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Harvard Business School 9-289-045

Philip Morris Companies and Kraft, Inc.

John M. Richman, the chairman and chief executive officer of Kraft, Inc., concluded his October 23,

1988, letter to shareholders as follows:

We deeply regret the dislocation and hardships that the [restructuring] plan we contemplate will

cause, and we will seek to ameliorate these hardships as much as possible. We know that our

shareholders, employees, customers, suppliers and communities recognize that today’s

situation is not of our making. Rather it is the product of current era investment policies and

financial attitudes that favor shortterm financial gratification over steady, long-term growth and

the need to provide a sound economy for future generations.

It will take several years, but with the history and traditions of Kraft and the dedication of Kraft

people, we are confident that we will rebuild Kraft to the position it occupies today.

The letter announced a radical restructuring of Kraft in response to a hostile tender offer by Philip Morris

Companies: $90 per share in cash for all of Kraft’s outstanding common stock. The offer had been announced

just five days earlier, on October 18, 1988.

Kraft, Inc.

In 1987, Kraft was known for such brand names as Miracle Whip, Seven Seas, and Kraft salad dressings;

Kraft mayonnaise; Velveeta cheese; Parkay and Chiffon margarines; Lender’s Bagels, and Breyers ice cream.

Net sales from continuing operations were $9.9 billion in 1987, an increase of 27% over 1986. Net income from

continuing operations rose 11%, to $435 million. Exhibit 1 presents operating and stockholder information for

Kraft from 1982 through 1987. Exhibit 2 presents balance sheet information for 1986 and 1987.

Kraft’s strategy was focused on food. Its 1987 annual report stated:

The food industry offers such diverse and rewarding opportunities that we see no

purpose in running the risk of diluting our efforts or our focus with other lines of business.

This all-food strategy was in sharp contrast to its earlier diversification program. Most of the diversification

occurred when Mr. Richman engineered the September 1980 merger between Kraft

This case was prepared by Professor Richard S. Ruback as the basis for class discussion rather than to illustrate either

effective or ineffective handling of an administrative situation.

Copyright © 1989 by the President and Fellows of Harvard College. To order copies or request permission to reproduce

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transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the

permission of Harvard Business School.

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and Dart Industries, a $2.4 billion consumer products manufacturer. Mr. Richman, who had been promoted to

chairman and CEO less than 1 year before the merger, noted that the merger brought “diversification in one fell

swoop to Kraft.” Dart’s products included Tupperware containers, Duracell batteries, and West Bend appliances.

The merger was accomplished by exchanging one share of the merged company, Dart & Kraft, for each

outstanding share of the two preexisting companies. Dart & Kraft was the twenty-seventh-largest company in the

United States at the time of the merger. Six months later, in March 1981, Dart & Kraft acquired for $460 million

Hobart Corporation, the manufacturer of KitchenAid and other food-related equipment.

Richman reversed direction and began pursuing the all-food strategy in 1986. Kraft spun off most of its

nonfood businesses acquired in the Dart & Kraft merger into Premark International, Inc., on October 31, 1986.

Each shareholder of Dart & Kraft received one share of Kraft common stock and a quarter share of Premark.

Kraft, with sales of about $9.9 billion after the spin-off, retained its food businesses and Duracell batteries.

Premark’s share of Dart & Kraft included Tupperware and Hobart food service equipment, with combined sales

of $1.8 billion.1

Kraft sold its last nonfood asset, Duracell, to Kohlberg, Kravis, Roberts & Co., a leveraged buyout firm,

for $1.8 billion in June 1988. According to Kraft’s 1987 annual report, the proceeds of the sale were to be used

to repurchase shares and to repay debt obligations. In October of 1987, Kraft authorized the repurchase of 10

million shares, and 6 million were repurchased under the authorization by year’s end.

In 1987, Kraft was organized into three business segments: U.S. Consumer Food, U.S. Commercial

Food, and International Food. In 1987, U.S. Consumer Food had sales of $4.5 billion and an operating profit of

$593 million. U.S. Commercial Food, which included Kraft Foodservice, the second-largest U.S. food service

distributor, had sales of $3 billion and an operating profit of $86.4

million. International Food had sales of $2.3 billion and an operating profit of $229.8 million. Exhibit

3 presents a financial summary of Kraft by business segments.

The Philip Morris $90-a-Share Tender Offer

On the evening of October 18, 1988, Philip Morris offered to purchase all Kraft common stock at $90

per share in cash. The offer represented a 50% premium over the $60.125 closing price on October 18. At $11

billion in total value the bid, if successful, would have been the second-largest acquisition ever completed,

exceeded only by Chevron Corporation’s $13.3 billion acquisition of Gulf Oil Corporation in 1984.2

Most Philip Morris sales and profits came from its Marlboro, Benson & Hedges, and Virginia

Slims cigarettes. The company’s tobacco sales increased by 15%, to $14.6 billion in 1987. Philip Morris

increased its domestic share of the cigarette market to 38% in 1987, from 37% in 1986, and 1987 operating profits

were $3.3 billion. Nevertheless, consumption of cigarettes in the United States had been declining from its 1981

peak of 640 billion cigarettes. Estimated U.S. consumption for 1988 was 563 billion cigarettes. Increases in

exports offset the decline in U.S. consumption, as new markets were entered, especially Japan and Taiwan.

Overall, cigarette exports were predicted to increase by 15%, to 115 billion cigarettes in 1988.

1 KitchenAid had been sold in February 1986 for $150 million.

2 Kraft had 119,285,155 shares outstanding and outstanding employee stock options on 2,396,808 shares. The total number of

Kraft shares purchased under the offer was, therefore, 121,681,963.

