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Danone Small Bites May Go Before Mead Johnson: Real M&A

Traders are betting Danone will buy baby-formula maker Mead Johnson Nutrition Co. There may be better ways for Europe’s second-largest food company to spend its money, at least for now.

Shares of $19 billion Mead Johnson reached a record this week on renewed speculation of a takeover by Danone. While Paris-based Danone has been under pressure to jump-start growth after first-half earnings fell 20 percent, shareholders and analysts say they’d rather see it focus on smaller acquisitions in emerging markets and rebuilding its position in China after last year’s recall of infant milk powder and bribery claims hurt sales there.

Revenue at Danone is projected to be flat this year after climbing about 7 percent on average since 2009, data compiled by Bloomberg show. And analysts see little upside for the stock, signaling the $48 billion company needs to find ways to create value or it risks becoming a target. Taking over Asian regional dairy companies such as $9.4 billion Yakult Honsha Co. is an option, said Equita SIM SpA, while Trimax Capital AG said Danone should raise its stake in China Mengniu Dairy Co. Danone is said to be in talks to sell its medical-nutrition unit, which would give it more cash for such deals.

Danone lost 0.5 percent to 55.44 euros at 3:39 p.m. in Paris trading, while Mead Johnson slid 1.4 percent in New York. Yakult shares rose 1.7 percent in Tokyo, and China Mengniu increased 0.5 percent in Hong Kong.

Shelf Space

“Investors would rather see them succeed in their cost-cutting, regaining shelf space in China and maybe even divesting the medical-nutrition business,” Eric Sagmeister, a money manager at Forward Investing, which owns Danone shares among the $5 billion it oversees, said in a phone interview. “I don’t think we would enjoy a major acquisition without any of that happening first. Going out and buying scale by buying Mead Johnson doesn’t solve the problem.”

It’s conceivable that if Danone doesn’t buy, it could get bought. The company is in a weaker position now to defend itself from a takeover, should a larger company such as Nestle SA or PepsiCo Inc. be interested, according to Pierre Tegner, an analyst at Natixis in Paris. Nestle’s market value of $245 billion yesterday was more than five times that of Danone, while PepsiCo was valued at $136 billion.

Representatives for Danone didn’t respond to phone calls or e-mails seeking comment.

Dairy Heavy

Dairy products such as Activia and Oikos yogurt generate more than half of Danone’s revenue, with another 18 percent coming from bottled water brands such as Evian and 20 percent from baby food, according to data compiled by Bloomberg. Its smallest business is medical nutrition, which makes the Nutrison tube-feeding system for people whose diets are restricted by illness.

Danone is negotiating a sale of that unit to Hospira Inc., a person familiar with the matter said this week, asking not to be identified because the discussions are private. The business could fetch about 3 billion euros ($4 billion), people familiar with the matter said in May. Selling it may almost double the company’s $4.2 billion of cash and equivalents.

“Danone needs to think about expansion, and using proceeds from a medical-nutrition sale would be very helpful,” Trung-Tin Nguyen, a hedge-fund manager at Trimax Capital in Zurich, said in a phone interview. “Options can include M&A.”

China Growth

Rather than buying Mead Johnson, he’d prefer that Danone raise its almost 10 percent stake in China Mengniu, which has a market value of $9.5 billion, as well as pursue deals with other Asian dairy producers. Danone agreed to more than double its stake in Mengniu in February as the Chinese dairy market is forecast to grow 40 percent to $65.5 billion by 2017, according to Euromonitor. Mengniu had a 21.2 percent share of the market in 2013, compared with Danone’s 0.4 percent.

“China is a key market and will be the biggest growth driver for decades to come,” Nguyen said. “It’s important to buy local-based producers as China will also shift to declaring these sectors key strategic industries,” which may limit opportunities to purchase them in the future.

Representatives for Mengniu declined to comment.

Danone, which competes with Nestle in baby food, is seeking to rebuild its infant-nutrition unit in China after a recall -- which turned out to be a false alert -- and bribery claims contributed to a 20 percent drop in trading operating profit in the first half of the year.

Bolt-ons, Buybacks

“I would prefer that Danone focus on re-energizing those parts of the business that have struggled in European dairy and in Chinese infant-nutrition before embarking on major M&A,” Jon Cox, an analyst at Kepler Cheuvreux in Zurich, said in an e-mail. “I would probably prefer the company do bolt-on deals and use any additional funds in, say, a buyback, which would be a sure signal that it regards its own stock as undervalued.”

Yakult would be another possible acquisition target for Danone because it already has a 20 percent stake in the Japanese company, according to Fabio Fazzari, an analyst at Equita SIM in Milan. Yakult’s probiotic and fermented milk drinks are similar to offerings from Danone.

“Danone’s Activia line is based on the success of Yakult’s first probiotic products,” Fazzari said. “It would make sense as it’s a great company with know-how in this field and has a big focus on R&D, which would both strengthen Danone.”

Danone last year said that a takeover of Yakult isn’t on the agenda after a previous agreement that prevented it from raising its stake in the company was replaced with a new one. Yakult’s yogurt market share in China was 5.5 percent last year, compared with Danone’s 1.7 percent.

Brazil Business

“There hasn’t been any acquisition offer from Danone,” Kenichi Kobayashi, a spokesman for Tokyo-based Yakult, said by phone. “Yakult and Danone are continuously in a friendly relationship.”

Danone has also expressed interest in BRF SA’s dairy unit in Brazil, people familiar with the matter said last month. BRF Executive Officer Claudio Galeazzi said the division, which the company is selling so it can focus on meat, would provide foreign buyers with instant scale in a market with high barriers to entry. The business generates about $1 billion in revenue and its Batavo brand is the third-biggest in Brazil’s yogurt market after Danone and Nestle, according to MilkPoint Inteligencia.

Still, buying Mead Johnson would be a “strategically good investment,” Fazzari said. Danone is a distant second to Nestle, which had a 23 percent share of the baby-food market last year, according to data compiled by Bloomberg Intelligence. Danone and Mead Johnson had about 13 percent and 10 percent, respectively.

Not Cheap

Since Mead Johnson was spun off from drugmaker Bristol-Myers Squibb Co. in 2009, the stock has quadrupled, driving its market value to more than $19 billion. It reached a record this week after the Wall Street Journal reported July 22 that Danone is exploring expansion opportunities.

Mead Johnson trades for about 18 times earnings before interest, taxes, depreciation and amortization, the same valuation Tyson Foods Inc. is paying for Hillshire Brands Co. in the most expensive major food acquisition of the past five years, according to data compiled by Bloomberg.

“A takeover of Mead Johnson would better diversify Danone, but that would not at all be cheap,” said Benno Galliker, a trader at Luzerner Kantonalbank AG in Lucerne, Switzerland. “First, Danone needs to do their homework in Europe. Then they need to grow organically and grow punctually with smaller takeovers.”

Possible Target

Danone itself may become vulnerable to bids, Tegner of Natixis wrote in a June 26 report. Concern that the French government would block a purchase of Danone damped takeover speculation back in 2005. While there are still political hurdles, Tegner notes that other iconic French brands such as Yoplait, Royal Canin and Orangina have been bought by foreign groups. Also, this year General Electric Co. won approval from France for a $17 billion purchase of Alstom SA’s energy assets after the government initially opposed the transaction.

“In terms of Danone being taken over, I believe politically that is now more possible after what we have seen in the Alstom-GE deal,” Cox of Kepler Cheuvreux said. “While there have been hiccups, I believe its portfolio is one of the best in the food space. I suspect there probably wouldn’t be just one buyer but potentially a couple of buyers who then might look at certain parts of the business.”

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