August 11, 2015 - 4:31pm EST by
2015 2016
Price: 46.00 EPS 0 0
Shares Out. (in M): 1,643 P/E 26 22
Market Cap (in $M): 75,578 P/FCF 0 0
Net Debt (in $M): 15,779 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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  • margin expansion
  • M&A (Mergers & Acquisitions)



I believe Mondelez International (MDLZ) is an attractive business given its stable, high quality cash flows from powerful consumer brands in attractive categories. While not optically cheap today at ~26x 2015E earnings, it trades at 10.2x 2018E earnings pro forma for margin expansion to industry-leading levels.

Assuming this is achieved in by the end of 2018, including dividends, an exit multiple of 20x earnings (a discount to current MDLZ at 26x and peers around 23x), and the value of the coffee JV, we arrive at a three and a half year price target of $96.4 for total upside of 109% or an IRR of 24%.

This is a margin expansion story. It’s already playing out, the only question is how far can current management push margins, and how quickly. There is a well-known activist on the board of directors (Nelson Peltz) pushing this along, and recently another activist took a large stake in the company, increasing the likelihood of speeding up margin expansion and perhaps a sale of the business.

I believe that the high quality of this business, and the glide path of growth and margin expansion under current management, limits the downside. If management is not changed and the company is not sold, I believe the shares are worth $65.5 in 2018, including dividends and the coffee JV, for a three and half year IRR of 10.6%.

If the stock de-rates and trades at 15x 2018 earnings, you still get a full value of $51 including dividends and the stock JV, above the current stock price.

This makes this investment, in my view, a safe and an attractive risk-adjusted return.


Mondelez is a “global snacking powerhouse” with $34 billion in sales and #1 positions in biscuits, chocolates and candy, and #2 in gum. It is the old Kraft Foods after the acquisition of Cadbury (chocolate, gum and candy) and the subsequent spinoff of the US grocery business, named Kraft Foods. The remaining snacks business renamed itself Mondelez, and kept CEO Irene Rosenfeld at the helm.

The company has a very attractive mix of categories and exceptional brands like Cadbury, Milka, Toblerone, Chips Ahoy!, Lacta, Lu, Nabisco, Oreo, Halls, Trident, etc.

While Mondelez does not appear cheap today, I believe it is exceptionally cheap if we adjust margins to the new industry benchmark set by 3G Capital in its acquisition of Heinz.

Until now, there has been no clear catalyst for achieving these margins. While activist investor Nelson Peltz has a board seat at Mondelez, and Mondelez has embarked on a cost cutting exercise, it is not nearly ambitious enough and won’t get anywhere close to Heinz-level margins.

On August 6, however, activist investor Bill Ackman (Pershing Square) unveiled a 13-D disclosing a 7.5% stake in MDLZ. The purpose of the transaction is to “engage in discussions with the Issuer and Issuer’s management and board of directors” to discuss, among other things, “potential mergers, acquisitions, divestitures, or a sale of the Issuer.”

Ackman is very familiar with 3G’s track record. He is personally invested in 3G’s investment funds. He is a large shareholder of Restaurant Brands International (RBI), run by 3G. He is also a large shareholder of Platform Specialty Products (PAH), whose CEO Dan Leever, as noted in PAH’s recent quarterly call, met with the RBI folks to learn their method of zero based budgeting (ZBB).

Ackman is also familiar with Kraft. In 2010, Ackman put together a presentation on Kraft, arguing that its margins were substantially below peers. This situation persists today.

3G’s Heinz Acquisition – The New Benchmark

In early 2013, 3G and Berkshire Hathaway announced the acquisition of Heinz. Observers were skeptical of the deal, believing that Heinz didn’t have much fat to cut, particularly given Nelson Peltz’s presence on the board. The WSJ article announcing the deal stated that “Heinz's frugal culture could spare some of the heavy cost cutting seen at companies such as Burger King and Anheuser-Busch.”

Heinz’s merger proxy had the following financial projections, prepared by incumbent management:

The projected EBITDA margins were 17.6% in 2013, rising steadily to 19.3% by 2018.