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Philip Morris had been pursuing a strategy of diversifying out of the tobacco business since 1969, when

it acquired 53% of the Miller Brewing Company’s common shares, the remainder of which it acquired in 1970.

With brands like Miller, Lite, and Matilda Bay Wine Coolers, the brewing

2

division generated sales of $3.1 billion in 1987. Philip Morris also purchased Seven-Up in May 1978 for $520

million. Its largest food acquisition by far was General Foods which Philip Morris purchased in 1985 for $5.6

billion. Like Kraft, General Foods was based on brand-name products such as Maxwell House coffee, Birds Eye

frozen foods, Jell-O, Oscar Mayer meats, Ronzoni pasta, and Post cereals. It had 1987 sales of $10 billion.

Philip Morris’s acquisitions had mixed results. See Exhibit 4 for operating and stockholder information

from 1982 through 1987. Exhibit 5 presents balance sheet information for 1986 and 1987. Exhibit 6 presents

the consolidated changes in financial position, and Exhibit 7 reports line-ofbusiness information.

Philip Morris sold its Seven-Up operations in 1986 for about book value after a $50 million write-off in

1985. General Food’s operating profit declined from $624 million in 1986 to $605 million in 1987. The 1987

operating profit represented a 9.3% return on Philip Morris’s $6.5 billion investment in the food industry,

including additional postacquisition investments of $868 million. Speculation was that Philip Morris might use

Kraft’s management team to revitalize General Foods, which had been without a chief executive officer since

July 1988, when Philip L. Smith left to become chairman of Pillsbury.3 Smith, a 22-year veteran of General

Foods, had been president and chief operating officer before its merger with Philip Morris.

The acquisition of Kraft would have made Philip Morris the world’s largest food company, and it would

have been a major step in the firms’s strategy of reducing its dependence on tobacco and moving into the food

business. As Hamish Maxwell, the chairman and CEO of Philip Morris, said in his October 21, 1988, letter to

John Richman,

Our goal is to have Kraft combine with Philip Morris to create the leading international food

company. . . . Our intention is to keep Kraft’s present businesses intact and for the company to

be managed by Kraft executives, using your present headquarters and facilities.

Exhibit 8 contains excerpts from the letters between the two companies throughout the takeover contest.

Philip Morris proposed to finance the acquisition with $1.5 billion in excess cash and its available bank

credit lines of up to $12 billion.

Kraft’s Response

On October 23, 1988, Kraft’s board of directors rejected the Philip Morris bid:

We strongly believe the $90 bid . . . undervalues Kraft, for these important reasons: first, after

careful analysis, our investment banker, Goldman Sachs & Co., has advised us that the bid is

inadequate; and second, our stock has been trading above the $90 offer, a clear signal that

investors see the bid as low.

Kraft’s response occurred when the food industry was undergoing a major restructuring and revaluation.

Grand Metropolitan PLC began a hostile tender offer for Pillsbury on October 4, 1988. Grand Met was a

diversified British company that brewed and distributed beer, ale, and lager; produced and distributed alcoholic

3 The combination also would have increased leverage with grocery stores and advertisers. In 1987, Philip Morris spent $1.5

billion and Kraft $400 million on advertising.

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beverages; and owned and operated pubs and restaurants. Pillsbury was a diversified food and restaurant company,

with popular brands such as Pillsbury

3

Doughboy bakery items, Green Giant vegetables, and Häagen-Dazs ice cream in its food business and Burger

King in its restaurant group. Like Kraft, Pillsbury had just completed a major restructuring that focused the

company on the food business. The $5.2 billion Grand Met bid was a 53% premium over the previous market

price—about 25 times Pillsbury’s net earnings and about four times the book value of common equity.4 Pillsbury

opposed the bid, and its outcome was uncertain.

The developments at RJR Nabisco were more startling. Management, in partnership with the investment

banking firm of Shearson Lehman Hutton, had proposed a $17 billion leveraged buyout of RJR Nabisco on

October 20, 1988. Like Philip Morris, RJR Nabisco was a tobacco and food company with brand names such as

Winston and Salem cigarettes, Oreo cookies, Ritz crackers, Planters nuts, Life Savers candy, Royal gelatin, and

Del Monte fruit and vegetables. At $75 a share, the buyout offer was at a 34% premium over the previous market

price of RJR Nabisco, $56.875. The $75 offer was about 16 times RJR Nabisco’s 1987 earnings per share of

$4.70 and about three times the book value of common equity. Analysts speculated that a higher offer for RJR

Nabisco was likely: its stock closed above the offer price.

Taken together, the Philip Morris bid for Kraft, Grand Metropolitan’s bid for Pillsbury, and the RJR

Nabisco leveraged buyout attempt by its management involved about $34 billion—an amount unprecedented in

the history of the industry. Exhibit 9 examines this history, with statistics on mergers and acquisitions for food

and beverage firms, as well as a listing of transactions of more than $1 billion. Exhibit 10 contains historical

stock prices and return-on-equity information for the food and tobacco industries.

Kraft proposed a restructuring plan as an alternative to the Philip Morris tender offer. For each share of

common stock, shareholders would receive a cash dividend of $84 and a high-yield debt valued at $14, and they

would retain their now highly leveraged equity interest. Kraft valued the postrestructuring stock at $12 per share

and the total restructuring package at $110 per share.

Under the plan Kraft would sell some businesses for cash proceeds of about $2.1 billion after taxes. The

businesses to be sold represented 45% of estimated 1988 revenues and 19% of estimated 1988 operating profits.

