of dollars) 1985 1986 1987 Funds Provided by: Net earnings $ 1,255 $ 1,478 $ 1,842 Depreciation and amortization 424 655 704 Deferred income taxes 159 133 338 Equity in undistributed net earnings of unconsolidated subsidiaries and affiliates (63) (52) (95) Total funds from operations 1,775 2,214 2,789 Increase in accrued liabilities and other payments 1,467 226 505 Working capital from sales of operations 169 487 20 Currency translation adjustments affecting working capital 18 77 139 Other, net 211 210 – Total Funds Provided $ 3,640 $ 3,214 $ 3,453 Funds Used for: Increase (decrease) in: Cash and receivables $ 1,005 $ (2) $ 321 Inventories 1,174 9 318 Other current assets 74 14 19 Capital expenditures 347 678 718 Dividends declared 479 590 749 Increase in property, plant, and equipment from income tax election – 508 – Investment in General Foods Corp. exclusive of $718 million working capital acquired 4,864 – – Other, net – – 301 Total Funds Used $ 7,943 $ 1,797 $ 2,426 Net funds provided (used) $(4,303) $ 1,417 $ 1,027 Financing Activities: Increase in current notes payable $ 149 $ 289 $ 189 Long-term debt financing 4,666 1,788 492 Reduction of long-term debt (326) (3,385) (1,534) Purchase of treasury stock (216) (140) (200) Issuance of shares 30 31 26 Funds (used for) Provided from Financing Activities $ 4,303 $(1,417) $(1,027) Increase (decrease) in working capital $ 637 $ (494) $ (36) Working capital (year-end) 1,926 1,432 1,396 Source: Company reports. Exhibit 7 Financial Summary for Philip Morris by Business Segment, 1982-1987 (millions of dollars) 1982 1983 1984 1985 1986 1987 Tobacco: Sales $7,821.8 $9,094.9 $9,802.0 $10,539.0 $12,691.0 $14,644.0 Operating profit 1,475.7 1,647.0 2,141.0 2,441.0 2,827.0 3,273.0 Identifiable assets 5,070.7 5,114.3 5,149.0 5,622.0 5,808.0 6,467.0 Depreciation 97.7 124.7 151.0 166.0 200.0 214.0 Capital expenditures 498.0 319.9 163.0 151.0 191.0 256.0 Operating profit/Identifiable assets 29.10% 32.20% 41.58% 43.42% 48.67% 50.61% Food Products: Sales – – – $ 1,632.0 $ 9,664.0 $ 9,946.0 Operating profit – – – 95.0 624.0 605.0 Identifiable assets – – – 7,974.0 8,629.0 9,129.0 Depreciation – – – 29.0 167.0 201.0 Capital expenditures – – – 71.0 395.0 402.0 Operating profit/Identifiable assets – – – 1.19% 7.23% 6.63% Beer: Sales $2,935.5 $2,935.5 $2,940.0 $ 2,925.0 $ 3,054.0 $ 3,105.0 Operating profit 159.0 227.1 116.0 136.0 154.0 170.0 Identifiable assets 2,113.7 2,138.9 1,892.0 1,779.0 1,736.0 1,680.0 Depreciation 122.3 130.5 144.0 134.0 136.0 137.0 Capital expenditures 286.3 174.6 94.0 87.0 80.0 57.0 Operating profit/Identifiable assets 7.52% 10.62% 6.13% 7.64% 8.87% 10.12% Othera: Sales $ 822.9 $ 945.5 $1,072.0 $ 868.0 – – Operating profit (loss) (2.4) (10.9) 23.0 14.0 $ (9.0) $ 19.0 Identifiable assets 979.4 1,007.3 1,018.0 643.0 – – Depreciation – – – – – – Capital expenditures – – – – – – Operating profit/Identifiable assets -0.25% -1.08% 2.26% 2.18% – – Source: Company reports. aIncludes the Seven-Up Company, which was sold in 1986. Exhibit 8 Correspondence During Takeover Bid Between Kraft and Philip Morris, October 1988 October 20, 1988 Mr. Hamish Maxwell Chairman and Chief Executive Officer Philip Morris Companies Inc. 120 Park Avenue New York, NY 10017 Dear Hamish: In addition to your letter requesting “negotiations” following your commencing, on Monday, a tender offer without talking to me beforehand, your lawyers and investment bankers have been barraging our advisers with similar requests. You did not see fit to discuss your takeover attempt when we were together at the Grocery Manufacturers of America meeting last Wednesday and Thursday, nor did you see fit to tell me that you were planning on filing a bizarre and baseless law suit against me and our Board of Directors on Monday. You must have been planning your takeover bid for a long time. We intend to take our time and study the situation very carefully. We have a fiduciary duty to our shareholders and an obligation to our employees, customers, suppliers, and communities to do so. Following our study, the Board of Directors will consider the situation and determine Kraft’s response. If at that time there is a purpose to be served by our meeting, we will so advise you. Sincerely, JOHN M. RICHMAN Chairman and Chief Executive Officer Kraft, Inc. October 21, 1988 Mr. John M. Richman Chairman and Chief Executive Officer Kraft, Inc. Kraft Court Glenview, IL 60025 Dear John: I understand and sympathize with your reaction to the events of this week. I would have preferred to discuss our offer with you prior to taking the actions we commenced. However, in