The document analyzes the stock market reaction and strategic options for Kraft Foods and Philip Morris following Philip Morris' bid to acquire Kraft. It shows that Kraft's share price doubled on the acquisition announcement but fell when a management buyout of Nabisco was announced, raising doubts. The price rebounded when Kraft announced a restructuring plan and KKR bid on Nabisco. The document models the financial viability of the acquisition for Philip Morris and valuations of Kraft under different ownership scenarios and assumptions. It considers negotiation tactics and strategies for both companies to increase or maintain the deal price.

1. Kraft and Philip Morris
Be Acquired or Restructure?

2. The Stock Market Reaction
50.00
65.00
80.00
95.00
110.00
03 Oct 08 Oct 13 Oct 18 Oct 23 Oct 28 Oct
Share Prices
Kraft Philip Morris
90.00
110.00
130.00
150.00
170.00
03 Oct 08 Oct 13 Oct 18 Oct 23 Oct 28 Oct
Relative Share Prices
Kraft Price Philip Morris Price S&P price
Important
dates
18 Oct.
PM bid. Kraft’s price
doubles, excess return of
51% following the offer at
90$
20 Oct.
Nabisco MBO
announced. Kraft’s price
falls by 5%, market starts
doubting the merger
24. Oct
The share price rebounds
thanks to Kraft
announcing the
restructuring plan and
KKR bidding on Nabisco

3. Share Price
0.00 20.00 40.00 60.00 80.00 100.00 120.00
Market price before offer
PM offer price
Market Price after PM offer
Value after restructuring
Market Value after restructuring announced
Share price High Yield Dividend
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
03 Oct 08 Oct 13 Oct 18 Oct 23 Oct 28 Oct
Excess return Kraft Excess Return PM
Effective Excess return on
announcement day 51%
Nabisco MBO
announcement
Kraft restructuring
announcement
Company
by company
S&P500
No major moves in the index,
that averages return of 0.5%
across the period
Kraft
After the price jump on
announcement date, Kraft’s
returns mirror the SP, but on
the day the Nabisco MBO is
announced and when the
restructuring is made public
Philip Morris
The price moves along with
the SP500,with two
exceptions: -5% on
announcement day and +3%
on Nabisco MBO
announcement

4. Can Philip Morris afford it?
Net Income
Assumptions
Revenue growth 5%
EBIT margins 14% adjusted to account for previous acquisitions
Debt
Repayment
Assumptions
The interest will be paid on the average amount of outstanding debt
Historical cost of debt at 9.5%
Acquisition price of $11b will be financed by 1.5b excess cash and 9.5b debt
FCF
Assumptions
We assume all FCFE will be used to repay the principal
Historical ratios of Capex, Depreciation and NWC to sales
Historical Tax rate at 44%

5. Acquisition financing
-
500
1,000
1,500
2,000
2,500
3,000
3,500
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Interest FCFF
Philip Morris alone appears to be generating enough cash to service the interest
on the loan and to pay down the principal. Even if the EBIT margins were to fall to
10% and the loan to increase to $10b, the company would still be able to face its
debt obligations.
If we were to add Kraft’s own cash flow projections, the situation would improve
even further, since Kraft has virtually no debt at the moment ($900 million) and is
generating around 1b in cash every year.
We therefore conclude that Philip Morris does have enough financial means to
acquire Kraft.

6. Assumptions
Projections
Revenue
Trust Management
projections
Margin
Do not trust Management
projections
Interest Payment
Do not trust Management
projections
0%
5%
10%
15%
20%
25%
Average
Historical
Average
Management
EBIT Margin
0%
1%
2%
3%
4%
5%
6%
Average
Historical
Average
Management
Revenue Growth
-4%
-3%
-2%
-1%
0%
1%
2%
3%
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Difference Mngmt and own
projections

7. Our Assumptions
Debt
Interest
14%
EBIT margin
5%
Revenue
Growth
Since the FCFE, which is entirely used to pay down the debt principal, is calculated on
inflated EBIT margins, we develop a model that can calculate FCFE and feed it back
into the debt schedule, so that is it easy to estimate debt interest and principal
payments with different assumptions.
The growth rate in the first year of management projections is 6%, however it
converges down to 5%. Albeit higher than historical growth rates, we believe this to be
a reasonable assumption.
The EBIT margin increases considerably from the historical average of 9% to 20%. This
cannot be justified even accounting for the retention of higher margin activities. We
believe a more accurate margin would be 14%, calculated as: 9% * (1-19%) / (1- 45%),
where (1-45%) is revenue retention and (1-19%) is profit retention
In the following analysis we will present the results that follow from our own assumptions, and we consider
the management projections as the best case scenario.