Kraft would also reduce operating expenses. It would finance the $10.2 billion in dividend payments to

shareholders with $6.8 billion in bank borrowings at a 12% annual interest rate and the $3 billion in debt with

rates ranging from 12.5% to 14.75%. The $2.1 billion from asset sales would be used to pay down the bank debt.

The company planned to retain $904 million of existing debt at an average annual interest rate of 8.65%.

The debt received by shareholders would accrue interest at a 15.25% annual rate (paid semiannually),

with no cash payments in the first 5 years. Interest would be paid in cash at the 15.25% semiannual rate after the

fifth year. Exhibit 11 presents prebid sales and profit forecasts for Kraft through 1989. Exhibit 12 presents

earnings and cash flow forecasts for the restructuring plan proposed by Kraft’s management.

4 Pillsbury's 1988 net earnings per share was $2.45, excluding unusual items, and $.81, including unusual items. The difference

was due to a restructuring charge of $1.64 per share. Its 1987 net earnings per share were $2.24, excluding unusual items, and

$2.10, including unusual items.

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The Stockmarket Response

The price of Kraft common stock rose $10 per share, to $102, in response to the restructuring

announcement. Philip Morris criticized the restructuring plan and reiterated its offer to negotiate with Kraft,

which responded that “if Philip Morris or another company truly wishes to negotiate with

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Kraft, a simple phone call proposing a price of more than $110 is all that is necessary.” Philip Morris did not

increase its bid.

Uncertainty about the market value of food assets grew as Kohlberg, Kravis, and Roberts entered the

bidding for RJR Nabisco, with a $20.6 billion offer on October 24, 1988.

On Thursday, October 27, Kraft’s common stock closed at $94.50. On Friday, October 28, Kraft’s stock

rose $2, closing at $96.50. Exhibit 13 contains the closing stock prices for Kraft and Philip Morris throughout

the takeover contest.

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Exhibit 1 Condensed Operating and Stockholder Information for Kraft, 1982-1987 (millions of dollars except per

share data)

1982 1983 1984 1985 1986 1987

Revenues $7,041 $6,660 $6,831 $7,065 $7,780 $9,876

Cost of goods solda 5,350 4,928 4,969 4,963 5,393 6,912

Depreciation 103 80 74 74 79 103

Delivery, sales, and

administrative expenses 1,183 1,157 1,238 1,391 1,620 2,068

Interest, net 24 (8) 22 26 31 91

Other income (expense)b (38) 23 43 37 37 86

Income from continuing

operations before taxes 343 526 571 648 694 788

Income taxes 164 225 252 286 300 353

Income from continuing

operations 179 301 319 362 394 435

Income from discontinued

operationsc 171 134 137 104 19 54

Net income $ 350 $ 435 $ 456 $ 466 $ 413 $ 489

Earnings per share $ 2.13 $ 2.65 $ 3.17 $ 3.24 $ 3.06 $ 3.73

Dividends per share 1.20 1.28 1.38 1.52 1.68 1.84

Closing stock priced,e 22.83 22.21 28.04 43.38 49.38 48.25

Price-earnings ratioe 11 8 9 13 16 13

Number of shares (millions)e 164 164 144 144 135 131

Betaf .72 .55 .69 1.12 1.18 .74

Sources: Company reports and casewriter’s estimates.

aCost of goods sold does not include annual depreciation.

bIncludes the cumulative effect of a change in method of accounting for income taxes of $45 million in 1987 and a nonoperating

item of -$91 million in 1982.

cDiscontinued operations include Duracell, whose sale was announced in 1987, and the business of Premark International,

which was spun off on October 31, 1986. Also included in discontinued operations is a $41 million gain on the sale of

KitchenAid in 1986. dAdjusted for a 3-for-1 stock split in 1985.

eYear-end.

fCalculated by

ordinary least-square regression using daily stock price data.

Exhibit 2 Consolidated Balance Sheets for Kraft, 1986-1987 (millions of dollars)

1986 1987

Cash $ 321.5 $ 189.0

Accounts Receivable 637.6 763.6

Inventories 1,061.1 1,283.4

Investments and long-term receivables 236.2 178.3

Prepaid and deferred items 127.5 161.5

Property, plant, equipment, net 1,087.7 1,424.2

Intangibles 419.0 888.3

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Net assets of discontinued operations 600.7 598.4

Total Assets $4,491.3 $5,486.7

Accounts payable $ 492.1 $ 544.8

Short-term borrowings 596.4 645.9

Accrued compensation 148.9 151.2

Accrued advertising and promotions 113.7 132.8

Other accrued liabilities 188.4 245.4

Accrued income taxes 335.3 399.3

Current portion of long-term debt 108.5 37.2

Current liabilities 1,983.3 2,156.6

Long-term debt 237.7 895.3

Deferred income taxes 286.4 282.7

Other liabilities 185.9 253.7

Total Liabilities 2,693.3 3,588.3

Shareholders’ equity 1,798.0 1,898.4

Total Liabilities and Net Worth $4,491.3 $5,486.7

Source: Company reports.

