Following Disney’s acquisition of Marvel Entertainment for $4bn and Kraft’s 745p bid for Cadbury it appears the market for mergers and acquisitions is back on track. With rumours a plenty about further consolidation across many sectors more activity is expected over the coming months and companies with strong brands top the list of targets. When these brands are valued under IFRS 3 or SFAS 141/142 for the acquirers’ balance sheet – a service Intangible Business provides – we are likely to see the brands and intangible assets dominate the purchase price allocation.

Despite the FTSE 100’s significant increase to 5,042.1 as at September 15th 2009 from a low of 3,529.9 on March 5th 2009, there still appears to be number of strong brands that are significantly undervalued in respect to the recovering global economy. The FTSE is still 20% down on 24 months ago (6,289.3) and 25% lower than its peak in recent times at 6,732.4 on June 15th 2007. Much of this lost value relates to intangibles, in particular brands.

From a short-term perspective this lost value is justifiable as consumers trade down during the recession impacting the earnings of branded companies, especially those in premium segments. This is just a short-term phenomenon and consumers will return to the brands they know and love; market prices should be reflective of long-term earnings potential rather that an immediate crises of consumer and investor confidence. 

Furthermore trading down has had an exaggerated impact on share prices in particular for strong brands. Although short-term growth has been stifled the impact of trading down has been marginal for strong brands driven by consumer loyalty and trust - Next’s sales were £3.272bn in 2009, £3.329bn in 2008, £3.284bn in 2007 and £3.106bn in 2006 while Marks & Spencer’s sales were £9.062bn were in 2009, £9.022bn in 2008, £8.588bn in 2007, £7.798bn in 2006. The brands that have suffered most are those that were already struggling due to weak market positioning such a Woolworths or a change in consumer behaviour and market dynamics such as Wedgwood and Royal Doulton.

Disney’s $4 billion acquisition of Marvel deceptively good value
With sales of $676m last year, at first glance Disney’s $4bn acquisition of Marvel Entertainment appears high but with only 300 employees, net income of $221m and a P/E of 21 the price is not as far-fetched as some of Marvel’s story lines. From Disney’s point of view the acquisition makes a lot of sense. The older age demographic of Marvel’s portfolio of properties is complementary and significantly extends Disney’s customer life cycle. Though dominated by the box office success of Spiderman and The X-Men, Marvel has a huge library of over 5,000 characters which is largely untapped including the Avengers, Captain America and Thor. Character merchandising and revenues from children’s entertainment are driven by television exposure and has been a significant limiting factor for Marvel which Disney has in abundance. Including the value that the Marvel portfolio could add to Disney’s theme parks and retail network, the acquistion looks to be a winner for all concerned.

Kraft’s bid for Cadbury is fair value
It’s certainly true that the chance to acquire Cadbury with a strong portfolio of brands (including Dairy Milk and Green & Black’s) is perhaps a once in lifetime opportunity, but at what price?  Kraft’s offer of 745p per share values Cadbury at £10.2bn - a 31% premium over the closing sharing price the previous week (568p). Following news of the bid Cadbury’s share peaked at 808p (a rise of nearly 40%) and is currently trading at 791p. The board of Cadbury rejected the proposal out of hand and many industry commentators consider that the bid is significantly undervalue. I’m not convinced that this opening salvo is so far short of the mark. The view that the bid vastly under values Cadbury is based more on the premise that other bidders may enter the fray rather than on fundamentals. 

The £10.2bn bid translates to a P/E of 35 for a company that has actually benefited during the recession. Providing a little affordable luxury and a pick-me-up for consumers in these trying times Cadbury’s revenues grew 15% to £5.4bn in 2008 from £4.7bn in 2007. Net income has actually declined from £405 million in 2007 to £364 in 2008. As consumers have not traded away from Cadbury’s products and I see little upside now economic recovery is imminent.

Three years ago Cadbury was trading at 562p (September 15 2006) and at 580p two years ago when the FTSE was considerably higher than it is now. In respect to Cadbury’s peak share price at 723.5p on 29 May 2007 Kraft’s bid only offers a small premium and there’s scope for a little more. There is significant scope to be realised through pumping Cadbury’s brands through Kraft’s global distribution network but brand building in new markets requires significant investment and the additional value from the network is resident in Kraft not Cadbury. It’s difficult to imagine a premium of greater than 20% and no more than 870p per share when there are few genuinely interested and capable bidders. A joint bid from Nestle and Hershey would not be straightforward, though a Cadbury Hershey merger could be a possibility. Mars has enough to deal with integrating its acquisition of Wrigley and it would be bit a little out of the comfort zone for other potential bidders mentioned including Coca-Cola, Pepsi Co and Unilever. A bid from private equity players who do not have enough scope to justify a deal at this price level is even more remote.

Potential brand acquisitions
Marks & Spencer whose customers have stayed loyal throughout the recession looks an attractive target currently trading at 367p compared to 24 months ago 597p. With negative equity and limited availability of competitive mortgages homeowners will spend on developing their existing homes and Home Retail Group owners of Argos and Homebase can benefit (trading at 293.6p compared to 399.5). It’s not just consumer brands that present such opportunities, Wincanton is a strong business-to-business brand whose sales have rise from £1.93m in 2007 to £2.36m 2009 while its share price is lingering at 232p compared to 371p two years ago.

From these potential targets and recent M&A activity and rumour, it is clear that while synergies are a key motivation, the primary motivation is access to brands.