8. Debt Schedule
To calculate the amount of interest due every year, we computed the debt levels. To do so, we assume
that:
• The high yield debt is worth 14$ per share.
• The regular debt will have an average cost of 13.63%
• The interest on the Bank debt will calculated on the average outstanding debt
• The Cash flows to equity will be entirely devoted to principal payments, according to management
schedule for the preexisting debt and using the remaining CF for the bank debt
• The chart shows the debt levels according to management projections. When we implement our
model the repayment schedule varies significantly.
-
2,000
4,000
6,000
8,000
10,000
12,000
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Existing Debt Bank Debt Debt High Yield

9. Discount rates
• βasset = 0.65
• Market premium = 8%
• Rf = 9%
R0
• We start assuming a value of 12$ per share, and we assume
that equity is going to grow at g = Re
• We calculate the β equity re-levering β assets for every
year
• We use Rf and Market premium to calculate Re for every
year
Re
• We assume that the cost of debt stays constant throughout
the period. We use the previously calculated Re and Rd to
compute the WACC
WACC
14.2%
58.2%
18.1%
12.9
13.6%

10. Cash Flows
CASHFLOWS
FCFF
EBIT 1,380 1,270 1,310 1,286 1,278 1,257 1,212 1,155 1,086 1,010
TAX @41% 565.80 521 537 527 524 515 497 474 445 414
Capex -dep-change
NWC
-442 -368 -423 -353 -409 66 72 77 83 63 720
Asset Sales 2,146
FCFF 3,402 1,117 1,196 1,112 1,163 676 643 604 558 533 6,092
Tax Shield
Bank Tax Shield 276.26 206.57 180.93 158.25 134.02 112.47 99.06 81.57 57.44 25.24
Debt Tax Shield 167.59 167.59 167.59 167.59 167.59 167.59 167.59 167.59 167.59 167.59
Preexisting Debt Tax
Shield
32.06 28.12 26.95 24.93 14.75 11.21 7.66 4.11 0.57 -
High Yield Tax Shield 110.58 128.08 148.36 171.84 199.05 230.56 230.56 230.56 230.56 230.56
Tot Tax Shield 586.48 530.36 523.83 522.62 515.41 521.83 504.87 483.84 456.16 423.39 5,666
CCF
FCFF 3,402 1,117 1,196 1,112 1,163 676 643 604 558 533
Tax Shield 586 530 524 523 515 522 505 484 456 423
CFF 3,989 1,648 1,720 1,634 1,678 1,197 1,148 1,088 1,014 956 10,931
FCFE
NI -61 128 213 277 333 400 483 577 680 791
Capex -dep-change
NWC
-442 -368 -423 -353 -409 66 72 77 83 63
Asset Sales 2,146
FCFE 2,527 496 636 630 742 334 411 500 597 728 8,812

11. Comparables Valuation
Column1 Premium P/E EV/Book P/S
Min 9.90 13.10 2.50 0.61
Max 39.50 23.00 4.10 0.92
Mean 29.03 16.93 3.12 0.74
Median 33.35 16.20 2.95 0.72
Lower range 33 13 2.5 0.75
Upper Range 38 15 2.7 0.95
Lower Value 80 126 113 71
Upper Value 83 145 122 90
We compute
Min, Max,
Median and
Average
values for all
comparable
transactions
We
subjectively
select a range,
basing our
selection on
the previously
calculated
values and the
overall value
of the deal
We calculate
the enterprise
value using the
multiples.

12. Valuations Summary
50 60 70 80 90 100 110 120 130 140 150
FCFE
WACC
APV
CFF
P/S
P/E
EV/Book
Multiples Valuations
DCF Valuations
We obtain valuations
ranges that are
consistent with Kraft’s
projections, but only
when the more
optimistic
assumptions are
used.
If we use our own
assumptions, the
valuation looks very
fragile, with Net
Income being
negative for the
better part of the
following decade,
due to the burden of
interest rates
expenditure.
In comparable
transactions, we
disregard the P/S
multiples, since it is
often inaccurate.