Exhibit 3 Financial Summary for Kraft by Business Segment, 1983-1987 (millions of dollars)

1983 1984 1985 1986 1987

U.S. Consumer Fooda

Sales $3,718.0 $3,781.2 $3,911.3 $4,016.1 $4,518.9

Operating profit 388.1 446.0 527.3 545.9 593.3

Identifiable assets 1,450.9 1,615.4 1,309.1 1,807.6 2,509.3

Depreciation 54.0 50.0 37.6 36.6 47.4

Capital expenditures 58.0 71.7 63.1 93.7 151.2

Operating profits/Identifiable assets 26.75% 27.61% 40.28% 30.20% 23.64%

U.S. Commercial Food

Sales $1,172.7 $1,349.3 $1,421.0 $1,755.8 $3,022.0

Operating profit na na 61.7 79.5 86.4

Identifiable assets na na 291.4 558.9 914.6

Depreciation na na 7.6 8.0 15.3

Capital expenditures na na 5.2 17.6 33.7

Operating profits/Identifiable assets na na 21.17% 14.22% 9.45%

International Food

Sales $1,769.7 $1707.2 $1,733.0 $2,007.7 $2,334.8

Operating profit 165.4 169.4 145.9 182.8 229.8

Identifiable assets 680.9 701.1 793.7 861.1 1,000.5

Depreciation 19.2 18.9 20.6 27.5 34.0

Capital expenditures 37.3 36.2 39.2 41.7 48.3

Operating profits/Identifiable assets 24.29% 24.16% 18.38% 21.23% 22.97%

Direct Sellingb

Sales $ 825.1 $ 776.9 – – –

Operating profit 189.3 138.8 – – –

Identifiable assets 462.7 488.0 – – –

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Depreciation 36.0 28.9 – – –

Capital expenditures 40.7 62.8 – – –

Operating profits/Identifiable assets 40.91% 28.44% – – –

Consumer Productsc

Sales $1,181.0 $1,244.8 $ 962.5 – –

Operating profit 104.7 118.4 66.9 – –

Identifiable assets 828.0 958.8 849.6 – –

Depreciation 26.9 42.9 34.2 – –

Capital expenditures 43.0 67.9 47.4 – –

Operating profits/Identifiable assets 12.64% 12.35% 7.87% – –

Commercial Productsd

Sales $1,047.5 $ 899.3 – – –

Operating profit 104.8 101.0 – – –

Identifiable assets 727.6 556.9 – – –

Depreciation 30.4 23.9 – – –

Capital expenditures 25.4 28.1 – – –

Operating profits/Identifiable assets 14.40% 18.14% – – –

Source: Company reports. na = not

available.

aFigures for 1983 and 1984 include both U.S. consumer foods and U.S. commercial foods.

bIncludes

Tupperware, which was spun off to Premark International in 1988. cIncludes Duracell, West Bend, Health Care, and KitchenAid. All assets except Duracell were sold or spun off to Premark

International in 1986.

dIncludes Hobart, which was spun off to Premark International in 1986.

Exhibit 4 Condensed Operating and Stockholder Information for Philip Morris, 1982-1987 (millions of dollars

except per share data)

1982 1983 1984 1985c 1986 1987

Revenues $11,586 $12,976 $13,814 $15,964 $25,409 $27,695

Cost of goods solda 5,046 5,028 5,170 5,926 10,495 10,664

Excise taxes 2,615 3,510 3,676 3,815 4,728 5,416

Depreciation and amortization 281 327 375 424 655 704

Selling, administrative, and

research expensesb 2,125 2,377 2,467 3,244 6,061 7,004

Equity in net earnings of

unconsolidated subsidiaries 71 83 54 82 111 126

Interest 246 230 273 308 770 685

Other expense 44 – 300 – – –

Income before taxes 1,300 1,587 1,607 2,329 2,811 3,348

Income taxes 518 681 718 1,074 1,333 1,506

Net income $ 782 $ 906 $ 889 $ 1,255 $ 1,478 $ 1,842

Earnings per share $ 3.11 $ 3.58 $ 3.62 $ 5.24 $ 6.20 $ 7.75

Dividends per share 1.20 1.45 1.70 2.00 2.48 3.15

Closing stock priced 30 35.875 40.375 44.125 71.875 85.375

Price-earnings ratiod 9 10 11 8 11 11

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Number of shares (millions)d 252 250 243 239 238 237

Betae 1.04 .77 .94 .88 1.24 .88

Sources: Company reports and casewriter’s estimates.

aCost of goods sold does not include annual depreciation.

bSelling,

administrative, and research cost includes corporate expenses. cGeneral

Foods was acquired on November 1, 1985. dYear-end.

eCalculated by

ordinary least-squares regression using daily stock price data.

Exhibit 5 Consolidated Balance Sheets for Philip Morris, 1986-1987 (millions of dollars)

1986 1987

Cash $ 73 $ 189

Receivables 1,878 2,083

Inventories 3,836 4,154

Other current assets 127 146

Property, plant, equipment, net 6,237 6,582

Investments in unconsolidated subsidiaries

and affiliates 1,067 1,244

Goodwill and other intangibles 3,988 4,052

Other assets 436 695

Total Assets $17,642 $19,145

Notes payable $ 864 $ 691

Accounts payable 813 803

Current portion of long-term debt 103 465

Accrued liabilities 1,967 2,277

Income taxes payable 557 727

Dividends payable 178 213

Current liabilities 4,482 5,176

Long-term debt 5,945 5,222

Deferred income taxes 994 1,288

Other liabilities 566 636

Total Liabilities 11,987 12,322

Stockholders’ equity 5,655 6,823

Total Liabilities and Net Worth $17,642 $19,145

Source: Company reports.