the current legal environment in which we live, I accepted the advice to proceed as we did as a business decision. Our actions were designed to minimize uncertainties and delays in addressing the main issue—the economic benefits and other factors favoring the merger of Kraft with Philip Morris. I hope you understand that any discussion of our interest in Kraft would have been premature and inappropriate when we saw each other last week at the Grocery Manufacturers of America meeting. At that time we had made no final decision to proceed with an offer and our Board had not yet approved our actions. In any event, I am hopeful you and we can now move forward in a positive and constructive manner. I quite appreciate your need to study our offer carefully before responding to it. We have, however, seen press reports that Kraft may consider other possibilities including highly leveraged transactions that could encumber the company, operationally and financially, and which also might lead to the dismemberment of Kraft. From what I know of you and some public statements you have made, I feel sure that this is not the route you would prefer to take. As we have said, our goal is to have Kraft combine with Philip Morris to create the leading international food company. I repeat that our intention is to keep Kraft’s present businesses intact and for the company to be managed by Kraft executives, using your present headquarters and facilities. I believe it to be in the best interests of your shareholders and other constituencies that we avoid a prolonged struggle that could disrupt Kraft’s business without adding to the value that would be realized by your shareholders I also believe that a meeting between us could only be helpful to you in understanding our purposes and positive thoughts concerning a combination of our two companies. . . .I want to emphasize that we are prepared to discuss all aspects of our offer. I would be available to meet with you in Chicago at any time on short notice. I can be reached through my office if, as I hope, you see the benefits of such a meeting. Yours sincerely, HAMISH MAXWELL Chairman and Chief Executive Officer Philip Morris Companies Inc. October 23, 1988 To: Shareholders of Kraft, Inc. Dear Shareholder: Kraft has an outstanding record of profitability and growth. It is a great company with great traditions, great brands, a great future, and great people who have devoted their lives to making your company what it is today. Kraft’s record of success—an increase in shareholder value, without regard to recent events, at a compound annual rate of more than 20% over the past 5 years—has been based on a strategy of balancing significant short-term returns and continued investment for long-term growth. This strategy has been working, but—frustratingly—the stock market has long been undervaluing companies which, like Kraft, sacrifice short-term profit in order to invest in long-term growth. Last Monday, Philip Morris Companies, seeking to take advantage of this undervaluation, announced an unsolicited tender offer for Kraft at $90 per share. We strongly believe the $90 takeover bid also undervalues Kraft, for these important reasons: first, after careful analysis, our investment banker, Goldman, Sachs & Co., has advised us that the bid is inadequate; and second, our stock has been trading above the $90 offer, a clear signal that investors see the bid as low. Your Board of Directors has unanimously rejected the offer, and we strongly recommend that you do not tender your Kraft shares to Philip Morris. At the same time, both your Board and company management recognize that, as a practical matter, the Philip Morris bid makes it impossible for us to go back to the situation that existed prior to the bid. Under the circumstances, your Board believes that we should take action to maximize shareholder value rather than accept an inadequate offer. Together with Goldman, Sachs we are developing a potential recapitalization plan that we believe will have a value of significantly more than $90 per share. The plan we are working on is intended to result in a total value estimated to be in excess of $110 per share, with a distribution in cash and securities totaling approximately $98 per share and the retention of your common stock interest, the price of which will be adjusted by the market to reflect the cash and securities distribution. Under the plan, you will receive a cash distribution and new securities, and retain your Kraft common stock. Most shareholders will have less tax to pay as a result of the distribution than if Kraft