Here’s what happened in reality, 18 months after 3G took over:





Adjusted EBITDA


Delta from projected EBITDA


EBITDA margin



Revenue was 10% below projections but EBITDA was 29% above projections, with an improvement of EBITDA margins of 816 bps from the actual 2013 results.

So much for “Heinz’s frugal culture.” (Note: H1 2015’s run rate for Heinz widened that improvement to 945 bps)

An article from late 2013, just after the deal was closed, indicated that 3G’s goal was to eventually achieve 30% EBITDA margins.

In 2014, Heinz’s gross margin was 33.2%. Mondelez’s gross margin in the same year was 36.8%. Mondelez participates in higher gross margin categories than Heinz. It also has three times more sales than Heinz.

These two data points indicate that Mondelez should be able to generate north of 30% EBITDA margins under a 3G-led team.

To put 3G’s achievements in context, its 26% EBITDA margin achievement in 2014 is heads and shoulders above industry comps, specifically, 870 bps above the average of all the comps listed in the merger proxy.

Its 30% EBITDA goal is also remarkable given that Coca-Cola sports an EBITDA margin of 28.1% despite having gross margins of 61.1%, a full 2,790 bps greater than Heinz’s. (Note to activists: KO is probably mismanaged.)

It’s no wonder that Nestlé’s CEO, in a recent speech at the company’s AGM, noted that 3G’s cost-cutting “has a revolutionary impact on all the other members of the industry.” Nestle itself has among the industry’s lousiest margins, particularly adjusting for its massive scale. One report noted that “Nestlé's seven independent businesses in the U.S., which run a total of 87 factories, were buying hair nets and safety shoes from more than 100 suppliers. Because the units weren't talking with each other, Nestlé, the world's biggest food company, couldn't get the best bulk discounts in its biggest national market. Now Nestlé says it uses just ‘a handful’ of suppliers.”

Everyone has noted, and CEOs aren’t standing still. Mondelez, for example, is now adopting ZBB.

But with current management, it will never match what Heinz has achieved.

Why Everybody Else’s Zero Based Budgeting Doesn’t Even Get Close

Here’s the problem: 3G-style ZBB cannot be implemented by incumbent management. You can’t flip a switch one day and wake up and tell your colleagues that you are going to ban office refrigerators, insist on double sided black and white printing, require CEO approval for color prints, cut off business class travel, eliminate employee product freebies, etc. Any incumbent management that did this would alienate its management team. To put it bluntly, it would destroy employee morale and just piss everybody off.

After Heinz was acquired, 3G began optimizing its byzantine supply chain. One article noted that “Frozen enchiladas, for instance, were trucked nearly 1,000 miles from a factory in San Diego, packaged with rice and sauce by workers in Pocatello, then shipped across the country to distribution centers on the East Coast.” When a particular plant was closed, the former CFO said that he understood the reason for the closure, “But because of his relationships with employees in Idaho, he says, ‘it would have been really tough for me to do.’”

Yes, Irene Rosenfeld sees the light. She even hired Accenture, the same consultants used by the 3G folks to help them with their ZBB efforts.

The results so far are encouraging, but are coming at a snail’s pace. Irene has been inching along, improving MDLZ’s margins by a couple hundred basis points over several years, while a 3G-led team would have accomplished multiples of that in just two years.

Only an outsider sweeping in can execute the types of cuts needed to arrive at 3G-level margins.

Is Irene Rosenfeld the Best CEO for Mondelez?

While Irene Rosenfeld, MDLZ’s CEO, is a probably a very capable manager, she has not covered herself in glory before or after the Kraft Foods spinoff. In 2010, she decided to sell Kraft’s frozen pizza business, in a deal that was heavily criticized by shareholder Warren Buffett because it consisted of $2.7 billion of after-tax proceeds for a growing business earning $280 million. Buffett was also critical of Irene’s acquisition of Cadbury with what he perceived as being undervalued currency (Kraft stock) instead of cash.