Exhibit 6 Consolidated Statements of Changes in Financial Position for Philip Morris, 1985-1987

(millions of dollars)

1985 1986 1987

Funds Provided by:

Net earnings $ 1,255 $ 1,478 $ 1,842

Depreciation and amortization 424 655 704

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Deferred income taxes 159 133 338

Equity in undistributed net earnings of unconsolidated

subsidiaries and affiliates (63) (52) (95)

Total funds from operations 1,775 2,214 2,789

Increase in accrued liabilities and other payments 1,467 226 505

Working capital from sales of operations 169 487 20

Currency translation adjustments affecting working

capital 18 77 139

Other, net 211 210 –

Total Funds Provided $ 3,640 $ 3,214 $ 3,453

Funds Used for:

Increase (decrease) in:

Cash and receivables $ 1,005 $ (2) $ 321

Inventories 1,174 9 318

Other current assets 74 14 19

Capital expenditures 347 678 718

Dividends declared 479 590 749

Increase in property, plant, and equipment from income

tax election – 508 –

Investment in General Foods Corp. exclusive of $718

million working capital acquired 4,864 – –

Other, net – – 301

Total Funds Used $ 7,943 $ 1,797 $ 2,426

Net funds provided (used) $(4,303) $ 1,417 $ 1,027

Financing Activities:

Increase in current notes payable $ 149 $ 289 $ 189

Long-term debt financing 4,666 1,788 492

Reduction of long-term debt (326) (3,385) (1,534)

Purchase of treasury stock (216) (140) (200)

Issuance of shares 30 31 26

Funds (used for) Provided from Financing Activities $ 4,303 $(1,417) $(1,027)

Increase (decrease) in working capital $ 637 $ (494) $ (36)

Working capital (year-end) 1,926 1,432 1,396

Source: Company reports.

Exhibit 7 Financial Summary for Philip Morris by Business Segment, 1982-1987 (millions of dollars)

1982 1983 1984 1985 1986 1987

Tobacco:

Sales $7,821.8 $9,094.9 $9,802.0 $10,539.0 $12,691.0 $14,644.0

Operating profit 1,475.7 1,647.0 2,141.0 2,441.0 2,827.0 3,273.0

Identifiable assets 5,070.7 5,114.3 5,149.0 5,622.0 5,808.0 6,467.0

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Depreciation 97.7 124.7 151.0 166.0 200.0 214.0

Capital expenditures 498.0 319.9 163.0 151.0 191.0 256.0

Operating profit/Identifiable

assets 29.10% 32.20% 41.58% 43.42% 48.67% 50.61%

Food Products:

Sales – – – $ 1,632.0 $ 9,664.0 $ 9,946.0

Operating profit – – – 95.0 624.0 605.0

Identifiable assets – – – 7,974.0 8,629.0 9,129.0

Depreciation – – – 29.0 167.0 201.0

Capital expenditures – – – 71.0 395.0 402.0

Operating profit/Identifiable

assets – – – 1.19% 7.23% 6.63%

Beer:

Sales $2,935.5 $2,935.5 $2,940.0 $ 2,925.0 $ 3,054.0 $ 3,105.0

Operating profit 159.0 227.1 116.0 136.0 154.0 170.0

Identifiable assets 2,113.7 2,138.9 1,892.0 1,779.0 1,736.0 1,680.0

Depreciation 122.3 130.5 144.0 134.0 136.0 137.0

Capital expenditures 286.3 174.6 94.0 87.0 80.0 57.0

Operating profit/Identifiable

assets 7.52% 10.62% 6.13% 7.64% 8.87% 10.12%

Othera:

Sales $ 822.9 $ 945.5 $1,072.0 $ 868.0 – –

Operating profit (loss) (2.4) (10.9) 23.0 14.0 $ (9.0) $ 19.0

Identifiable assets 979.4 1,007.3 1,018.0 643.0 – –

Depreciation – – – – – –

Capital expenditures – – – – – –

Operating profit/Identifiable

assets -0.25% -1.08% 2.26% 2.18% – –

Source: Company reports.

aIncludes the Seven-Up Company, which was sold in 1986.

Exhibit 8 Correspondence During Takeover Bid Between Kraft and Philip Morris, October 1988

October 20, 1988

Mr. Hamish Maxwell

Chairman and Chief Executive Officer Philip

Morris Companies Inc.

120 Park Avenue New

York, NY 10017

Dear Hamish:

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In addition to your letter requesting “negotiations” following your commencing, on Monday, a tender offer

without talking to me beforehand, your lawyers and investment bankers have been barraging our advisers with

similar requests. You did not see fit to discuss your takeover attempt when we were together at the Grocery

Manufacturers of America meeting last Wednesday and Thursday, nor did you see fit to tell me that you were

planning on filing a bizarre and baseless law suit against me and our Board of Directors on Monday.

You must have been planning your takeover bid for a long time. We intend to take our time and study the situation

very carefully. We have a fiduciary duty to our shareholders and an obligation to our employees, customers,

suppliers, and communities to do so. Following our study, the Board of Directors will consider the situation and

determine Kraft’s response. If at that time there is a purpose to be served by our meeting, we will so advise you.

Sincerely, JOHN M. RICHMAN

Chairman and Chief Executive Officer Kraft,

Inc.

October 21, 1988

Mr. John M. Richman

Chairman and Chief Executive Officer Kraft,

Inc.

Kraft Court

Glenview, IL 60025

Dear John:

I understand and sympathize with your reaction to the events of this week. I would have preferred to discuss our

offer with you prior to taking the actions we commenced. However, in the current legal environment in which

we live, I accepted the advice to proceed as we did as a business decision. Our actions were designed to minimize

uncertainties and delays in addressing the main issue—the economic benefits and other factors favoring the

merger of Kraft with Philip Morris.

I hope you understand that any discussion of our interest in Kraft would have been premature and inappropriate

when we saw each other last week at the Grocery Manufacturers of America meeting. At that time we had made

no final decision to proceed with an offer and our Board had not yet approved our actions. In any event, I am

hopeful you and we can now move forward in a positive and constructive manner.