were to be acquired by Philip Morris (or anyone else) at a price that is equal to the value of the restructuring plan. Your Board believes that this plan will enable you as a shareholder to realize present value for your shares and also continue to participate in the future of Kraft, including some exciting new product lines we have been developing. The plan will involve the sale of some of our businesses, bank borrowings of more than $6.8 billion, and the sale of $3.0 billion of debt. We have already begun to implement some of these transactions. Goldman, Sachs has advised us that it is highly confident with respect to the placement of the debt under current market conditions. We will retain our core businesses, together with the key brands which have provided Kraft’s historic strength and currently account for approximately 80% of its profitability. Because the restructured Kraft will have more than $12.4 billion in debt and require herculean efforts by our employees, the plan will replicate the structure currently in use in sponsored leveraged buyouts by providing significant equity incentives for employees in the form of stock options and an employee stock ownership plan. This very important link between employee compensation and company performance will, we believe, ensure the enormous efforts required to make the recapitalization a complete success. We expect that the plan will be fully developed and our Board will be able to approve it in the very near future, at which time we will announce the details. Because the plan involves very significant restructuring of our businesses and financial structure, the Board also believes you should have the opportunity to vote upon it at a special meeting of shareholders. For your further information, on Friday, October 21, there was a series of communications with Philip Morris. Philip Morris renewed their request for immediate negotiation, stating that all aspects of their offer, including price, are open for discussion. Philip Morris said that there would be real value to them if they could conclude the agreement with us over the weekend and asked for a meeting on Saturday. We responded that if Philip Morris were prepared to offer a realistic price, we would meet on Saturday. We told Philip Morris that their $90 bid is substantially below our valuation and Goldman, Sach’s valuation and that there would be no purpose served by a meeting unless Philip Morris were prepared to start the negotiations from a price substantially greater than $90. We asked Philip Morris to tell us where they stood and told Philip Morris that if they were in the range of value that we and Goldman, Sachs believe is obtainable, we would meet with them on Saturday. Philip Morris replied that they completely disagree with our opinion of their $90 price, that they believe $90 represents full value, and they would not tell us what price they are prepared to offer. Given this attitude on the part of Philip Morris, it was clear that a meeting would not have served any purpose of Kraft and its shareholders, and we so advised Philip Morris. We also advised Philip Morris that we were not foreclosing negotiations and that if they were to offer a price that reflects the full value of Kraft, we would negotiate with them. Since we believe that the restructuring plan will create greater shareholder value and opportunity than the Philip Morris bid or any other known alternative, it is our intention to proceed with the restructuring on an exclusive basis. However, if someone comes forward with a transaction that would be more desirable than the restructuring plan, we will negotiate and your Board will give full consideration to such a transaction. We deeply regret the dislocation and hardships that the plan we contemplate will cause, and we will seek to ameliorate these hardships as much as possible. We know that our shareholders, employees, customers, suppliers, and communities recognize that today’s situation is not of our making. Rather it is the product of current era investment policies and financial attitudes that favor short-term financial gratification over steady, long-term growth and the need to provide a sound economy for future generations. It will take several years, but with the history and traditions of Kraft and the dedication of Kraft people, we are confident that we will rebuild Kraft to the leading position it occupies today. On behalf of the Board of Directors, JOHN M. RICHMAN Chairman October 24, 1988 Calvin J. Collier, Esq. Senior Vice President and General Counsel Kraft, Inc. Kraft Court Glenview, IL 60025 Dear