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.

Unilever may have a fight on its hands to stay independent in the face of a pursuit by U.S. food giant Kraft Heinz Co. The Anglo-Dutch consumer goods group has rebutted an initial $143 billion cash-and-shares proposal. It sounds big but it's a low-ball offer that's easy to swat away. If Kraft comes back with more, Unilever will need to serve up with some clever ideas to stay independent.

Size is no defense. Unilever was valued at 101 billion pounds ($125 billion) prior to Kraft's interest leaking. But it is trapped in some awkward trends. Even though it is an international stock denominated in sterling, the shares have under-performed the FTSE 100 over the past year. Recently it has fallen victim to the sell-off in plodding defensive stocks as investors have sought racier growth stories.

Stock Laggard
Before today, Unilever shares had under-performed the FTSE 100 over the past year

For Kraft, the attraction is the chance to grab an asset that provides a great platform for what it does best: rip out cost by integrating businesses or staging a break-up. The U.S. group has fattened margins considerably over the past three years and more progress is expected.

Outpacing Unilever
Operating margin has grown faster at Kraft Heinz than at Unilever
Source: Bloomberg
Note: reference firgures are adjusted.

The approach was at $50 a share, with $30.23 in cash and the rest in stock. That's roughly a 20 percent premium over Unilever's closing share price on Thursday and 25 percent above its three-month average. It's clearly just an opening shot and Unilever is right to reject it outright.

To have a chance of success, Kraft will need to offer more value and perhaps more cash. The share component of the initial proposal is a big problem. Kraft is 100 percent food, while Unilever is 60 percent consumer goods and household products. There are no synergies between Dove and ketchup. Maybe there's a partner involved to take the non-food piece.

Personal Care
The division is Unilever's biggest generator of revenue and operating income
Source: Bloomberg
Data as of 12/31/2016

What's more, as Gadfly has noted, Kraft has a mixed record at sustaining sales growth in its acquisitions. To grow, it needsto keep doing M&A.

All told, Unilever investors would be switching into a very different investment story.

How much cash can Kraft put into the mix? It looks like it wants to gear up Unilever's balance sheet, effectively paying the cash back to the target's own shareholders. Spreads on 10-year Unilever debt widened 40 basis points on the news. Maybe Kraft's friend Warren Buffett can help by providing some equity. But he'll be mindful of his own returns. That could limit how much equity he would contribute.

Unilever's Reach
Africa and Asia account for the largest part of the company's revenue and operating income
Source: Bloomberg

If Kraft can't put any more cash in, the risk is that its own share price falls as it tries to use more shares. For now, the market is helpfully cheering it on.

Paul Polman spends a lot of time outside Unilever talking about saving the planet. He may now need to save his job. It shouldn't be too hard. He has options. He could gear up Unilever himself. He could cut costs. He could sell the spreads business. Hey, he could even do a big break up of the group between personal care and food. Time to get to work.

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:
James Boxell at jboxell@bloomberg.net