Read the Case study, this case addresses a conflict between governance and the valuation of the company. List and evaluate these issues being addressed and the obligations of all the parties.

Case Study

Hersheys chocolate. Like baseball and apple pie, it was an American icon. So when Hersheys largest shareholder proposed selling the company in early 2002, the residents of Hershey, Pennsylvania, the state attorney general, legislators, and current and former Hershey employees reacted with alarm. For them, the idea of selling the Great American Chocolate Bar was an insult to a beloved American institution and a threat to the principles on which Milton Hershey had built his company.

Unlike most large corporations, Hershey Foods majority shareholder was not a corporate raider, institutional investor, or multinational, but rather the Hershey Trust Company, which owned 77% of its voting stock. The trust had been endowed by a gift, in 1918, by Milton Hershey himself, with the objective of supporting the Milton Hershey School, an institution for orphans in Hershey, Pennsylvania. Nevertheless, in March 2002, the Hershey Trusts board of trustees decided that the school would be better served if its holdings were less concentrated in Hershey stock. Therefore, the Hershey Trust announced its decision to sell its entire stake in Hershey Foods, which effectively put the corporation up for sale.

Six months after making its decision to explore a potential sale, the board of the Hershey Trust Company was examining two serious offers: a joint bid from Cadbury Schweppes PLC and Nestle? S.A. and an independent bid from the Wm. Wrigley Jr. Company. The primary question for the boards 17 members was whether the bidders had accurately valued Hershey and, if so, whether the economic value created through the deal was consistent with the boards obligation to safeguard Hersheys legacy of community involvement.

The Confectionary Industry

In 2001, the U.S. confectionary industry was worth $24 billion. Chocolate products accounted for 55% of that market; gum, 12%; and nonchocolate candy, 32%. The consumption of all confectionery had stagnated in the United States during the past four years, and the consumption of chocolate, in particular, had declined during the previous year. Despite the disappointing trend in the U.S. market, several factors had helped a few key industry players grow during this period:

Developing innovative products with high consumer appeal and price per pound

Identifying and acquiring target companies to execute expansion strategies Developing operations and/or distribution systems in new countries

With a market share of 30%, Hershey led the U.S. market for candy and gum in 2001, followed by M&M Mars, Inc. (Masterfoods Corp.) at 17.1%, Wm. Wrigley Jr. Co. at 6.6%, and Nestle? at 6.5%. The other players sharing the remaining 40% of the market included Cadbury Schweppes, Worlds Finest Chocolate, Inc., and Tootsie Roll Industries, Inc.

With its aggressive introduction of new products, Wrigley posted a 12.3% growth in revenues over the previous year. Wrigley, the largest producer of chewing gum in the world, had recently introduced Wrigley Eclipse Flash Strips, which accounted for some of the companys impressive performance and moved it from fourth to third place in U.S. rankings. Nestle? showed 6.5% sales growth, and Mars and Hershey each showed 1.4% growth.

Milton Snavely Hershey: Entrepreneur

Milton Snavely Hershey was born to a German-Mennonite family in south-central Pennsylvania, on September 13, 1857, shortly before the outbreak of the American Civil War. In his youth, Hershey was a poor student, and after transferring among seven different schools, he dropped out before reaching the fourth grade. As a young adult, Hershey developed an interest in becoming a confectioner, and in 1886, he opened the Lancaster Caramel Company in Lancaster, Pennsylvania, which specialized in caramels made with fresh milk. Because he believed there would be great demand for affordable, mass-produced chocolate, Hershey sold his caramel business for $1 million in 1900, but retained the firms chocolate-making machines. Attracted by central Pennsylvanias ample supplies of water, dairy farms, and hard-working immigrants, Hershey used the proceeds from the sale to purchase 1,200 acres of farmland and to break ground for the Hershey factory on March 2, 1903. Upon its completion, in December 1904, Hershey had built the largest chocolate factory in the world, and the Hershey Chocolate Company was born.

