M&A

Can Kellogg’s CFO Give the Soggy Company More Pop?

Thomas Webb tells CFO.com why his firm's latest acquisition will prove a success.
Ed ZwirnApril 23, 2001

At the end of the day, Thomas J. Webb is not a great believer in cycles.

When Webb, a 22-year veteran of the Ford Motor Co., left in January 2000 to become executive vice president and CFO of Kellogg, he had already realized the difficulties encountered when trying to predict the timing and magnitude of shifts in the economy.

According to Webb, Martin B. Zimmerman, the MIT professor who signed on with Ford as economic guru and governmental relations expert in the early 90s, instilled in him the view that while it is “difficult to predict the economy, if softness exists, there is always an event” that will inflict “shock.”

Last October, when the Battle Creek, Mich.-based food giant announced plans to purchase Keebler, the cookie and snack concern, in a transaction valued at $4.3 billion, corporate funding was drying up, in a situation that could only be exacerbated by Middle East tensions and uncertainty surrounding the presidential election.

In addition, the company was having troubles of its own. Kellogg’s stock at that point was hovering at around $22 per share, less than half the $49.60 it fetched Dec. 31, 1997.

Part of the problem was the stagnant behavior of the market for cereal, upon which Kellogg depended for nearly all of revenue. In addition, the inevitable comparisons between “old economy” low-tech companies and more innovative, quickly growing “new economy” concerns were hardly a lure to investors.

Fast forward to March 2001: the U.S. bond market, after having completely evaporated at the end of 2000, had rebounded at the beginning of the year, with investors queuing up for the latest debt offerings from some of the same “boring” companies earlier in disfavor.

In no case was this more apparent than that of Kellogg.

According to reports from market sources, the four-tranche debt issue, which the cereal maker had intended to price March 26 via lead managers J.P. Morgan, Salomon Smith Barney and Banc of America Securities, was at least four times oversubscribed at the $4 billion level originally sought. Click here for more on this.

That the private rule 144A offering priced a few days early at $4.6 billion, some 15 percent more than the company had sought to borrow, and at enviable yields, surprised no one in hindsight. The market is normally attracted to issuers with conservative debt profiles who come to the market infrequently, and this attraction was, if anything, magnified by the tumultuous course taken by the stock market in March.

“The overall market conditions for financing were clearly tough at the end of last year,” recalls Webb, who says he is prohibited from commenting on the recent bond issue due to its private status under rule 144A.

While debt markets are obviously in better shape now than they were at the end of last year, there is the potential for them to “cycle back,” he observes.

“It only takes one unrelated serious event to jar something that’s fragile,” he says.

Part of the New Team

But, whatever his views of economics on the macro scale, the CFO is less guarded in his optimism about the “micro” situation he faces at Kellogg.

Webb, whose tenure as CFO started at the tail end of a management reshuffle that included the appointment of Carlos M. Guiterrez as CEO in April 1999 and the resignation of CFO John Hinton and three other high-ranking executives at around the same time, was clearly under some pressure to help turn around the company.

Key to the strategy outlined by the new team was diversification from the cereal market. The company had made earlier attempts at accomplishing this through acquisition, such as its purchase of Lenders Bagels in 1996 and Worthington Foods in 1999. The former was acknowledged as an obvious mistake in October 1999, when Kellogg was forced to sell it for $275 million, about $200 less than it paid, while the latter has been given less than stellar reviews by the Street.

According to G. Leonard Teitelbaum, an analyst who covers the firm for Merrill Lynch, the Keebler deal was critical to Kellogg’s diversification. While clearly a Guiterrez brainchild, its success required the presence of such experienced outsiders as Webb.

“Worthington was not as complicated,” says Teitelbaum. “It doesn’t mean that Worthington didn’t have its own problems, but to do something this big you really need to bring in someone with that kind of experience.”

“It will be Tom Webb’s responsibility to integrate the two firms,” he adds. “Any time you do a massive integration like this or make a bold step, you have to have somebody who is used to integrating acquisitions financially and integrate reporting systems.”

Goodwill Is GRRRReat!!!

And Webb, for his part, is sounding upbeat about the prospects for success.

“Folks out there have a lot of goodwill for Kellogg,” he says, noting that a good part of this goodwill originates from definable identification of solid product lines with strong brand images.

Webb recalls that at a recent investor breakfast hosted by the firm in New York, many of the product mascots were walking around in full costume.

“One of the guests there brought his little son, who must have been around two years old,” he says. “The little kid looked up, saw Tony the Tiger, and ran across the room and hugged Tony’s leg.”

‘Ernie’ Joins Roster

Enter Ernie the Elf.

The Keebler acquisition, the largest ever for 105-year-old Kellogg, promises to do a lot more than add a few characters to keep Tony, and Snap Crackle and Pop company. It also drives home the importance of brand image.

While official Kellogg announcements have predicted that the acquisition will add to reported earnings in three years, a likely FASB change eliminating the requirement to amortize goodwill from acquisitions in many cases would probably add $150 million to company income and make the deal profitable in year one.

All the more reason to take good care of “goodwill” surrounding the company’s many brand names, assuming the amortization requirement is eliminated for the many cases in which a brand name is still alive and healthy. This may take effect as soon as July 1.

“We’ve gotten a really good reception to our acquisition of Keebler,” he says, noting that the firm has already made substantial progress toward implementation of the $170 million of annual cost- saving “synergies” to which it is committed through 2003.

Part of this savings will soon be realized with the May 31 closure of Keebler’s Denver plant, a move that will cut 470 jobs, and with the elimination of more than 150 overlapping jobs from headquarters and administration at the two firms.

Reverse Merger

But there are additional, less painful, synergies to be had from more rationally aligning the distribution networks employed by the two firms, according to Webb.

“The integration effort involved here is a little unique for us,” he says. “I call it a ‘reverse merger’ because many of our products will be going through Keebler’s DSD [Direct Store Delivery system],” he adds.

Kellogg produces both food and snack products, he explains, with examples of the former being Corn Flakes and Rice Krispies and the latter being items such as Rice Krispies Treats.

While demand for cereal has remained relatively sluggish, the fact that it is subject to no great surges and dips means there is no need to improve upon the traditional Kellogg distribution setup of providing a relatively constant flow of cereal products to regional warehouses, which in turn supply retail outlets.

But snack foods such as Cheez-Its and cookies are much more “impulse type products,” Webb says, adding that the Keebler DSD, which utilizes more advanced inventory systems to manage sales more directly to stores, is “great for snack foods like Rice Krispies Treats.”

He says, “It’s just like [Keebler] bought another company and got more throughput.”