Here’s a transcript of Buffett’s comments on the two deals:

WARREN BUFFETT: I feel poorer. (Laughs.) Kraft, in my judgment, well just in the past two weeks there's been two things that caused me to feel poorer. They sold a very fine pizza business and they said they got 3.7 billion for it. But, because it had practically no tax basis, they really got about 2.5 billion. They sold a business for 2.5 billion that Nestle is willing to pay 3.7 billion. Now can Nestle run it that much better than Kraft? I doubt it. But that business that was sold for 2.5 billion earned 280 million pre-tax last year. But they sold that at less, right around nine times pre-tax earnings in terms of their own figure. Now they mentioned paying 13 times EBITDA for Cadbury, but they're paying more than that. For one thing, EBITDA is not the same as earnings. Depreciation is a very real expense. But on top of that, they've got a billion-three they're going to spend of various rearrangements of Cadbury. They've got 390 million dollars of deal expenses. They are using their own stock, 260 million shares or something like that, that their own directors say is significantly undervalued. And when they calculate that 13, they're calculating Kraft at market price, not at what their own directors think the stock is worth. So, the actual multiple, if you look at the value of the Kraft stock, is more like 16 or 17 and they sold earnings at nine times. So, it's hard to get rich doing that. And I've got a lot of doubts about the deal.

The 2012 spinoff of Kraft Foods had the purpose of splitting the company into a low-growth, mature business (the US grocery business named Kraft Foods) and the higher growth international business in sexier categories (Mondelez). It turned out that Kraft actually performed better on various metrics.

Through either bad luck or poor management, Mondelez hasn’t lived up to its potential. The split was expensive, resulting in tens of millions of dollars of deal costs, and probably hundreds of millions of dollars of added duplicated overhead.

Given Irene Rosenfeld’s lackluster deal making track record, Mondelez’s inferior results since the split, and specifically, the fact that she is institutionally unable to execute 3G-style ZBB as noted above, perhaps she isn’t the right CEO for Mondelez.

Putting the Pieces Back Together

Does it make sense to put Kraft Foods – now Kraft Heinz Company – and Mondelez back together? Buffett, who owns 26.9% of Kraft Heinz, seems to think so.

On the occasion of Heinz’s acquisition of Kraft in early 2015, Buffett went on CNBC and entertained the question of buying Mondelez:



Naturally, Buffett doesn’t want to telegraph his intentions and drive up Mondelez’s stock price. On August 10th Buffett told CNBC that he has no immediate interest:

“At Kraft Heinz, we have our work cut out for us for a couple of years,” he said. “Frankly, most of the food companies sell at prices that it would be very hard for us to make a deal even if we had done all the work needed at Kraft Heinz.” [Emphasis added]

Buffett did preface his comments by saying, “I will listen to anything my friends at 3G want to do.”

3G Capital owns 24.2% of Kraft Heinz so together with Berkshire they have a controlling interest in the company. It is likely that 3G contemplated buying Mondelez instead of Kraft, but given Kraft’s CEO’s departure and its $18.2 billion in sales, it was an easier snack to digest.

The merged Kraft Heinz Company will have pro forma sales of $29.1 billion, making it practically the same size as Mondelez. Merger synergies for Kraft Heinz are expected to be $1.5 billion, equivalent to 8.2% of acquired sales of $18.2 billion or 5.1% of total sales. Given 3G’s track record, this is probably on the conservative side.

The perception is that Kraft Heinz has a highly leveraged balance sheet, until one looks at the math on deleveraging and merger synergies. Pro forma for the synergies, I calculate net debt to EBITDA of 3.6x right off the bat. Fitch agrees that this is quickly achievable.

Assuming Kraft Heinz can achieve a 30% EBITDA margin by 2018, it should have a solid balance sheet with net debt to EBITDA of ~1.6x by the end of that year, giving it plenty of firepower for more deals, particularly if financed in a friendly manner with Berkshire preferred equity.

On the Mondelez side, net debt to EBITDA as of Q2, pro forma for the receipt of the additional $4.2 billion of coffee JV proceeds on July 2nd per MDLZ’s 10-Q should be 3.1x.

However, MDLZ should also rapidly delever. Using management’s guidance for operating margins, share buybacks, capital spending, tax and interest rates, it’s easy to model that net debt to EBITDA should be around 2.1x at the end of 2018 and 1.7x using slightly more optimistic assumptions.