Hershey, Pennsylvania: From Factory to Company to Town

Hershey enjoyed making money, but he wanted it used for a purpose of enduring good. (A sign on his office wall read Business Is a Matter of Human Service.) Influenced by utopian manufacturing communities of the time, Milton Hershey decided to surround his business enterprise with a model town. In the pastures sur- rounding his new factory, Hershey mapped out a village, with tree-lined streets whose names evoked the exotic lands of the cocoa bean, including Trinidad, Caracas, and Ceylon (Sri Lanka). Milton Hershey created the Hershey Improvement Company, a division of Hershey Chocolate, which built a complete infrastructure, including roads, sewers, utilities, houses, and public buildings. In 1906, the village of Derry Church, Pennsylvania, was renamed Hershey. The development of Hershey, Pennsylvania, followed the ebb and flow of the companys fortunes. Following financial difficulties in 1920, Milton Hershey reorganized and refinanced his company, creating three new entities: Hershey Chocolate Corporation, which acquired all the chocolate properties; Hershey Corporation, which acquired the companys 65,000 acres of sugar-cane fields and eight sugar-processing plants in Cuba; Hershey Estates, which continued the work of the Hershey Improvement Company. Through Hershey Estates, the Hershey Chocolate Company played an ever- larger role in the lives of Hersheys citizens. By 1927, Hershey Estates had a hand in more than 30 nonchocolate interests, including the telephone company, a department store, the hospital, and the cemetery. See Exhibit 1 for a list of Hershey Estates enterprises. Milton Hersheys dedication to his employees and the residents of the town was steadfast. During the Great Depression, despite a 50% drop in sales, Hershey refused to lay off any local employees. Instead, between 1929 and 1939, he launched a series of massive building projects that resulted in the construction of most of Hersheys major buildings, including the Hershey Community Center, the lavish Hotel Hershey, the high school, the Hershey Sports Arena, Hershey Stadium, and the Hershey Choco- late Corporation headquarters, at 19 East Chocolate Avenue. Hershey Estates served the town well but operated at a financial loss. During Milton Hersheys lifetime, profit for the Estates division was never a primary consideration. In fact, after 1927, Milton Hershey relied on profits from the companys Cuban sugar operations to provide the capital for his many construction projects. Following Hersheys death, in 1945, pressure grew to reduce Hershey Chocolates involvement in the town. In the 1960s, owing to increased regulation, competition for financing, and a poor business climate, Hershey Estates divested its electric, water, sewer, and telephone utilities. The lumberyard and creamery were also sold, the ballroom torn down, the pool filled in, and the community center turned over to Hershey Foods for office space. In 1970, after years of benign neglect, Hershey Estates began to focus on Hersheypark, an amusement park, as a revenue generator, and approved a five-year plan to revitalize it. Later, Hershey Estates was renamed Hershey Entertainment and Resorts Company (HERCO), and committed itself to managing Hersheys entertainment properties. See Exhibit 2 for a description of HERCOs businesses.

Milton Hersheys Commitment: The Milton Hershey School

In 1909, at the suggestion of his wife, Kitty, the unschooled Milton Hershey created a residence and school for homeless boys. In 1918, three years after his wifes death, the childless Milton Hershey bequeathed his entire personal fortune to the Milton Hershey School, including thousands of acres of land and all his stock in the Hershey Chocolate Company. The Hersheys designated the newly created Hershey Trust Company as the sole trustee for the school. According to the deed of trust, the trustee was responsible for managing the trusts considerable endowment and for reporting to the schools managers. Ever since the bequest, the Hershey Trust Company had had a controlling interest in every major Hershey entity. Moreover, the schools managers and the trusts board comprised the same 17 individuals. Hershey Foods board, how- ever, was, for the most part, an independent entity with only one of its nine members also serving on the trusts board. See Exhibit 3 for an organizational chart. By 2002, the Milton Hershey School (MHS) admitted both boys and girls with- out regard to race and provided instruction from kindergarten through the 12th grade. MHS enrolled 1,300 students, who lived on the schools 1,400-acre campus. Annual spending per student was $96,000, which included housing, food, clothing, and medical care. MHSs endowment, administered by the Hershey Trust Company, had grown from its initial bequest of $60 million to approximately $5.4 billion, making it one of the largest educational endowments in the United States. See Exhibit 4 for a comparison of private educational endowments.

