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Cocoa Imperia – Implications of the Mondelez /Hershey Bid

The Romans had a word for it: “imperium”, to hold sway over large territories. This might be achieved through colonization of a territory, or by conquest. The Imperia of the Romans, the Mongols and then the British, amassed vast territories across the globe in an earlier form of globalization.

Last week Mondelez sought to extend its “imperium” to include the USA, where today its products are distributed by Hershey, bidding $23bn for Hershey Co (HSY.N). Hershey shares are up by 23% since mid-May and circa 17% on the news. And the fun for Hershey shareholders may not be over: both Ferrero and Nestle are thought to have entertained a similar ambition for some years. In 2011 Ferrero and Hershey established a joint logistics operation for handling confectionery products in North America. The Mondelez (MDLZ.O) assault on Hershey could possibly also prompt Nestle (NESN.S) to respond with a counter offer, in a clash of the leading “Cocoa Imperia”. US based Mars Inc, is likely excluded on antitrust grounds. But Hershey is well fortified: empire expansion will have to overcome the Hershey Trust, established by Milton Hershey for philanthropic purposes, and which has stopped previous takeover attempts on the US chocolate and confectionery company. With a reported 81% of Hershey’s voting rights, the Trust is a powerful voting block to be persuaded. In 2002 the Trust was widely seen to prevent Wrigley’s from acquiring Hershey. To date the Hershey board has responded negatively to the Mondelez initiative, unanimously rejecting the bid on the basis “that it provided no basis for further discussion between Mondelez and the company“.

Hershey Price Chart

If Hershey is intent on retaining its independence, it may in turn seek alliances of its own, Ferrero would be one obvious candidate, the Italian company’s product range adding a premium element to Hershey’s larger mass offering, or further afield it could seek to penetrate the growth markets of Near and Middle East tying up with a company like Ulker, or Arcor in South America.

The word “imperium” is highly appropriate for these huge confectionery brands, especially in the chocolate segment of confectionery. They hold sway over huge slices of market share and have territorial dominance in key markets. A Hershey plus Mondelez combine would create the world’s largest confectioner, both are already within the top 5 globally. The merged entity would reportedly consume some 650,000 mt of cocoa beans equivalent annually, about 15% of the world crop (the ‘Cocoa Barometer’ published by non-profit industry watchdog VOICE Network). According to Euromonitor International Ltd, a Hershey Mondelez combine would surge ahead of Mars Inc to become the world’s top confectionery company with market share of circa 18%. Mars is thought to have market share of circa 13% in global confectionery and by our estimates, circa 12% of the $100bn global chocolate confectionery sector.

Choc Brand TableSource: Company reports, Hardman Agribusiness, Reuters

Marc Donaldson, Senior Partner of ‘On The Ball Consulting’ (a Hardman Agribusiness (HAB) partner organisation in the food & beverages sector, based in Singapore) opines that “the most likely motivation for the Mondelez bid, will be the desire to acquire North American based production facilities, and to achieve effective distribution of its product range in the USA”. With Hershey in its stable, Mondelez would gain control over the production and distribution of Cadbury brand chocolates in the United States, for which Hershey currently holds the licence. According to Marc Donaldson “Mondelez would likely wish to use Hershey distribution for all their brands in the USA, just as the company has used the Cadbury’s infrastructure in India”. Donaldson notes that with foodstuffs requiring complex temperature management, such as chocolate, “good quality distribution is critical for success”.

A secondary factor motivating the move on Hershey could be the pressure from activist Mondelez shareholders who are pushing for greater value creation from the company’s management. Sales growth for the past three years has been negative. In 2015, William Ackman’s activist hedge fund, Pershing Square, announced that it had taken a position worth circa $5.5 billion in Mondelez. Media reports suggest that Ackman and another activist, Nelson Peltz, were pressing the company to either ramp up earnings or sell itself.

Rev CARGSource: Company reports, Hardman Agribusiness, Reuters

Then there is Nestle. The Swiss food and confectionery giant manufactures Kit Kat worldwide. HAB partner Donaldson argues that Kit Kat is “one of the most popular chocolate brands in the world”. In the USA, Hershey has the rights to manufacture and distribute Kit Kat, paying Nestle royalties from sales, but on a change of ownership it is believed that the licence would revert to Nestle…apparently without compensation to the new owner. Mondelez’s bid for Hershey could therefore encourage Nestle to consider its own bid for the US company.

However, it is the implications for another Swiss based giant of the chocolate confectionery sector for whom a successful bid for Hershey could have significant and possibly negative implications. In 2007, Barry Callebaut reached a deal to supply Hershey with chocolate through to 2022. Three years later, it agreed to supply Kraft Foods – which spun off Mondelez in 2012. While Marc Donaldson notes that Barry Callebaut’s margins on supply of chocolate to Mondelez are likely very low, Barry Callebaut could find supplying a combined Hershey/Mondelez a challenge in the USA.

Mergers in the chocolate confectionery sector have a pattern of altering supply arrangements: when Kraft acquired Cote D’Or, Callebaut was the sole supplier, but Kraft took manufacture in-house.  Similarly, when Cacao Barry and Callebaut merged, Ferrero shifted to in-house production. Donaldson draws attention to Hershey’s cocoa processing and manufacturing capacity in the USA, in China and soon also in Malaysia where the company is just completing a significant production facility. These are all markets in which Mondelez is likely heavily dependent on Barry Callebaut which has a commanding global footprint. If the Mondelez bid for Hershey can be concluded successfully, then it is likely that there will be significant risk for Barry Callebaut. Mondelez may be tempted to produce more chocolate in-house and will likely look to improve further on pricing in its arrangements with the Swiss company.

As the cocoa imperia extend their market reach so their buying power increases: cocoa traders, cocoa processors, sugar and milk suppliers, can all expect to feel the growing weight of these leviathans bearing down on their margins…in return of course for huge off-take opportunities. Yet, as noted in our recent publication ‘Cocoa: The Midas Commodity’, there remains significant opportunity in the fast growing premium end of the chocolate confectionery sector for new, tightly focused brand formats like Hotel Chocolat in the UK, and Royce in Asia. These nimble, country or regionally focused brands can address segments of demand that the ‘Cocoa Imperia’ are too occupied to address in their quest for global supremacy. However, noting that Lindt & Sprungli enjoys a market valuation of 4.4x sales, in the premium segment too, growth by acquisition will likely be an attractive strategy for premium names with highly valued ‘paper’.