I quite appreciate your need to study our offer carefully before responding to it. We have, however, seen press

reports that Kraft may consider other possibilities including highly leveraged transactions that could encumber

the company, operationally and financially, and which also might lead to the dismemberment of Kraft. From

what I know of you and some public statements you have made, I feel sure that this is not the route you would

prefer to take.

As we have said, our goal is to have Kraft combine with Philip Morris to create the leading international food

company. I repeat that our intention is to keep Kraft’s present businesses intact and for the company to be

managed by Kraft executives, using your present headquarters and facilities.

I believe it to be in the best interests of your shareholders and other constituencies that we avoid a prolonged

struggle that could disrupt Kraft’s business without adding to the value that would be realized by your

shareholders

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I also believe that a meeting between us could only be helpful to you in understanding our purposes and positive

thoughts concerning a combination of our two companies. . . .I want to emphasize that we are prepared to discuss

all aspects of our offer.

I would be available to meet with you in Chicago at any time on short notice. I can be reached through my office

if, as I hope, you see the benefits of such a meeting.

Yours sincerely, HAMISH MAXWELL

Chairman and Chief Executive Officer Philip

Morris Companies Inc.

October 23, 1988

To: Shareholders of Kraft, Inc.

Dear Shareholder:

Kraft has an outstanding record of profitability and growth. It is a great company with great traditions, great

brands, a great future, and great people who have devoted their lives to making your company what it is today.

Kraft’s record of success—an increase in shareholder value, without regard to recent events, at a compound annual

rate of more than 20% over the past 5 years—has been based on a strategy of balancing significant short-term

returns and continued investment for long-term growth. This strategy has been working, but—frustratingly—the

stock market has long been undervaluing companies which, like Kraft, sacrifice short-term profit in order to invest

in long-term growth.

Last Monday, Philip Morris Companies, seeking to take advantage of this undervaluation, announced an

unsolicited tender offer for Kraft at $90 per share.

We strongly believe the $90 takeover bid also undervalues Kraft, for these important reasons: first, after careful

analysis, our investment banker, Goldman, Sachs & Co., has advised us that the bid is inadequate; and second,

our stock has been trading above the $90 offer, a clear signal that investors see the bid as low.

Your Board of Directors has unanimously rejected the offer, and we strongly recommend that you do not tender

your Kraft shares to Philip Morris.

At the same time, both your Board and company management recognize that, as a practical matter, the Philip

Morris bid makes it impossible for us to go back to the situation that existed prior to the bid. Under the

circumstances, your Board believes that we should take action to maximize shareholder value rather than accept

an inadequate offer. Together with Goldman, Sachs we are developing a potential recapitalization plan that we

believe will have a value of significantly more than $90 per share.

The plan we are working on is intended to result in a total value estimated to be in excess of $110 per share, with

a distribution in cash and securities totaling approximately $98 per share and the retention of your common stock

interest, the price of which will be adjusted by the market to reflect the cash and securities distribution. Under

the plan, you will receive a cash distribution and new securities, and retain your Kraft common stock. Most

shareholders will have less tax to pay as a result of the distribution than if Kraft were to be acquired by Philip

Morris (or anyone else) at a price that is equal to the value of the restructuring plan.

Your Board believes that this plan will enable you as a shareholder to realize present value for your shares and

also continue to participate in the future of Kraft, including some exciting new product lines we have been

developing.

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The plan will involve the sale of some of our businesses, bank borrowings of more than $6.8 billion, and the sale

of $3.0 billion of debt. We have already begun to implement some of these transactions. Goldman, Sachs has

advised us that it is highly confident with respect to the placement of the debt under current market conditions.

We will retain our core businesses, together with the key brands which have provided Kraft’s historic strength

and currently account for approximately 80% of its profitability.

Because the restructured Kraft will have more than $12.4 billion in debt and require herculean efforts by our

employees, the plan will replicate the structure currently in use in sponsored leveraged buyouts by providing

significant equity incentives for employees in the form of stock options and an employee stock ownership plan.

This very important link between employee compensation and company performance will, we believe, ensure the

enormous efforts required to make the recapitalization a complete success.

We expect that the plan will be fully developed and our Board will be able to approve it in the very near future,

at which time we will announce the details. Because the plan involves very significant restructuring of our

businesses and financial structure, the Board also believes you should have the opportunity to vote upon it at a

special meeting of shareholders.

For your further information, on Friday, October 21, there was a series of communications with Philip Morris.

Philip Morris renewed their request for immediate negotiation, stating that all aspects of their offer, including

price, are open for discussion. Philip Morris said that there would be real value to them if they could conclude

the agreement with us over the weekend and asked for a meeting on Saturday. We responded that if Philip Morris

were prepared to offer a realistic price, we would meet on Saturday. We told Philip Morris that their $90 bid is

substantially below our valuation and Goldman, Sach’s valuation and that there would be no purpose served by a

meeting unless Philip

Morris were prepared to start the negotiations from a price substantially greater than $90. We asked Philip Morris

to tell us where they stood and told Philip Morris that if they were in the range of value that we and Goldman,

Sachs believe is obtainable, we would meet with them on Saturday. Philip Morris replied that they completely

disagree with our opinion of their $90 price, that they believe $90 represents full value, and they would not tell

us what price they are prepared to offer. Given this attitude on the part of Philip Morris, it was clear that a meeting

would not have served any purpose of Kraft and its shareholders, and we so advised Philip Morris. We also

advised Philip Morris that we were not foreclosing negotiations and that if they were to offer a price that reflects

the full value of Kraft, we would negotiate with them.