At that point a merger between the two companies would be possible. (It is probably possible a lot sooner, although I don’t have Lazard on retainer to help with financing ideas.) I do however have a very rough back of the envelope calculation showing that even a premium such as 18x MDLZ’s 2018E EBITDA would translate into 11.6x after synergies of ~12% of acquired sales, which would generate a combined EBITDA margin of 31.9%, which I believe is reasonable given the scale of $67.2 billion in sales and 3G’s management.

That premium, plus interim dividends and the monetization of the coffee JV ($3.2 / sh), would result in a stock price of $88.8 or 93% above the recent price for a 3.5-year IRR of 21%.

Example of Depressed Margins at Mondelez

Working off MDLZ’s 2014 numbers before the removal of the coffee business into the JV, we can observe pockets of inefficiency.

For instance, Cadbury standalone average gross margins in the years 2007-2009 were 47%, as evidenced by Cadbury’s 2008 and 2009 annual reports. Looking at a more recent comp, the 2014 accounts of Ferrero (maker of Nutella, Kinder, Tic Tac and other goodies), also reveals gross margins of 47%.

If we consider that 41% of MDLZ’s 2014 sales were in the chocolate, gum and candy category, and assume these should have been at the 47% gross margins per Cadbury historical and Ferrero 2014’s accounts, then the balance of MDLZ’s gross margins are running at an implied 29.7%, a full 710 bps below reported gross margins of 36.8%.




Comp gross margins


Total sales for MDLZ (2014, before coffee JV)


Chocolate, gum and candy sales for MDLZ


Chocolate, gum and candy gp for MDLZ at comp levels


Total Mondelez gp (2014 reported, before coffee JV)


Implied gp for balance of business


Sales for rest of business


GM for rest of business


Reported GM for MDLZ


Margin opportunity for remaining 59% of sales



It goes without saying – but I’ll say it anyway – that Ferrero isn’t managed by 3G so we don’t know what gross margins 3G would be able to achieve in a similar business, but I’d bet it’s higher than 47%.

Let’s look now at the next big bucket of sales at MDLZ, biscuits. Sell-side research pegs appropriate gross margins for this business at 40%.

The rest of the business is comprised of beverages (Tang, coffee), 16.6% of sales (again, before the coffee JV), and, incongruously, cheese & grocery at 8.8% of sales.

If we assume MDLZ’s chocolate, candy and gum margins at 47% as above, and biscuits at 40%, we get an implied gross margin of 16.0% for the remaining 25% of sales, which is nuts.

Let’s assume these sales should instead generate 38% gross margins, in line with the divested coffee assets. Then, the total gap in gross margins for the entire business would appear to be at least 558 bps (A).

In terms of gross dollars, this translates into additional $1.9 billion or $1.5 billion after tax. Using the current share count, this would result in EPS 52% higher than reported in 2014.


Margin opportunity in gross dollars


Taxed at current rate (22%)


Shares outstanding (Q2 '15)


Gain per share


Reported 2014 adjusted EPS


Total pro forma EPS





Next, we can take a look at SG&A, a huge bucket that included $8.5 billion of spend in 2014, or 24.7% of sales. Where’s Heinz? In 2014 it printed 18.9% of SG&A to sales.

For the half-year ending 6/30/2015, Heinz printed 18.3% of SG&A to sales and EBITDA margins of 27.3% (consisting of EBITDA margins of 26.3% in Q1 and 28.2% in Q2).

Let’s assume 18.3% SG&A to sales is doable for Mondelez. This would imply a gap of 640 bps (B).

Putting (A) and (B) together would imply an improvement potential of 1,200 bps to MDLZ’s margins. This gets us to EBITDA margins of 28%, starting from MDLZ’s reported 2014 adjusted EBITDA margin of 16%.

Finally, we have to consider that Heinz is 1/3 the size of MDLZ and is in lower gross margin categories, and it still reportedly has a goal of 30% EBITDA margins. A goal of 30% EBITDA margin for MDLZ, therefore, appears very achievable.