Hershey Foods Corporation

Milton Hershey learned that the secret of mass production for his chocolate lay in the manufacture of huge quantities of one item, standardized in design, and with a continuity of streamlined output that held down costs. The plain milk-chocolate bar and the milk-chocolate bar with almonds were the bread and butter of the Hershey Chocolate Company. With this recipe, Hershey had generated sales of $5 million by 1911, more than eight times the companys first-year revenues. By 1921, Hersheys sales had soared to $20 million.

In 1937, the quartermaster of the United States Army asked the Hershey Choco- late Corporation to develop a military-ration bar that could meet the needs of soldiers in the field. The requirements for the bar were that it should weigh about four ounces, be able to withstand high temperatures, and taste just a little better than a boiled potato. The result was the Field Ration D. By the end of World War II, Hershey was producing 24 million units of Field Ration D per week.

And so, while other confectioners were forced to limit or even cease production during the war, the Hershey Chocolate Corporation was winning millions of loyal consumers, as well as a place in American history. Between 1940 and 1945, more than three billion units of Field Ration D bars were made and distributed to soldiers around the world.

Shortly after the end of World War II, Milton S. Hershey died at age 88, on October 13, 1945. Hersheys passing, however, did not diminish the strength of his business. By 1951, sales had grown to $154 million, and by 1962, sales had reached $183 million. In 1963, the Hershey Chocolate Corporation undertook its first major acquisition when it purchased the H. B. Reese Candy Company, Inc., makers of Reeses Peanut Butter Cups. This move began a string of acquisitions by Hershey that would continue for the next 25 years.

During the 1960s, Hershey diversified by acquiring several major pasta manufacturers, including San Giorgio Macaroni, Inc., and Delmonico Foods, Inc. By the 1980s, the company had become the largest pasta manufacturer in the United States. This diversification away from chocolate products led to a change in the companys name to Hershey Foods Corporation in 1984. By 1999, however, the company had changed its strategy again and sold its U.S. pasta business, the Hershey Pasta Group, to New World Pasta, LLC, for $450 million plus equity.

By 2002, Hershey remained the number-one candy maker in the United States, with sales comprising roughly 80% chocolate and 20% nonchocolate foods. Its largest customer was Wal-Mart, which represented 17% of the companys total sales. Other major Hershey customers included Kmart, Target, Albertsons, and CVS. Sales outside the United States accounted for 10% of total revenues. According to Money magazine, Hershey Foods stock ranked as the 28th-best performer of the last 30 years, with annualized returns of 17.4%.

The Hershey Trust Company Considers a Sale

Over the years, both the composition and the size of Hershey Trusts board of directors had changed (see Exhibits 5 and 6). In particular, the trusts board had expanded from 10 members, in 1990, to 17 members, in 2002, and the composition of the board had shifted toward education professionals, Hershey School alumni, and various public-sector leaders. The boards mandate, however, remained that of serving the interests of the Milton Hershey School, the primary beneficiary of the trusts endowment. The endowment had grown from Milton Hersheys original gift of $60 million of Hershey stock to its current level of $5.4 billion. Beginning in the 1990s, Hershey Foods had reduced the concentration in Hershey shares through a share-repurchase program. In all, Hershey Foods repurchased $1.2 billion of its own shares so that, by 2002, only 58.6% of the endowment comprised Hershey Foods shares. The trusts large holding amounted to 31% of Hershey Foods common shares and 77% of the stockholders votes.

During the past 16 years, Hersheys stock had shown variable performance, but had significantly outperformed Standard & Poors 500-stock index by an average of 6.8% per year (see Exhibit 7).2 Despite the overall strong investment performance of the trust and its gradual diversification away from Hershey shares, by early 2002 there was an increasing concern among board members that the trust was compromising its fiduciary responsibility by concentrating a disproportionate amount of the endowment fund in the shares of Hershey Foods Corporation. Therefore, during a meeting in March 2002, the trusts board voted 152 to explore a potential sale of its holdings in Hershey Foods.

The board believed that a sale of the trusts entire stake in Hershey Foods would garner a higher premium than if its shares were sold piecemeal; therefore, the decision to sell was tantamount to putting Hershey Foods Corporation on the block. According to Robert C. Vowler, president and CEO of the Hershey Trust Company, the trust planned to invest the profits from the sale in a variety of U.S. equities and fixed- income and international securities to provide more straight lines of return and not the volatility of one stock.

