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Why 'Smart Money' May Have Exited Kraft

So the details are now in. On Tuesday, the board of directors of Kraft Foods (KFT), the world's second-largest food company with trailing 12-month revenue of $54.4 billion, released more information about its plans to spin off its North American grocery business.

The board announced that the new company, Kraft Foods Group, will formally come into existence on October 1. Beginning on October 2, Kraft Foods Group will trade on Nasdaq under the ticker symbol "KRFT." Kraft Foods Inc. will change its name to Mondelez International and its ticker symbol to "MDLZ." The current ticker symbol, "KFT," will be retired.

Both Kraft Foods Group and Mondelez International plan to host investor events in early September. The company said it will announce details about these events by mid-August. It will certainly take time for the investment community to digest all these changes and what they suggest.

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The company first said it would divide the company in its August 2 news release announcing quarterly earnings results. It put a positive spin on a somewhat controversial spin-off.

So why did Pershing Square Capital Management's Bill Ackman sell his entire 15-million-share holding of Kraft at the end of the first quarter? We also now know that Warren Buffett's company, Berkshire Hathaway (BRK-A), also sold 25% of its stake in Kraft around the same time.

According to a story in the Wall Street Journal, Pershing Square Capital Management has acquired a 21.8-million-share position in Procter & Gamble (PG) and call options on an additional 8.3 million shares. That may help explain why Ackman's firm checked out of Kraft and raised lots of cash months ago.

At P&G's share price of $66.73 as of the close Tuesday, Ackman's position was worth close to $1.5 billion. No one seems to know why he is accumulating so many shares of P&G, which has a market cap of nearly $188 billion.

It has been rumored that he is interested in meeting with P&G Chairman Bob McDonald. Whether he'll have that opportunity, no one knows for sure. Activists like Ackman often use their ownership clout to push for changes in companies, whether in leadership, direction, or both.

It's fitting that today's income-thirsty investors have lifted both Kraft and P&G stock close to their 52-week highs. At the present time, P&G's yield-to-price ratio of 3.37% is better than Kraft's at 2.84%.

Here's a chart comparing both the share prices and earnings-per-share growth of P&G and Kraft. Notice Kraft's EPS-growth spike (green line) and P&G's lackluster EPS-growth performance.

PG Chart

P&G data by YCharts

Yet P&G reported year-over-year second-quarter earnings growth of almost 45%, compared to Kraft's 5.4% growth in the same quarter. P&G has $9.05 billion of levered free cash flow, compared to Kraft's $2.75 billion.

Personally, I like to compare the total debt-to-equity ratio of companies to see if they're carrying more debt than is reasonable. P&G's debt-to-equity ratio at the end of the second quarter stood at 46.50, while Kraft had a much higher ratio of 84.81. This may be one of the reason's some of the "smart money" has exited Kraft.

Speculation abounds that eventually P&G will be split asunder like Kraft and divided into two companies. If so, it might follow the Kraft formula of spinning off the parts of the company that have created the largest share of the debt load.

Eighteen months ago, Kraft paid a rich 50% premium to buy sweets producer Cadbury. Since the day before it announced the Cadbury bid, Kraft has had total-return growth of 57%.

Now it appears that the Cadbury acquisition is a significant part of what is being spun off. It has been a rewarding acquisition, but 80% of Cadbury's sales come from outside North America, and that has dampened the enthusiasm for its value.

For now, Kraft's North American grocery unit, whose growth has been rather disappointing to some, is expected to pay richer dividends then the other part of the split-up company. I anticipate that fact alone may cause it to outperform its departed "sister" for the time being.

Kraft's split-off snack division, the company that will be called Mondelez International and stay under the leadership of current CEO Irene Rosenfeld, may yet prove to be the grand prize of the coming split for shareholders, but it's way too early to tell.

Maybe that, in combination with how expensive it is to divide a company into two companies and issue new shares to millions of shareholders, is why mega-investors like Ackman and Buffett wanted out many months ago.

The record date of Kraft share ownership to participate in the 1-for-3 shares spin-off (via a pro-rata dividend) is September 19. Kraft's Board also announced a regular quarterly dividend of $0.29 per share. The value of all these manipulations may already be baked into the stock's share-price, as well as every Oreo cookie that emerges from Kraft's bakeries.

Going forward, it wouldn't surprise this analyst to see some correcting in both companies' share prices. Six months from now it may be a toss-up which group of shareholders, those who own today's Kraft Foods or those who own Procter & Gamble, make the better total return on their original investment.

At the time of publication, the author had no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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