Examples of Less Than Stellar Management

  • Management recently said that only now does it have monthly visibility into inventory levels of products and KPIs in the various regions that it operates (comments made in Q2 ’15 conf call)

  • Pricing actions are very important for this business, particularly given that MDLZ reports in USD and earns so much income abroad. Management said it used to price goods once a year, and now they are pricing “far more frequently” (comments made in Q2 ’15 conf call)

  • Management has guided to adjusted operating margins of 15-16% in 2016. At the low end this should be equivalent to an EBITDA margin of around 18.1%. Management admits there are opportunities to grow from there, and pats itself on the back for “industry-leading” margins – except that Heinz, with 1/3 the sales and lower gross margins is already at an EBITDA margin of 27%

  • At one point, Mondelez had more than 100,000 suppliers, which is more suppliers than employees(!)

  • Mondelez had 60-year old factories that had not been updated; one analyst noted, “Compared with the lines being retired, this upgraded technology stands to offer [10 percentage] points of margin improvement by taking up a fraction of the floor space, running two times as fast, and necessitating just one third the human capital investment (and half as much operating costs)”

Misconceptions about 3G

One of the biggest knocks on 3G is that they focus on cost cutting at the expense of revenue growth. It’s a fair criticism to the extent that 3G is a one trick pony – they’re cost cutters – but it’s a damn good trick.

However, the other aspect of 3G that’s not often explored is that they need to grow. 3G may not be stellar at organic growth, but they’re great at growth through acquisitions.

Take a look at this slide from a presentation on AB InBev by a smart T2 analyst from five years ago:

D:\Dropbox\Investment Ideas\Mondelez\VIC write-up\abi.PNG

If, as an investor, this slide doesn’t get your pulse going, I don’t know what will.

The reason 3G likes to grow so much rather than simply milking its assets for cash is that growth keeps great people motivated and allows them to recruit the best and brightest. Growth opens opportunities for managers under the 3G fold to move up and put new talent under them, perpetuating the culture and forming new superstars. This is an underappreciated part of their strategy.

3G’s CEOs – not the HR or IR folks – are expected to go to top universities to evangelize and recruit. They fill a room with ambitious young students and start going on about their culture. Zero based budgeting, meritocracy, below market salaries but the opportunity to make multiples of your salary in incentive compensation, tied to goals. A constant vigilance over costs (Marcel Telles, one of the 3G founders, likes to say that like finger nails, they need constant trimming).

As the CEO drones on, the audience trickles out and the room is left with a dozen or so students. It’s a self-selection process. But the remaining students are salivating, ready to go to work at a 3G company.

I’d also like to address another misconception by the media, which is typically framed like this: if 3G is telling people to print double sided in black and white, it’s obvious that the low hanging fruit is gone.

This is a fundamental misunderstanding of the 3G philosophy. The idea is that every expense matters. That’s the whole point of zero based budgeting. It’s not something that’s implemented after all expenses have been reviewed; rather, it’s something that’s implemented on day one, to set the tone and the expectations. And no, it does not mean that they torture their executives with coach on long-haul international flights.

Coffee JV: Another Dumb Deal?

In May 2014, MDLZ announced a joint venture with D.E Master Blenders 1753 whereby MDLZ would contribute its coffee businesses with Master Blenders’ to create “the world’s leading pure-play coffee company.”

Master Blenders has a knack for names that just roll of the tongue, and the new venture was therefore fittingly christened Jacobs Douwe Egberts, or JDE for short.

The details of the JV have shifted since the announcement but in the end MDLZ contributed most of its coffee businesses, which generated $3.77 billion in revenues in 2014 (about €2.8 billion at the average fx rate), in exchange for $5.2 billion in cash and a 43.5% stake in JDE.

Master Blenders is noted in the announcement as having generated €2.5 billion in revenues in 2013. Slide 20 in the Q2 2015 presentation has details on how to model the coffee JV.

It’s great that MDLZ got $5.2 billion in cash up front for this business, but it’s harder to tell what it gave up. The folks on the other side of the table aren’t dumb. MDLZ did spend $185 million in deal costs to form the JV. There are unknown tax leaks associated with the eventual monetization of the JV. MDLZ also gave up control and has little visibility into the economics of the JV. In any case, how do we value the coffee deal?