Following the March board meeting, a delegation from the trust told the chair- man and CEO of Hershey Foods Corporation, Richard H. Lenny, to begin the process of finding suitable bidders for the company. But Lenny opposed the idea of a sale and asked for time to make a counterproposal. In May, Lenny presented a stock-buyback offer to the head of the trusts investment committee, J. Robert Hillier, who also sat on the board of Hershey Foods. The plan called for Hershey Foods to purchase half of the trusts shares at a 10% premium. Hershey Foods would also help the trust sell the remainder of its shares over the next three to five years. The trusts board, how- ever, rejected the plan on the ground that the 10% premium was insufficient.

On July 25, 2002, a day that would become known by those opposed to the sale as Black Thursday, the trust made public its decision to sell its portion of the outstanding shares of Hershey Foods Corporation. Following news of the announcement, Hersheys stock price soared from $63 to $79 per share. In the ensuing weeks, rumors swirled about potential bidders. Among the names to emerge were the Wm. Wrigley Jr. Company, Nestle? S.A., Cadbury Schweppes PLC, Kraft Foods, the Coca-Cola Company, and PepsiCo.

Swift Reaction

The prospect of a sale of Hershey Foods, an American icon and the paternalistic benefactor of a town, produced a groundswell of opposition by employees, local businesses, and politicians who feared Hershey would become part of someone elses global empire. Many residents of Hershey, Pennsylvania, whose population of 22,400 included 6,200 Hershey employees, were concerned that the legacy of Hersheys involvement in the community would be compromised and many jobs might be lost. Community leaders organized rallies and developed a Web site, www.friendsofhershey.org, gathering 6,500 signatures of people opposed to the sale.

The controversy over the proposed sale of Hershey Foods became increasingly public as protests by company employees and retirees and Milton Hershey School alumni came to the attention of Pennsylvanias attorney general, whose office over- saw trusts and charities in the state. On August 12, the attorney general filed a petition asking that any sale of Hershey Foods be subject to approval by the Dauphin County Orphans Court, which had jurisdiction over charitable trusts. On August 24, the attorney general sought an injunction to stop the sale altogether.3

The issues underlying the controversy emerged during the ensuing court proceedings:

Jack Stover, lawyer for the Hershey Trust Company: [The injunction] causes irreparable harm to us. . . . It ties the hands of the Trustees with regard to its single largest asset . . . Who in the courtroom has not read in the paper what happens in todays economy when you invest too heavily in a single stock?

Judge James Gardner Collins: What makes the attorney generals office better financial managers than the board of the Hershey Trust, and literally the worldwide experts they have hired as well?

Jerry Pappert, deputy attorney general: Because were managing different clients. Were managing the interests of the public, and we have an opportunity and a duty under law to make sure that the ultimate beneficiary of the trust, the public, is not harmed.

During the injunction hearings, several former Hershey Foods executives testified against the sale, including Richard Zimmerman, former CEO of Hershey Foods, and Bruce McKinney, former CEO of HERCO. Representative James Sensenbrenner (R-Wis.), chairman of the House Judiciary Committee, asked the Federal Trade Commission to scrutinize carefully any antitrust implications of the potential sale of Hershey Foods.

The Bids: Wrigley and Nestle?Cadbury Schweppes

By September 14, 2002, the final date by which bids could be submitted, the Hershey Trust Company board was considering two serious offers: a $12.5 billion bid from the Wm. Wrigley Jr. Company and a $10.5 billion joint-bid from Nestle? S.A. and Cadbury Schweppes PLC.

The Wm. Wrigley Jr. Company

The worlds largest maker of chewing gum had been based in Chicago since 1892, when William Wrigley, while working as a salesman for his familys soap factory, began offering customers chewing gum. In 1898, he merged his company with one of his suppliers to form the Wm. Wrigley Jr. Company, and by 1910, the firms spearmint gum was the leading U.S. brand. As late as 1961, the company still offered its original five-cent price and product line. But by 1971, as it faced competitive and economic pressures, the company

increased its price to seven cents and launched several new products, including the following:

Big Red (1975) Hubba Bubba (1978) Orbit, a sugar-free gum (1977) Extra (1980)

Wrigley continued to expand its business by launching operations in Eastern Europe and China (1993). In 1999, Bill Wrigley, a member of the fourth generation of Wrigleys to lead the company, became president and CEO. After 2000, the company focused on testing innovative gums with such attributes as cough suppression and teeth whitening.