Mr. Collier: In light of the announcement yesterday of Kraft, Inc.’s proposed recapitalization plan, Philip Morris believes that Kraft is required to take all necessary steps to ensure that Philip Morris is given an opportunity to analyze fully Kraft’s contemplated recapitalization transaction and any other proposed transaction for the sale of Kraft or any of its assets to a third party. . . . We have a number of questions that bear on the feasibility and value to Kraft’s shareholders of the announced recapitalization plan. . . . We request that Kraft immediately supply to us specific information concerning the details of Kraft’s recapitalization plan, all information concerning Kraft which may assist us in evaluating the company, and any information supplied to other third parties with respect to the sale of the company or any parts of the company. We also request that, consistent with the responsibilities of your Board of Directors to your shareholders, Kraft not enter into, or agree to enter into, any extraordinary transaction, including a recapitalization plan, a sale of assets or securities of Kraft, or a sale of the company, or take any steps to implement any of the foregoing, until Philip Morris is given a full and fair opportunity to develop its response, and that Kraft not take any action which may diminish the value of Kraft. The that end we are today filing a motion in the Federal District Court. Philip Morris continues to believe that, if our companies work together, a transaction can be negotiated which will achieve maximum value for Kraft’s shareholders speedily and without the extraordinary disruptions to Kraft’s businesses which Kraft acknowledges would be inherent in the contemplated restructuring plan. Sincerely, MURRAY H. BRING Senior Vice President and General Counsel Philip Morris Companies Inc. October 25, 1988 Mr. Hamish Maxwell Chairman and Chief Executive Officer Philip Morris Companies Inc. 120 Park Avenue New York, NY 10017 Dear Hamish: I have previously advised Philip Morris of Kraft’s position on your tender offer. The letter your general counsel sent to our general counsel yesterday, and the papers your lawyers filed in court yesterday, indicate that Philip Morris does not understand what Kraft is doing—or more likely, Philip Morris is pretending not to understand in order to increase its pressure tactics. Obviously it is in your interest to try to pressure Kraft and the Kraft shareholders into a transaction that benefits you at their expense. Kraft will not permit this. Let me again make clear Kraft’s position. Kraft was not “for sale” and is not “for sale.” This is no “auction” of Kraft. Philip Morris made a unilateral tender offer for Kraft. The Kraft Board of Directors rejected your tender offer. Your price is too low. Kraft has a recapitalization plan that creates far greater value for the Kraft shareholders than your inadequate offer. Kraft is submitting the recapitalization plan to Kraft shareholders for their consideration. The recapitalization will take place only if our shareholders approve it. Kraft will not pressure its shareholders, nor will Kraft permit you to stampede them. The Kraft Board is not taking action to “entrench” itself. Just the opposite, it is proceeding expeditiously to provide Kraft shareholders with a choice between your inadequate $90 bid and a better than $110 recapitalization. As frequently happens—witness the RJR Nabisco situation—new bidders appear and old bidders raise their bids. The Kraft Board recognizes that another company or Philip Morris may offer more than $110 per share to acquire Kraft. Accordingly, the Kraft Board said that Kraft would negotiate with that company, or you, and if it, or your company, has a better transaction than the recapitalization plan, Kraft will enter into that transaction. In other words, if Philip Morris or another company truly wishes to negotiate with Kraft, a simple phone call proposing a price of more than $110 is all that is necessary. Please give a copy of this letter to your general counsel as our answer to his letter, and ask him to give copies to your other lawyers and financial advisers, and instruct them to stop mischaracterizing our position. Sincerely, JOHN M. RICHMAN Chairman and Chief Executive Officer Kraft, Inc. For the exclusive use of R. FRENCH, 2020. 