Chocs Away? Cadbury to face hostile takeover bid tomorrow?

Kraft's shares have in fact fallen some 4% cent since it went public with its offer, closing at $26.78 on Friday. Cadbury's shares, which were trading at 568p before Kraft went public with its proposal, closed at 758p. The Daily Telegraph suggests that 820p a share would be a "starting point" for discussions with Kraft, according to some Cadbury shareholders.

Cadbury has certainly come out fighting; last month it reported higher-than expected sales for the third quarter, raising pressure on Kraft to improve its bid. The firm also raised its forecast for revenue this year to "around the middle" of its previous guidance of 4-6% growth.

Carr is expected to reiterate tomorrow that while Kraft may need Cadbury to deliver growth, Cadbury does not need Kraft. He is understood to be holding out for an offer approaching 850p a share before he will even begin discussions with Kraft.

But is Kraft willing to raise its offer price significantly? Last week's poor results for Kraft effectively eroded the value of the stock component of the offer; it may have to increase the amount of cash it is offering to compensate. While the firm is also heavily indebted, it has secured another £5.4 billion in bridge financing from nine banks last week.

Kraft's approach two months ago sparked much talk of a take-over battle, but interest from firms such as Nestle and Hershey has yet to materialise and Unilever, also touted as a bidder, last week publicly ruled itself out of the bidding.

Kraft has tried to appease union opposition here in the UK by offering to keep open the Cadbury Somerdale chocolate plant in Keynsham, near Bristol, which Cadbury has said will close. This would theoretically save 500 jobs, but the union Unite union remains sceptical, stressing that two meetings with Kraft have failed to produce any concrete details.

Given that Kraft shifted its Terry's Orange operation out of the UK back in 2005, closing the Terry's factory in York, one wonders how committed Kraft really would be to the UK. The US firm has indicated it expects to find $625m of cost savings from a link-up with Cadbury, with some analysts putting the figure as high as $1bn. Where will the savings come from if factories aren't closed?

But hang on a minute, why is this happening at all? Cadbury is a well run firm which has delivered some excellent results in a tough trading environment.

As I've stressed in previous blogs, the economics textbook tells us that the stock-market supposedly provides a mechanism for enforcing good corporate governance. According to the theory badly run firms will be vulnerable to takeover by well performing firms which see the unrealised efficient gains in the share price and are able to offer a premium bid to get hold of a firm and then run it more efficiently. This is supposed to keep management on their toes.

There's just one small problem with the theory. It doesn't reflect reality.

Huge amounts of academic and management consultancy research have overwhelmingly shown that at least two-thirds of takeovers fail on the very terms the takeover firm sets itself, never mind the wider social and economic impact that ensues.

Post takeover, profits usually stay the same or go down, and not up as the free-market takeover model predicts. In fact, takeovers usually lead to huge organisational disruption that leads to higher costs. And of course management often take their eye off the ball in terms of focusing on assimilating activities rather than the real job; serving customers and adding value.

So why do businesses do it, repeating the same mistakes over and over again?

One driver of this socially-sub optimal behaviour is a band-wagon effect; other firms are doing it so if management of firm X doesn't do it they fear losing out. That's how bubbles happen - the madness of crowds.

Secondly, being big is something of a defence (albeit not perfect) against being taken over yourself. So best to buy someone else to stop getting swallowed up yourself.

Thirdly one of the biggest determinants of a manager's salary and benefits is the size of an organisation they manage. Grow your business through takeovers and you can pay yourself more.

Fourthly, the stock market operates a 'dual valuation' system whereby firms like Cadbury can suddenly find themselves in play through no fault of their own. Ordinarily there are people like you and me buying and selling shares like Cadbury, adjusting their portfolios.

The share price reflects exactly that - often a small number of trades at the margins of investors' portfolios. Those trades are not valuing strategic decision-making control of the firm but rather the price put on shares as a portfolio investment by a small number of people.

That all changes in an instant when - suddenly - another firm (usually a large one) wants control. The bid price and share price jump - not because of unrealised efficiency gains but because something else is being valued: control of the actual takeover target.

The difference in what is being valued in this 'dual valuation system' means that institutional investors have an opportunity to put the firm in play and sell at a profit. It makes short-term sense for them, but not for the firm being targeted, and probably not even for the acquiring firm, which often ends up over-paying.

So, here are four reasons why Cadbury management and shareholders should stick with the firm and not sell out:
1. Cadbury's management team has been doing a good job - leave them to it to grow the business.
2. Most takeovers really do fail. It really is a fact.
3. Kraft is already weighed down by debt and borrowing to buy Cadbury will make it worse. This will not help Cadbury long term.
4. Cadbury becoming part of a multinational may well eventually lead to Kraft cutting UK operations long term and may threaten high value added functions here in Birmingham like R&D and marketing.

If you want to see what can happen when a British choccy firm is taken over by a huge foreign multinational, think back to Rowntree which was acquired over by Nestle in the late 1980s. By 2006 the Rowntree brand had been ditched and Smarties production was moved abroad, leading to over 600 job losses in York.

I should stress that I am not against foreign investment in the UK - after all I welcomed the Tata takeover of JLR. What concerns me is the risk to another well run British firm that is now exposed because of the workings of our capital market.

Takeovers -especially hostile ones - need to be made more difficult so that efficient businesses can plan and invest long-term and grow their businesses organically.

Labour promised to do this before being elected in 1997. Blair backed off in the face of big business opposition. We are still living with the consequences today.

Professor David Bailey works at Coventry University Business School.