13. Possible issues
We are assuming from the start that the High Yield debt is work 14$ per share
Similarly, we are assuming that the equity is worth 12$ per share
Having chosen different assumptions, the Capex, NWC and Depreciation
calculations are based on our own analysis and might not be accurate
The choice of which debt to pay down first may heavily affect the valuation
We are considering the debt to be risk free, although with a D/EV close to 90%,
this is probably not the case
We did not compute a B for the debt
The Comparables ranges are subjectively selected

14. Kraft’s Choices
Possible Course of
action
Accept Philip
Morris Offer 90$
Undervalues the
company
Lower than
current Stock
price
Proceed with the
Restructuring Plan
High risk
implementation
Management
Incentive
Wait for Philip
Morris to increase
their offer price
Use restructuring
to force PM to
pay more
Encourage
appearance of
another bidder

15. Negotiations
Philip Morris
• Calm and ready to negotiate, willing to meet on short
notice
• Simultaneously pressuring Kraft to obtain information
through non conventional measures
• Involve Kraft in litigation to distract management and to
prevent the restructuring
Kraft
• Aggressive
• Hired Goldman Sachs
• Setting the pace (“We will take our time”)
• Clear, Strong, Committed Shareholders
communication
• Stressing 90$ (PM offer) versus 110$ (restructuring
value)
• Keep the door open for further negations, while
clearly stating 90$ is not enough
$
$

16. Moving Forward
• Continue with aggressive communication
• Find an alternative bidder (White Knight)
• Stress the importance of being independent
• Release private information (Business strategy,
growth forecasts,…)
Kraft
How to increase the
Price
• Expose fragility of Kraft’s proposed restructuring
• Tender offer directly to Shareholders (premium of
50% over undisturbed share price)
• Offer more than 90$ but less than 110$ to initiate
talks
Philip Morris
How to Keep the Price

17. APPENDIX
We show in the appendix the debt and cash flows that would result in keeping the
management assumptions of 23% EBIT margin, 5% growth and starting share price of
12$. To observe what the model forecasts the value of the company to be in other
situations, we suggest inputting the assumptions in the excel spreadsheet directly.

18. Philip Morris Debt and Cash
Flow
Debt
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Start balance 5,222 13,243 11,753 10,070 8,179 6,060 3,697 1,069 - -
Issuance 9,500 - - - - - - - - -
Repayment 1,479 1,490 1,683 1,892 2,118 2,363 2,628 1,069 - -
End Balance 13,243 11,753 10,070 8,179 6,060 3,697 1,069 - - -
Average balances 9,232 12,498 10,912 9,125 7,120 4,879 2,383 534 - -
Interest 889 1,203 1,050 878 685 470 229 51 - -
Income Statement
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Revenue 29,080 30,534 32,060 33,663 35,347 37,114 38,970 40,918 42,964 45,112
Dep 748 786 825 866 909 955 1,003 1,053 1,105 1,161
EBIT 4,187 4,397 4,617 4,848 5,090 5,344 5,612 5,892 6,187 6,496
Interest 889 1,203 1,050 878 685 470 229 51 - -
EBT 3,299 3,194 3,566 3,969 4,405 4,875 5,382 5,841 6,187 6,496
Tax 1,462 1,416 1,581 1,759 1,952 2,161 2,386 2,589 2,742 2,879
Net Income 1,837 1,778 1,985 2,210 2,452 2,714 2,997 3,252 3,444 3,617
FCFF
EBIT 4,187 4,397 4,617 4,848 5,090 5,344 5,612 5,892 6,187 6,496
Tax @ 44% 1,856 1,949 2,046 2,149 2,256 2,369 2,487 2,612 2,742 2,879
Capex 949 996 1,046 1,099 1,153 1,211 1,272 1,335 1,402 1,472
Dep 748 786 825 866 909 955 1,003 1,053 1,105 1,161
NWC 1,552 1,630 1,711 1,797 1,887 1,981 2,080 2,184 2,294 2,408
Change in NWC 156 78 81 86 90 94 99 104 109 115
FCFF 1,974 2,159 2,267 2,381 2,500 2,625 2,756 2,894 3,039 3,190
FCFE
Net Income 1,837 1,778 1,985 2,210 2,452 2,714 2,997 3,252 3,444 3,617
Capex 949 996 1,046 1,099 1,153 1,211 1,272 1,335 1,402 1,472
Dep 748 786 825 866 909 955 1,003 1,053 1,105 1,161
Change NWC 156 78 81 86 90 94 99 104 109 115
FCFE 1,479 1,490 1,683 1,892 2,118 2,363 2,628 2,865 3,039 3,190