Using the inputs on that slide, I’m assuming revenue growth of 4% per annum, 18% EBITDA margins rising to 20.5% by 2018, D&A to sales of 3%, interest rate of 4%, tax rate of 22% and a P/E multiple of 15x. I arrive at a value of $2.8 per MDLZ share in 2018. A 20x multiple would yield $3.8 per share.

Alternatively in a take-out scenario, I’m using EV/EBITDA of 14x in 2018, which gets me $3.2 per MDLZ share. I’m using this number in my target price estimate.

The one nice thing I can say about JDE is that’s run by smart folks. This much can be inferred from the bottom of the closing announcement. Bart Becht seems to have a nice track record. And the trio seems to be very experienced. Other folks involved in this are Byron Trott, Buffett’s favorite banker, and Alex van Damme, who’s on the board of AB InBev.

Modeling Considerations

The downside scenario, whereby MDLZ continues along its current glide path, is the following:

I’m starting with MDLZ revenues stripped out of the divested coffee revenues, so $30,468 million. I’m growing revenues 4% per annum. MDLZ printed Q2 adjusted gross margins of 40.2%, but I’m assuming 38% in 2015, rising to 40.5% in 2018. I’m assuming SG&A to sales is 23.5% in 2015, declining to 22.0% in 2018. D&A to sales is steady at 3.1%, average coupon on debt is 4.5%, and tax rate is 22%.

The company has $6.9 billion in remaining buyback authorization; I’m assuming $1 billion gets bought back in H2, 2 billion in each of 2016 and 2017, and the rest in 2018. I’m assuming rising share prices each year, with an average price of $46.5 in 2015, $50 in 2016, $55 in 2017 and $60 in 2018.

This gives me a diluted share count of 1,513 million in 2018. Capex to sales is flat at 5.0% for the period except for H2 ‘15 (5.4%). I also decrease cash and equivalents by $1 billion for the cash costs of restructuring and assume rising dividend payments to 0.19 per share in 2018.

This would result in an EBITDA margin of 21.6% in 2018 and EPS of $2.99. Interim dividends are a total of $2.5 per share and the coffee JV is worth $3.2 per share. This scenario would result in the 10.6% IRR noted above.

The bull case of course is 30% EBITDA margins by 2018, which would result in EBITDA of $10.7 billion then, and a full stock price (20x EPS of $4.53 + dividends + coffee JV) of $96.3.

That would result in upside of 109% or 24% IRR over three and a half years.


There are several ways this could play out:

  • Irene Rosenfeld manages to achieve 30% EBITDA margins on her own – I’d say this is low probability

  • Ackman is able to replace management with a CEO who can implement the full gamut of 3G philosophy

  • Mondelez continues on its current path and eventually gets taken out, most likely by Kraft Heinz Company as they would be able to extract the most synergies

  • Mondelez gets broken up into two companies: chocolate, gums and candy; and biscuits, selling the grocery business to another buyer

  • Mondelez continues on its current path and does not get taken out – this would be the worst case scenario but in this case I believe you make only 10.6% IRR

I do believe the Kraft Heinz Company would love to own this as soon as they’re done digesting the Kraft Foods acquisition. The combined business would have $67 billion in sales, similar to Pepsi and still 2/3 of the size of Nestlé.


I think the biggest risk is a material de-rating due to rising interest rates, a falling market, a dramatic appreciation of the dollar against other currencies, or a mix of these. I’d argue that if these factors happen, you could be invested in worse assets than the stable of brands at MDLZ with the current restructuring momentum it has.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


  • Irene Rosenfeld manages to achieve 30% EBITDA margins on her own – I’d say this is low probability

  • Ackman is able to replace management with a CEO who can implement the full gamut of 3G philosophy

  • Mondelez continues on its current path and eventually gets taken out, most likely by Kraft Heinz Company as they would be able to extract the most synergies

  • Mondelez gets broken up into two companies: chocolate, gums and candy; and biscuits, selling the grocery business to another buyer

  • Mondelez continues on its current path and does not get taken out – this would be the worst case scenario but in this case I believe you make only 10.6% IRR

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