Since we believe that the restructuring plan will create greater shareholder value and opportunity than the Philip

Morris bid or any other known alternative, it is our intention to proceed with the restructuring on an exclusive

basis. However, if someone comes forward with a transaction that would be more desirable than the restructuring

plan, we will negotiate and your Board will give full consideration to such a transaction.

We deeply regret the dislocation and hardships that the plan we contemplate will cause, and we will seek to

ameliorate these hardships as much as possible. We know that our shareholders, employees, customers, suppliers,

and communities recognize that today’s situation is not of our making. Rather it is the product of current era

investment policies and financial attitudes that favor short-term financial gratification over steady, long-term

growth and the need to provide a sound economy for future generations.

It will take several years, but with the history and traditions of Kraft and the dedication of Kraft people, we are

confident that we will rebuild Kraft to the leading position it occupies today.

On behalf of the Board of Directors,

JOHN M. RICHMAN Chairman

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October 24, 1988

Calvin J. Collier, Esq.

Senior Vice President and General Counsel Kraft, Inc.

Kraft Court Glenview,

IL 60025

Dear Mr. Collier:

In light of the announcement yesterday of Kraft, Inc.’s proposed recapitalization plan, Philip Morris believes that

Kraft is required to take all necessary steps to ensure that Philip Morris is given an opportunity to analyze fully

Kraft’s contemplated recapitalization transaction and any other proposed transaction for the sale of Kraft or any

of its assets to a third party. . . .

We have a number of questions that bear on the feasibility and value to Kraft’s shareholders of the announced

recapitalization plan. . . .

We request that Kraft immediately supply to us specific information concerning the details of Kraft’s

recapitalization plan, all information concerning Kraft which may assist us in evaluating the company, and any

information supplied to other third parties with respect to the sale of the company or any parts of the company.

We also request that, consistent with the responsibilities of your Board of Directors to your shareholders, Kraft

not enter into, or agree to enter into, any extraordinary transaction, including a recapitalization plan, a sale of

assets or securities of Kraft, or a sale of the company, or take any steps to implement any of the foregoing, until

Philip Morris is given a full and fair opportunity to develop its response, and that Kraft not take any action which

may diminish the value of Kraft. The that end we are today filing a motion in the Federal District Court.

Philip Morris continues to believe that, if our companies work together, a transaction can be negotiated which

will achieve maximum value for Kraft’s shareholders speedily and without the extraordinary disruptions to Kraft’s

businesses which Kraft acknowledges would be inherent in the contemplated restructuring plan.

Sincerely, MURRAY H. BRING

Senior Vice President and General Counsel Philip

Morris Companies Inc.

October 25, 1988

Mr. Hamish Maxwell

Chairman and Chief Executive Officer Philip

Morris Companies Inc.

120 Park Avenue New

York, NY 10017

Dear Hamish:

I have previously advised Philip Morris of Kraft’s position on your tender offer. The letter your general counsel

sent to our general counsel yesterday, and the papers your lawyers filed in court yesterday, indicate that Philip

Morris does not understand what Kraft is doing—or more likely, Philip Morris is pretending not to understand in

order to increase its pressure tactics. Obviously it is in your interest to try to pressure Kraft and the Kraft

shareholders into a transaction that benefits you at their expense. Kraft will not permit this.

Let me again make clear Kraft’s position.

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Kraft was not “for sale” and is not “for sale.” This is no “auction” of Kraft. Philip Morris made a unilateral

tender offer for Kraft. The Kraft Board of Directors rejected your tender offer. Your price is too low. Kraft has

a recapitalization plan that creates far greater value for the Kraft shareholders than your inadequate offer. Kraft

is submitting the recapitalization plan to Kraft shareholders for their consideration. The recapitalization will take

place only if our shareholders approve it. Kraft will not pressure its shareholders, nor will Kraft permit you to

stampede them. The Kraft Board is not taking action to “entrench” itself. Just the opposite, it is proceeding

expeditiously to provide Kraft shareholders with a choice between your inadequate $90 bid and a better than $110

recapitalization.

As frequently happens—witness the RJR Nabisco situation—new bidders appear and old bidders raise their bids.

The Kraft Board recognizes that another company or Philip Morris may offer more than $110 per share to acquire

Kraft. Accordingly, the Kraft Board said that Kraft would negotiate with that company, or you, and if it, or your

company, has a better transaction than the recapitalization plan, Kraft will enter into that transaction.

In other words, if Philip Morris or another company truly wishes to negotiate with Kraft, a simple phone call

proposing a price of more than $110 is all that is necessary.

Please give a copy of this letter to your general counsel as our answer to his letter, and ask him to give copies to

your other lawyers and financial advisers, and instruct them to stop mischaracterizing our position.

Sincerely, JOHN M. RICHMAN

Chairman and Chief Executive Officer Kraft,

Inc.

For the exclusive use of R. FRENCH, 2020.

289-045 -18-

Exhibit 9 Mergers and Acquisitions in the Food Processing and Beverage Industries, 1981-1987

Number and Dollar Value of Mergers in the Food and Beverage Industry

Amount Paid No. of Transactions ($ billions)

1981 88 $ 4.55 1982 83 4.96 1983 85 2.71 1984 79 7.95 1985 105 12.86

1986 127 8.43

1987 97 7.75

Mergers in the Food and Beverage Industry Over $1 Billion ($ millions)

Bidder Target Year

Target’s Sales

Amount Paid

Premium Percent

Price-Earnings Ratio

Multiple

to Book

Philip Morris General Foods 1985 $9,022.4 $5,627.5 35.2% 18.7 3.5

RJ Reynolds Nabisco Brands 1985 5,985.0 4,906.4 31.5 16.7 4.1

Nestle S.A. Carnation Co. 1984 3,370.0 2,885.4 9.9 14.4 2.7

Beatrice Foods Esmark, Inc. 1984 4,120.0 2,508.6 39.5 15.7 2.5

RJ Reynolds Heublein, Inc. 1982 2,140.0 1,302.6 36.5 13.1 2.7

Bond Corporate Holdings Ltd. G. Heileman Brewing Co. 1987 1,173.8 1,083.6 21.6 23.0 3.2

Source: W.T. Grimm and Co., Mergerstat Review, 1981-1987.

