By Lyle Niedens

BridgeNews Commentary

KANSAS CITY (B)--What a difference a week can make. Last week, this column targeted Kellogg Co. as a poor investment choice because the company had failed to reduce its reliance on sales of breakfast cereal, a declining product category.

"Unless it succeeds in winning the current auction for Keebler Foods, it is difficult to see how Kellogg will alter its sinking fortunes," I wrote.

Now that Kellogg has won that auction, its victory has implications for the entire food industry.

Let's start with the winner. The Battle Creek, Mich.-based company once dominated the U.S. cereal industry on the strength of Corn Flakes and Tony the Tiger. Of course, it no longer does after losing its market share lead to General Mills last year.

Nevertheless, Kellogg still relies on cereal for three-quarters of its revenue. Before last week, that was a bad sign for future growth at a company with stagnating sales and dwindling profits.

But after announcing plans Oct. 26 to buy Keebler, the second-biggest U.S. cookie and cracker manufacturer, Kellogg's fortunes look brighter than they have at any time since Carlos Gutierrez took over as chief executive in March 1999.

Formerly Kellogg's chief operating officer, Gutierrez has done little in the past 18 months to please Wall Street analysts or investors. In a big cost-cutting measure, he shut down a portion of the company's decades-old production facility in Battle Creek. He also bought functional foods marketer Worthington Foods in an attempt to expand Kellogg's reach beyond cereal, and restructured the company's front office.

But perhaps his biggest move--make that mistake--involved the company's reduced promotional spending in the second half of last year. That decision cost Kellogg its lead in the U.S. cereal market, a hefty public relations blow for a company struggling to make more money.

Gutierrez, though, deserves credit for last week's deal. Although it may triple the amount of Kellogg's debt by the time it is completed, it could have cost Kellogg even more. Though it is still risky, sometimes you have to spend money to make money, as they say--and that time certainly is now for Kellogg.

Keebler's current owner, baking concern Flowers Industries, announced plans to sell its 55% stake in Keebler in July, less than a month after Philip Morris said it would buy Keebler's main rival, Nabisco Holdings, for $18.9 billion. Philip Morris agreed to pay $55 per share for the maker of Oreo cookies and Ritz crackers.

Based on that price, most analysts thought Keebler could fetch at least $50 per share. But Gutierrez played it cool and did not immediately throw a can't-refuse bid at Flowers' board of directors.

Eventually, France's Group Danone, the world's biggest biscuit manufacturer and a company Kellogg likely could not have outbid, decided in mid-September it would pass on Keebler.

That paved the way for Kellogg's final bid of $42 per share. Kellogg also will assume Keebler's $590 million in debt, pushing the deal's total value to about $4.3 billion.

David Nelson, an analyst with Credit Suisse First Boston, summed it up well when he reviewed the deal in a report released Monday morning.

"The desperate buyer got the best of the desperate seller," Nelson said. "Kellogg got a great company at a good price."

Cereal now will account for only half of Kellogg's annual revenue, which will grow to about $9.7 billion. It now has a broader base to battle General Mills, which also is reducing its reliance on cereal via its pending acquisition of baking mix giant Pillsbury.

During a conference call announcing the deal, Gutierrez acknowledged Kellogg has "undermarketed our brand in recent years." While Kellogg tries to rectify that mistake, it will gain access to perhaps Keebler's biggest strength, its direct-store delivery system.

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