19. Management Underlying assumptions for Kraft's Restructuring
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Rev Growth 6% 4% 5% 5% 5% 5% 5% 5% 5% 5%
EBIT Margin 20% 22% 23% 23% 23% 23% 23% 23% 23% 23%
Tax 39% 41% 41% 41% 41% 41% 41% 41% 41% 41%
Op costs 5,235 5,317 5,454 5,726 6,013 6,313 6,629 6,960 7,309 7,674
What
cash dividend 84
high yield 14
stock 12
Tot 110
How
Structure
Sell businesses 2.1
% Revenues 55%
% Profits 81%
Bank debt
Bank borrowings 6.8
Interest 12%
Debt
Debt 3.00
Interest low 12.50%
Interest high 14.75%
Average 13.63%
Existing
Debt repaid 2.1
Debt retained 0.904
Interest on retained 8.65%
High Yield
high Yield interest 15.25%
Effective 7.63%
No payment (years) 5.00
Shares
Number of shares 1987 131
Number or shares 1988 121.7
Restructuring Assumptions
Average
Historical
Average
Management
Own
Assumption
Revenue Growth 3% 5% 5%
EBIT Margin 9% 23% 14%
Dep/Sales 1% 1%
Capex/Sales 2% 2%
NWC/sales 5% 5%

20. Debt Schedule
Existing debt
DEBT
. 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Start Balance 904 793 760 703 416 316 216 116 16 -
Interest 78 69 66 61 36 27 19 10 1 -
Principal 111 33 57 287 100 100 100 100 16 -
End Balance 793 760 703 416 316 216 116 16 - -
Bank debt (interest paid on average yearly balance)
Start Balance 6,800 4,430 3,967 3,388 3,045 2,403 2,169 1,858 1,458 877
Interest 674 504 441 386 327 274 242 199 140 62
Principal 2,370 463 579 343 642 234 311 400 581 728
End Balance 4,430 3,967 3,388 3,045 2,403 2,169 1,858 1,458 877 149
Debt
Start Balance 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
Interest 409 409 409 409 409 409 409 409 409 409
Principal - - - - - - - - - -
End Balance 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
High Yield debt
Start Balance 1,704 1,973 2,286 2,647 3,067 3,552 3,552 3,552 3,552 3,552
Interest Paid Out - - - - - 562 562 562 562 562
Interest Accrued 270 312 362 419 485 - - - - -
Tot Interest 270 312 362 419 485 562 562 562 562 562
End Balance 1,973 2,286 2,647 3,067 3,552 3,552 3,552 3,552 3,552 3,552
Total Interest 1,430 1,294 1,278 1,275 1,257 1,273 1,231 1,180 1,113 1,033
Total Interest Mngmt 1,380 1,270 1,310 1,286 1,278 1,257 1,212 1,155 1,086 1,010
Total Debt Year End 10,196 10,013 9,738 9,528 9,271 8,937 8,526 8,026 7,429 6,701
Total Debt Mngmt 10,197 10,013 9,739 9,528 9,272 8,938 8,527 8,027 7,430 6,702
Total Initial debt 12,408 10,196 10,013 9,738 9,528 9,271 8,937 8,526 8,026 7,429
FCF 2,481 496 636 630 742 334 411 500 597 728
Preexisting debt payment 111 33 57 287 100 100 100 100 16 -
Bank Debt Payment 2,370 463 579 343 642 234 311 400 581 728

21. Rf 9%
Market Premium 8%
Beta Leveraged 0.74
Debt 895
Equity MV 6321
E/EV 88%
Beta asset 0.65
R0 14.2%
Discount Rates
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Value of Debt 12,408 10,196 10,013 9,738 9,528 9,271 8,937 8,526 8,026 7,429
Value of Equity 1,460 2,311 3,167 4,136 5,227 6,463 7,861 9,439 11,220 13,228
Value of Kraft 13,868 12,507 13,180 13,874 14,755 15,734 16,798 17,965 19,246 20,657
D/V 89% 82% 76% 70% 65% 59% 53% 47% 42% 36%
E/V 11% 18% 24% 30% 35% 41% 47% 53% 58% 64%
Beta equity 6.16 3.51 2.70 2.17 1.83 1.58 1.39 1.23 1.11 1.01
Re 58.2% 37.1% 30.6% 26.4% 23.6% 21.6% 20.1% 18.9% 17.9% 17.1%
Rd 12.8% 12.8% 12.8% 12.8% 12.8% 12.8% 12.8% 12.8% 12.8% 12.8%
WACC 12.9% 13.0% 13.1% 13.2% 13.3% 13.3% 13.4% 13.5% 13.6% 13.7%

22. Scenario assumptions
Lower range Difference Upper Range Lower Range
. .
DCF
FCFE 101 16 116 g 4%
WACC 72 33 106 Ebit Margin 14%
APV 113 23 136 Stock value 12$
CFF 127 25 151 Upper Range
0
Multiple
P/S 71 19 90 g 5%
P/E 126 19 145 Ebit Margin 23%
EV/Book 113 9 122 Stock Value 12$