289-045 -18- Exhibit 9 Mergers and Acquisitions in the Food Processing and Beverage Industries, 1981-1987 Number and Dollar Value of Mergers in the Food and Beverage Industry Amount Paid No. of Transactions ($ billions) 1981 88 $ 4.55 1982 83 4.96 1983 85 2.71 1984 79 7.95 1985 105 12.86 1986 127 8.43 1987 97 7.75 Mergers in the Food and Beverage Industry Over $1 Billion ($ millions) Bidder Target Year Target’s Sales Amount Paid Premium Percent Price-Earnings Ratio Multiple to Book Philip Morris General Foods 1985 $9,022.4 $5,627.5 35.2% 18.7 3.5 RJ Reynolds Nabisco Brands 1985 5,985.0 4,906.4 31.5 16.7 4.1 Nestle S.A. Carnation Co. 1984 3,370.0 2,885.4 9.9 14.4 2.7 Beatrice Foods Esmark, Inc. 1984 4,120.0 2,508.6 39.5 15.7 2.5 RJ Reynolds Heublein, Inc. 1982 2,140.0 1,302.6 36.5 13.1 2.7 Bond Corporate Holdings Ltd. G. Heileman Brewing Co. 1987 1,173.8 1,083.6 21.6 23.0 3.2 Source: W.T. Grimm and Co., Mergerstat Review, 1981-1987. This document is authorized for use only by RODERICK FRENCH in 2020. Exhibit 10 Stock Price Indexes and Returns on Equity, 1982-1987 1982 1983 1984 1985 1986 1987 Stock price indexes (1981 = 100) Kraft 144.1 148.5 200.6 321.2 397.3 409.3 Philip Morris 128.8 161.2 190.0 218.3 368.7 453.0 RJR Nabisco 114.8 144.8 192.2 220.1 357.4 337.0 Pillsbury 133.0 202.1 256.4 365.4 413.5 440.8 Food index 132.9 161.1 186.9 297.6 387.4 398.8 Tobacco index 117.7 142.4 165.7 179.2 279.7 299.0 S&P 500 index 114.7 134.5 136.4 172.3 197.6 201.5 Return on equity (ROE) Kraft 12.6% 14.9% 17.6% 16.2% 23.0% 25.8% Philip Morris 21.3 22.4 21.7 26.5 26.1 27.0 RJR Nabisco 20.8 17.1 22.3 20.8 20.0 22.8 Pillsbury 16.6 15.0 17.0 17.3 16.8 13.5 Food index 14.3 17.0 17.9 18.0 12.0 12.5 Tobacco index 19.0 18.2 19.4 21.6 20.0 20.3 S&P 500 index 10.9 11.7 13.1 11.0 10.5 11.8 Exhibit 11 Pre-Bid Sales and Profit Forecasts for Kraft, 1988-1989 (millions of dollars) 1987 Est. 1988 Est. 1989 Revenues $9,876 $11,200 $12,500 Earnings before interest and taxes 834 950 1,050 Interest, net 91 95 108 Income from continuing operations before taxes 743 855 942 Income taxes 353 333 368 Accounting change 45 - - Income from continuing operations 435 522 574 Income from discontinued operationsa 54 658 - Net income $ 489 $ 1,180 $ 574 Source: Analyst’s estimates. aDuracell was sold to Kohlberg, Kravis, Roberts & Co. for $1.8 billion on June 24, 1988. Duracell’s 1987 after-tax income was $54 million, and Kraft’s 1988 gain on its sale was $658 million. For the exclusive use of R. FRENCH, 2020. 289-045 -20- Exhibit 12 Projections for Kraft’s Restructuring Plan, 1989-1998 (millions of dollars) 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Sales $ 6,515 $ 6,804 $7,125 $7,481 $7,855 $8,248 $8,660 $9,093 $9,548 $10,025 Earnings before interest and taxes 1,280 1,487 1,671 1,755 1,842 1,935 2,031 2,133 2,239 2,351 Interest 1,380 1,270 1,310 1,286 1,278 1,257 1,212 1,155 1,086 1,010 Taxes (39) 89 148 192 231 278 336 401 473 550 Profit (loss) after taxes from continuing operations (61) 128 213 277 333 400 483 577 680 791 Cash flow available for capital paymentsa 2,481b 496 636 630 742 334 411 500 597 728 Principal payments Preexisting debt 111 33 57 287 100 100 100 100 16 0 Bank debt 2,370 463 579 343 642 234 311 400 581 728 Year-end book values Preexisting debt 793 759 703 416 316 216 116 16 0 0 Bank debt 4,430 3,968 3,389 3,046 2,404 2,170 1,859 1,459 878 150 High-yield debt 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 Cram-down debt 1,974 2,286 2,648 3,067 3,553 3,553 3,553 3,553 3,553 3,553 Total $10,197 $10,013 $9,740 $9,529 $9,273 $8,939 $8,528 $8,028 $7,431 $ 6,703 Sources: Kraft and casewriter’s estimates. aCash flow available for capital payments = net income + depreciation, amortization, deferred taxes - capital expenditures - change in working capital + net proceeds from asset sales & non-cash interest. bIncludes the $2,146 million in cash proceeds from the sale of businesses in 1989. This document is authorized for use only by RODERICK FRENCH in 2020. Exhibit 13 Stock Prices and Market Index, October 1988 Date Philip Morris Kraft S&P 500 Event Oct. 3 $ 97.000 $ 60.000 638.710 4 98.000 58.500 637.010 Grand Metropolitan bids for Pillsbury Company. 5 97.375 59.375 640.020 6 96.875 59.375 641.360 7 100.875 60.625 654.830 10 101.125 60.750 655.320 11 100.750 60.375 654.680 12 98.875 59.500 645.470 13 99.250 59.250 648.480 14 98.625 59.500 649.230 17 100.000 60.125 651.460 18 95.500 88.250 658.560 Philip Morris bids $90 per share for Kraft. 19 94.000 90.375 652.970 20 99.000 90.250 666.990 RJR Nabisco management proposes a $17 billion 21 97.375 92.000 668.920 leveraged buyout. 24 97.500 102.000 665.760 Kraft proposes its restructuring plan and Kohlberg, 25 95.875 99.000 666.090 Kravis, Roberts announces its bid for RJR Nabisco. 26 95.500 97.500 663.820 27 95.000 94.500 654.240 28 94.750 96.500 657.280 -research paper writing service