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Exhibit 10 Stock Price Indexes and Returns on Equity, 1982-1987

1982 1983 1984 1985 1986 1987

Stock price indexes (1981 = 100) Kraft 144.1 148.5 200.6 321.2 397.3 409.3

Philip Morris 128.8 161.2 190.0 218.3 368.7 453.0

RJR Nabisco 114.8 144.8 192.2 220.1 357.4 337.0

Pillsbury 133.0 202.1 256.4 365.4 413.5 440.8

Food index 132.9 161.1 186.9 297.6 387.4 398.8

Tobacco index 117.7 142.4 165.7 179.2 279.7 299.0

S&P 500 index 114.7 134.5 136.4 172.3 197.6 201.5

Return on equity (ROE) Kraft 12.6% 14.9% 17.6% 16.2% 23.0% 25.8%

Philip Morris 21.3 22.4 21.7 26.5 26.1 27.0

RJR Nabisco 20.8 17.1 22.3 20.8 20.0 22.8

Pillsbury 16.6 15.0 17.0 17.3 16.8 13.5

Food index 14.3 17.0 17.9 18.0 12.0 12.5

Tobacco index 19.0 18.2 19.4 21.6 20.0 20.3

S&P 500 index 10.9 11.7 13.1 11.0 10.5 11.8

Exhibit 11 Pre-Bid Sales and Profit Forecasts for Kraft, 1988-1989 (millions of dollars)

1987 Est. 1988 Est. 1989

Revenues $9,876 $11,200 $12,500

Earnings before interest and taxes 834 950 1,050

Interest, net 91 95 108

Income from continuing operations before taxes 743 855 942

Income taxes 353 333 368

Accounting change 45 – –

Income from continuing operations 435 522 574

Income from discontinued operationsa 54 658 –

Net income $ 489 $ 1,180 $ 574

Source: Analyst’s estimates.

aDuracell was sold to Kohlberg, Kravis, Roberts & Co. for $1.8 billion on June 24, 1988. Duracell’s 1987 after-tax income was

$54 million, and Kraft’s 1988 gain on its sale was $658 million.

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289-045 -20-

Exhibit 12 Projections for Kraft’s Restructuring Plan, 1989-1998 (millions of dollars)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Sales $ 6,515 $ 6,804 $7,125 $7,481 $7,855 $8,248 $8,660 $9,093 $9,548 $10,025

Earnings before interest and taxes 1,280 1,487 1,671 1,755 1,842 1,935 2,031 2,133 2,239 2,351

Interest 1,380 1,270 1,310 1,286 1,278 1,257 1,212 1,155 1,086 1,010

Taxes (39) 89 148 192 231 278 336 401 473 550

Profit (loss) after taxes from

continuing operations (61) 128 213 277 333 400 483 577 680 791

Cash flow available for capital

paymentsa 2,481b 496 636 630 742 334 411 500 597 728

Principal payments

Preexisting debt 111 33 57 287 100 100 100 100 16 0

Bank debt 2,370 463 579 343 642 234 311 400 581 728

Year-end book values

Preexisting debt 793 759 703 416 316 216 116 16 0 0

Bank debt 4,430 3,968 3,389 3,046 2,404 2,170 1,859 1,459 878 150

High-yield debt 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000

Cram-down debt 1,974 2,286 2,648 3,067 3,553 3,553 3,553 3,553 3,553 3,553

Total $10,197 $10,013 $9,740 $9,529 $9,273 $8,939 $8,528 $8,028 $7,431 $ 6,703

Sources: Kraft and casewriter’s estimates.

aCash flow available for capital payments = net income + depreciation, amortization, deferred taxes – capital expenditures – change in working capital + net proceeds from asset sales & non-cash interest.

bIncludes the $2,146 million in cash proceeds from the sale of businesses in 1989.

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Exhibit 13 Stock Prices and Market Index, October 1988

Date

Philip

Morris Kraft S&P 500 Event

Oct. 3 $ 97.000 $ 60.000 638.710

4 98.000 58.500 637.010 Grand Metropolitan bids for Pillsbury Company.

5 97.375 59.375 640.020

6 96.875 59.375 641.360

7 100.875 60.625 654.830

10 101.125 60.750 655.320

11 100.750 60.375 654.680

12 98.875 59.500 645.470

13 99.250 59.250 648.480

14 98.625 59.500 649.230

17 100.000 60.125 651.460

18 95.500 88.250 658.560 Philip Morris bids $90 per share for Kraft.

19 94.000 90.375 652.970

20 99.000 90.250 666.990 RJR Nabisco management proposes a $17 billion

21 97.375 92.000 668.920 leveraged buyout.

24 97.500 102.000 665.760 Kraft proposes its restructuring plan and Kohlberg,

25 95.875 99.000 666.090 Kravis, Roberts announces its bid for RJR Nabisco.

26 95.500 97.500 663.820

27 95.000 94.500 654.240

28 94.750 96.500 657.280