Deals

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

The flip-side of having a lot of energy is that you can get bored without something exciting to do.

Reckitt Benckiser Group Plc’s $16.6 billion agreement to buy U.S. baby formula maker Mead Johnson Nutrition Co. will certainly fend off any managerial ennui. The deal, announced on Friday, will be the biggest test of CEO Rakesh Kapoor's M&A skills: Will he be able to make a pricey, complex transaction with few synergies and only a distant prospect of paying off deliver for his shareholders?

Infant Phenomenon
Reckitt shares have climbed since the companies said they were in talks
Source: Bloomberg

Infant nutrition is a new area for Reckitt. The company’s traditional strengths were once in household products. Think stuff you put on the floor rather than stuff you pop in the mouth. Through a series of takeovers, consumer healthcare has become an important part of Reckitt’s business -- its brands include Strepsils and Nurofen. Baby formula is another new departure and will put Reckitt in head-on competition with formidable rivals like Nestle SA and Danone SA.

Believing this is a good move means believing the growth rate for infant nutrition will be much faster than Reckitt’s existing markets. Perhaps it will. While growth has stuttered in recent years, it is poised to rebound, according to estimates from Euromonitor International, a research firm.

Feeding Time
After a brief contraction, growth in the baby food market is forecast to rebound
Source: Euromonitor International

The lack of overlap with Reckitt's businesses means cost savings are relatively low given the size of the deal -- just 200 million pounds ($250 million) annually after three years. As a result, it will take as long as five years for the returns to cover the threshold 7 percent to 8 percent cost of capital. That’s a long time to wait.

Some investors have been concerned about the amount of debt being taken on to fund this all-cash transaction: net debt will initially be about four times the companies' combined Ebitda in 2017. That concern is valid, but it shouldn't be overdone: credit ratings companies have barely blinked and leverage should fall quickly from that level.

Reckitt has done deals well in the past and probably needs one to regain momentum. Fourth-quarter sales were disappointing, with like-for-like sales growing a measly 1 percent. Guidance for growth this year is lower than analysts hoped.

Revenue Run
Reckitt's stellar revenue growth had been stalling in recent years
Source: Bloomberg
Note: figures for 2017, 2018 are based on conensus analyst estimates

The risk with businesses that are slowing down is that the most talented staff get restless and leave, exacerbating the problem. Mead Johnson may have been the best available M&A option to revive Reckitt given the stratospheric prices for assets in consumer healthcare right now. 

Even so, the deal leaves Reckitt a bigger, more complicated and more indebted company. To make a success of it will at the very least require a rethink of the management structure and a clean-up of the portfolio involving some disposals. That would also cut borrowings. Reckitt's food business is the obvious candidate to go, and analysts at Bernstein see potential proceeds of 8 billion pounds from asset sales.

Mead Johnson is Kapoor's biggest and most complex deal as CEO. It will make or break his reputation. Keeping busy has never had higher stakes.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Chris Hughes in London at chughes89@bloomberg.net
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net