In 2002, the Wrigley family owned about 35% of the company and controlled 60% of its voting shares. With 2001 revenues of $2.4 billion, Wrigley commanded a 50% share of the global gum market, and sold its products in more than 150 countries. Nearly all its revenues were derived from gum. Wrigleys Web site described its business strategy as follows:

Wrigley is committed to achieving generational growth and prosperity for our stakeholders. To achieve this mission, we are executing against a long-term strategic business plan based on six key objectives. Those objectives include:

Boosting our core chewing gum business Expanding business geographically and into new channels Diversifying our product line in close to home areas Focusing on innovation in our products, marketing, and business processes Delivering the highest quality at lowest costs Growing and developing our Wrigley people around the world

The Wm. Wrigley Jr. Company offered $12.5 billion ($7.5 billion in stock and $5.0 billion in cash) for 100% of the outstanding shares of Hershey Foods Corporation. The Hershey Trust Company would exchange its Hershey shares for cash and shares in the new company, to be renamed Wrigley-Hershey. This offer, the equivalent of $89 per share, represented a 42% premium over Hersheys preannouncement stock price. The deal included commitments to the Hershey community, including assurances of job retention at Hershey Foods plants in Derry Township.

Some analysts speculated that Wrigley management was assuming it could put Hershey products into its product mix and sell them internationally. Although it was unlikely that Wrigley could achieve significant cost savings, management hoped to generate higher sales volumes. Wrigley had been successful in selling chewing gum internationally and was hoping to do the same with Hersheys chocolates.

Nestle? S.A.

Nestle? S.A. was founded in 1843, when Henri Nestle? purchased a factory in Vevey, Switzerland, that made products ranging from nut oils to rum. In 1904, the company began selling chocolates, and one year later merged with the Anglo-Swiss Company, retaining the Nestle? name. During World War I, the company developed a water- soluble coffee cube, and the idea became one of the companys most popular products, Nescafe?. Nestle? continued to introduce popular products during the next four decades, including Nestle?s Crunch bar (1938), Quik drink mix (1948), and Tasters Choice instant coffee (1966).

In the 1970s, the company expanded its product line by acquiring a 49% stake in Gesparal, a holding company that controlled the French cosmetics firm LOre?al. In the 1980s, Nestle? continued its expansion by acquiring the U.K. chocolate company Rowntree, maker of Kit Kat (licensed to Hershey Foods Corporation). In the 1990s, Nestle? completed several more acquisitions, including Butterfinger, Baby Ruth candies, Source Perrier water, and Alpo pet food. Simultaneously, Peter Braceck- Letmathe, named CEO in 1997, divested Nestle?s noncore businesses such as Contadina tomato products and Libbys canned-meat products.

After acquiring Ralston Purina, in 2001, Nestle? consolidated its position as the worlds number-one food company. Nestle? had become a leader in coffee (Nescafe?), bottled water (Perrier), and pet food (Ralston Purina) and an important player in the cosmetics industry. Through its stake in Alcon, Inc., Nestle? also participated in ophthalmic pharmaceuticals, contact-lens solutions, and equipment for ocular surgery.

Nestle?s strategy, according to its Web site, was as follows:

Nestle?s strategic priorities are focused on delivering shareholder value through the achievement of sustainable, capital-efficient, and profitable long-term growth. The combination of our four-pillar strategy and efficiency programmes will deliver market- share growth and margin improvement.

Our four-pillar strategy is based on:

Operational performance Product innovation and renovation Product availability Consumer communication

Through this strategy, Nestle? had been able to establish itself as both an international and a local company. With nearly 470 factories in 84 countries, many of Nestle?s brands were unique to particular countries. Nestle? had been successful at satisfying local tastes with local products. In the future, the company planned to expand into specialty nutritional foods and ice cream.

Cadbury Schweppes PLC

In 2002, Cadbury Schweppes was a major global player in both the beverage and confectionary industries. With bottling and partnership operations in 10 countries and licensing agreements in 21 more, Cadbury Schweppes was the third-largest soft-drink company by sales volume in the world. Its confectionary products were manufactured in 25 countries and sold in almost 200, making it the fourth-largest confectioner in the industry.

Both Schweppes Ltd. and Cadbury Group Ltd. had sought new markets since their founding in the nineteenth century. The two companies merged in 1969, giving birth to one of the biggest players in the candy and soft-drink sectors. The new company, Cadbury Schweppes PLC, began a continuous program of worldwide expansion. By 2001, the company derived 45% of its revenues from the Americas, 38% from Europe, and 12% from Asia. Cadbury Schweppes employed more than 41,000 people worldwide.

According to its Web site, Cadbury Schweppes governing objective was the growth of shareowner value through focusing on the beverages and confectionary businesses, developing robust and sustainable positions in regional markets, and growing organically and by acquisition.

Since the mid-1980s, acquisitions and divestments had played a key role in Cadbury Schweppes expansion plans. Key transactions included the acquisition of Dr. Pepper/Seven-Up, Hawaiian Punch, Snapple Beverage Group, and Kraft Foods candy business in France.

The Nestle?Cadbury Schweppes offer for Hershey Foods was $10.5 billion in cash. At $75 a share, this offer represented a significantly lower premium than that offered by Wrigley. Moreover, the bid was complicated by the fact that Nestle? received royalties from Hershey for U.S. sales of its Kit Kat and Rolo brands. The licensing arrangement had been negotiated between Rowntree and Hershey prior to Nestle?s acquisition of Rowntree. Because the licensing agreement was structured to continue in perpetuity, Hershey valued the licensing of the two brands at approximately $1 billion. An important aspect of the agreement, however, was that a change of ownership of Hershey would transfer all rights to the two brands back to Nestle?. Therefore, according to the agreement, regardless of who won the bidding battle for Hershey, Nestle? stood to gain the value of the licensing agreement.

The deal included a provision making Hershey, Pennsylvania, the headquarters of Cadbury Schweppes operations in the United States and calling it the chocolate capital of the world. With new production facilities and distribution capabilities in the United States, however, they expected to reduce costs by consolidating operations and reducing workforces. See Exhibit 8 for a summary of the bidders financials.

The Hershey Trust Company Board Decides

In essence, the board faced both an economic and a governance decision. On the economic side, the board needed to determine the value of Hershey as a stand-alone entity compared with the bids being offered. See Exhibit 9 for Hersheys historical financials, Exhibit 10 for Hershey managements financial forecasts,4 and Exhibit 11 for industry comparables. On the governance side, the board needed to decide whether selling Hershey compromised the boards original mandate from Milton Hershey.

EXHIBIT 1 Businesses Operated by Hershey Estates (1927) Hershey Baking Company Hershey Cemetery Hershey Cold Storage Hershey Community Building Hershey Community Inn Hershey Community Theatre Hershey Country Club Hershey Dairy Hershey Department Store Hershey Electric Company Hershey Experimental Candy Kitchen Hershey Feed and Grain Hershey Farms Hershey Farming Implements Hershey Filling Station Hershey Garage Hershey Greenhouse and Nursery Hershey Hospital Hershey Laundry Hershey Museum Hershey Park Hershey Park Golf Club Hershey Rose Garden Hershey Sewerage Company Hershey Telephone Company Harchoy Transit Cnmnanv Bookshelf Online: Case Studies in Finance Hershey Zoo Hotel Hershey Coal Real Estate EXHIBIT 1 Businesses Operated by Hershey Estates (1927) Hershey Baking Company Hershey Cemetery Hershey Cold Storage Hershey Community Building Hershey Community Inn Hershey Community Theatre Hershey Country Club Hershey Dairy Hershey Department Store Hershey Electric Company Hershey Experimental Candy Kitchen Hershey Feed and Grain Hershey Farms Hershey Farming Implements Hershey Filling Station Hershey Garage Hershey Greenhouse and Nursery Hershey Hospital Hershey Laundry Hershey Museum Hershey Park Hershey Park Golf Club Hershey Rose Garden Hershey Sewerage Company Hershey Telephone Company Harchoy Transit Cnmnanv Bookshelf Online: Case Studies in Finance Hershey Zoo Hotel Hershey Coal Real Estate